Invesco Mortgage Capital Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. In this quarterly report on Form 10-Q, or this “Quarterly Report,” we refer to Invesco Mortgage Capital Inc. and its consolidated subsidiaries as “we,” “us,” “our Company,” or “our,” unless we specifically state otherwise or the context indicates otherwise. We refer to our external manager, Invesco Advisers, Inc., as our “Manager,” and we refer to the indirect parent company of our Manager, Invesco Ltd. together with its consolidated subsidiaries (which does not include us), as “Invesco.” The following discussion should be read in conjunction with our condensed consolidated financial statements and the accompanying notes to our condensed consolidated financial statements, which are included in Item 1 of this Report, as well as the information contained in our most recent Form 10-K filed with the Securities and Exchange Commission (the “SEC”). Forward-Looking Statements We make forward-looking statements in this Report and other filings we make with the SEC within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and such statements are intended to be covered by the safe harbor provided by the same. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, investment strategies, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “intend,” “project,” “forecast” or similar expressions and future or conditional verbs such as “will,” “may,” “could,” “should,” and “would,” and any other statement that necessarily depends on future events, we intend to identify forward-looking statements. Factors that could cause actual results to differ from those expressed in our forward-looking statements include, but are not limited to: • ongoing spread and economic and operational impact of the COVID-19 pandemic; • our business and investment strategy; • our investment portfolio and expected investments; • our projected operating results; • general volatility of financial markets and effects of governmental responses, including actions and initiatives of the U.S. governmental agencies and changes to U.S. government policies in response to the COVID-19 pandemic, mortgage loan forbearance and modification programs, actions and initiatives of foreign governmental agencies and central banks, monetary policy actions of the Federal Reserve, including actions relating to its agency mortgage-backed securities portfolio and our ability to respond to and comply with such actions, initiatives and changes; • the availability of financing sources, including our ability to obtain additional financing arrangements and the terms of such arrangements; • financing and advance rates for our target assets; • changes to our expected leverage; • our expected book value per common share; • interest rate mismatches between our target assets and our borrowings used to fund such investments; • the adequacy of our cash flow from operations and borrowings to meet our short-term liquidity needs; • our ability to maintain sufficient liquidity to meet our short-term liquidity needs; • changes in the credit rating of the U.S. government; • changes in interest rates and interest rate spreads and the market value of our target assets; • changes in prepayment rates on our target assets; • the impact of any deficiencies in loss mitigation of third parties and related uncertainty in the timing of collateral disposition; • our reliance on third parties in connection with services related to our target assets; • disruption of our information technology systems; 34 Table of Contents • effects of hedging instruments on our target assets; • rates of default or decreased recovery rates on our target assets; • modifications to whole loans or loans underlying securities; • the degree to which our hedging strategies may or may not protect us from interest rate volatility and foreign currency exchange rate; • the degree to which derivative contracts expose us to contingent liabilities; • counterparty defaults; • compliance with financial covenants in our financing arrangements; • changes in governmental regulations, zoning, insurance, eminent domain and tax law and rates, and similar matters and our ability to respond to such changes; • our ability to maintain our qualification as a real estate investment trust for U.S. federal income tax purposes; • our ability to maintain our exemption from the definition of “investment company” under the Investment Company Act of 1940, as amended (the “1940 Act”); • availability of investment opportunities in mortgage-related, real estate-related and other securities; • availability of U.S. Government Agency guarantees with regard to payments of principal and interest on securities; • the market price and trading volume of our capital stock; • availability of qualified personnel of our Manager; • the relationship with our Manager; • estimates relating to taxable income and our ability to continue to make distributions to our stockholders in the future; • estimates relating to fair value of our target assets and loan loss reserves; • our understanding of our competition; • changes to generally accepted accounting principles in the United States of America (“U.S. GAAP”); • the adequacy of our disclosure controls and procedures and internal controls over financial reporting; and • market trends in our industry, interest rates, real estate values, the debt securities markets or the general economy. The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. You should not place undue reliance on these forward-looking statements. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. Some of these factors are described under the headings “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. New risks and uncertainties arise over time, and it is not possible for us to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following discussion should be read in conjunction with our condensed consolidated financial statements and the accompanying notes to our condensed consolidated financial statements, which are included in this Report. Executive Summary We are a Maryland corporation primarily focused on investing in, financing and managing residential and commercial mortgage-backed securities ("MBS") and mortgage loans. Our objective is to provide attractive risk-adjusted returns to our investors, primarily through dividends and secondarily through capital appreciation. To achieve this objective, we have historically invested in the following: • Residential mortgage-backed securities ("RMBS") that are guaranteed by a U.S. government agency such as the Government National Mortgage Association ("Ginnie Mae") or a federally chartered corporation such as the Federal National Mortgage Association ("Fannie Mae") or the Federal Home Loan Mortgage Corporation ("Freddie Mac") (collectively "Agency RMBS"); 35 Table of Contents • Commercial mortgage-backed securities ("CMBS") that are guaranteed by a U.S. government agency such as Ginnie Mae or a federally chartered corporation such as Freddie Mac or Fannie Mae (collectively "Agency CMBS"); • RMBS that are not guaranteed by a U.S. government agency or a federally chartered corporation ("non-Agency RMBS"); • CMBS that are not guaranteed by a U.S. government agency or a federally chartered corporation ("non-Agency CMBS"); • Credit risk transfer securities that are unsecured obligations issued by government-sponsored enterprises ("GSE CRT"); • Residential and commercial mortgage loans; and • Other real estate-related financing arrangements. We elected to be taxed as a real estate investment trust ("REIT") for U.S. federal income tax purposes under the provisions of the Internal Revenue Code of 1986. To maintain our REIT qualification, we are generally required to distribute at least 90% of our REIT taxable income to our stockholders annually. We operate our business in a manner that permits our exclusion from the definition of "Investment Company" under the 1940 Act. We are externally managed and advised by Invesco Advisers, Inc., our Manager, which is an indirect, wholly-owned subsidiary of Invesco Ltd. During the six months ended June 30, 2020, we experienced unprecedented market conditions as a result of the COVID-19 pandemic. Due to significant spread widening in both Agency and non-Agency securities, we received an unusually high number of margin calls from counterparties. On March 23, 2020, we notified our financing counterparties that we were not in a position to fund the margin calls we received on March 23, 2020, and that we did not expect to be in a position to fund the anticipated volume of future margin calls under our financing arrangements in the near term as a result of market disruptions created by the COVID-19 pandemic. We engaged third party financial and legal advisors to assist us in restructuring our debt with our financing counterparties. To generate liquidity and reduce leverage, we sold MBS and GSE CRTs for cash proceeds of $23.1 billion and repaid $17.5 billion of our repurchase agreement s and $ 910.0 million o f our secured loans with proceeds from these asset sales and the return of cash margin previously pledged on our repurchase agreements during the six months ended June 30, 2020. As of June 30, 2020, our total borrowings consist of $740.0 million of secured loans that are due by December 2020. We intend to repay our secured loans with proceeds from sales of non-Agency CMBS assets that are currently collateralizing these loans. We repaid an additional $435.0 million of our secured loans in July 2020. Invesco, including our Manager, is committed to helping its employees, clients and communities navigate the challenges presented by the spread of COVID-19. The primary focus of Invesco's efforts is to ensure the health and safety of its employees while preserving its ability to serve clients and manage assets in a highly dynamic market environment. To help ensure it can continue to meet client needs, such as those of our Company, a significant number of our Manager’s employees are working remotely, with small select teams working at alternate sites or operating in split shifts to mitigate the risks associated with the virus. Portfolio managers, research analysts and traders are successfully working remotely or in secure locations with access to all systems necessary to fulfill their responsibilities and an ability to connect with their teams in managing client assets. Additionally, our Manager’s operational, control and support teams have successfully transitioned to a remote working environment. In July 2020, we resumed investing in Agency securities and financed these securities with repurchase agreement borrowings. As of July 31, 2020, we have a total investment portfolio, excluding cash, of approximately $3.3 billion consisting of 68% of Agency RMBS, 30% commercial credit investments and 2% residential credit investments. Approximately $473 million of our investment portfolio is unencumbered. As of July 31, 2020, we have a cash balance of $230.3 million, approximately $89.5 million of which is posted as collateral for derivatives and our remaining secured loans. Our total debt consisted of $2.1 billion of repurchase agreement borrowings that are collateralized by Agency RMBS and $305.0 million of secured loans that are collateralized by non-Agency CMBS and cash as of July 31, 2020. We continue to evaluate potential credit investments that do not rely on short-term or mark-to-market financing. To further strengthen our balance sheet and position ourselves for future investment opportunities, we have explored and will continue to explore additional sources of financing including issuances of debt and equity securities and other forms of long-term financing arrangements. However, no assurance can be given that we will be able to access any additional sources of financing. We paid our first quarter 2020 common stock dividend of $0.50 per share on June 30, 2020 in a combination of cash and common shares. In addition, on June 17, 2020, we declared a second quarter 2020 common stock cash dividend of $0.02 per common share that was paid in cash on July 28, 2020. Dividends on our Series A Preferred, Series B Preferred and Series C Preferred Stock are current. 36 Table of Contents Market Conditions Macroeconomic factors that affect our business include interest rate spread premiums, governmental policy initiatives, residential and commercial real estate prices, credit availability, consumer personal income and spending, corporate earnings, employment conditions, financial conditions and inflation. Financial conditions rebounded sharply during the second quarter of 2020 as equities and most credit sectors reacted favorably to the massive government action taken in response to the COVID-19 pandemic as well as the re-opening of parts of the economy. This rebound can be seen across a number of economic measures, as economic activity picked up after an unprecedented drop during the first quarter. For example, nonfarm payrolls, retail sales and consumer confidence data showed record drops during March and April, followed by record recoveries during May and June. While the increase in economic activity is encouraging, we remain cautious about the pace of future gains as COVID-19 case numbers continue to grow in the U.S., and some states are re-instituting partial economic shutdowns. Interest rates were little changed during the quarter, with the yield on the 2 year Treasury note falling 10 basis points to 0.15% and the yield on the 10 year Treasury bond falling a basis point to 0.66%. The short end of the yield curve remains pinned close to zero, as the Federal Funds target rate is at the lower bound, and the futures market is forecasting no change for the next several years. Interest rate volatility measures also reflect the view that rates will remain low, as these have fallen to multi-year lows. Price data has been subdued, as both the consumer price index (0.1% in May) and price consumption expenditure index (1.0% in May) measures have fallen over the past several months. Breakeven rates on inflation protected Treasuries reflect low expectations for inflation, as the inflation rate implied by 2 year and 5 year TIPs was 0.88% and 1.17%, respectively, at quarter end. Most risk markets have rallied off of the March lows. Equity markets showed remarkable resilience despite continued economic uncertainty, as the S&P 500 was up 20% during the second quarter after dropping 20% during the first quarter. The NASDAQ index fared even better, as it returned 30.6% during the second quarter after dropping 14.2% during the first quarter. The broader credit markets also rallied during the quarter, buoyed by support from the Federal Reserve. In particular, spreads on investment grade and high yield corporate credits have tightened notably during the quarter as those sectors have received direct support from the Federal Reserve. Covid-19 has negatively impacted commercial real estate fundamentals. The lodging and retail sectors have been the most impacted due to travel restrictions and a slowdown in discretionary consumption. In the retail sector, despite long-term leases, tenants that are not open for business are finding it difficult to meet rent obligations and, in some instances, are foregoing payments or seeking forbearance relief. Real estate loans are experiencing growing delinquencies and are at greater risk of default which could impact the fundamental performance of our investments. Despite fundamental deterioration, CMBS risk premiums contracted in the second quarter due to relatively minimal new issuance supply and increased investor demand. The United States Federal Reserve’s Term Asset-Backed Securities Loan Facility (TALF), which provides financing for triple-A rated conduit non-Agency CMBS, has also helped provide stability to the CMBS market. We believe TALF, along with slowly renewed economic activity, will continue to assist in creating renewed investor interest in CMBS. While there has been a partial recovery in residential mortgage credit spreads, particularly in higher rated securities, valuations continue to reflect an uncertain outlook for borrowers, and the sector has not benefited from direct support from the Federal Reserve. The U.S. Congress responded to the COVID-19 pandemic by passing three rounds of fiscal stimulus measures, the most notable being the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which included relief measures for households and businesses directly or indirectly impacted by the virus. The CARES Act includes provisions for COVID-19 related temporary forbearance on federally backed mortgage loans, which allows borrowers of loans guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae to suspend making principal and interest payments for a period of up to 360 days if they are facing hardship. Following the temporary forbearance period, mortgage servicers must provide several options to impacted borrowers, including a repayment schedule or loan modification, depending on the borrowers’ circumstances. We believe the provision of forbearance and loan modifications will substantially reduce borrower defaults and loan losses relative to levels that would have likely occurred without these actions. The performance of Agency RMBS was strong during the second quarter as that sector benefited directly from unprecedented purchases by the Federal Reserve. Spreads on Agency RMBS and pay-ups on specified pool collateral have completely recovered from their March lows despite an uptick in prepayment risk due to lower rates. We expect the market for Agency RMBS to continue to be constructive as the level of support from the Federal Reserve remains strong. Proposed Changes to LIBOR In 2017, the U.K. Financial Conduct Authority (the “FCA”), which regulates LIBOR, announced that the FCA will no longer persuade or compel banks to submit rates for the calculation of the LIBOR benchmark after 2021. This announcement indicates that the continuation of LIBOR will not be guaranteed after 2021. The Alternative Reference Rates Committee (“ARRC”), which was convened by the Federal Reserve Board and the New York Fed to help ensure a successful transition 37 Table of Contents from LIBOR, has proposed that the Secured Overnight Financing Rate (“SOFR”) is the rate that represents best practice as the alternative to LIBOR for use in derivatives and other financial contracts that are currently indexed to LIBOR. ARRC has proposed a paced market transition plan to SOFR from LIBOR, and organizations are currently working on industry wide and company specific transition plans as it relates to derivatives and cash markets exposed to LIBOR. SOFR is an overnight rate unlike LIBOR which is a forward-looking term rate, making SOFR an inexact replacement for LIBOR. There is currently no perfect way to create robust, forward-looking, SOFR term rates. Market participants are still considering how various types of financial instruments and securitization vehicles should react to a discontinuation of LIBOR. It is possible that not all of our assets and liabilities will transition away from LIBOR at the same time, and it is possible that not all of our assets and liabilities will transition to the same alternative reference rate, in each case increasing the difficulty of hedging. Switching existing financial instruments and hedging transactions from LIBOR to SOFR requires calculations of a spread. Industry organizations are attempting to structure the spread calculation in an objective manner, but there is no assurance that all asset types or securitization vehicles will use the same spread. We and other market participants have less experience understanding and modeling SOFR-based assets and liabilities than LIBOR-based assets and liabilities, increasing the difficulty of investing, hedging, and risk management. We have material contracts that are indexed to LIBOR and are monitoring this activity and evaluating the related risks. However, it is not possible to predict the effect of any of these developments, and any future initiatives to regulate, reform or change the manner of administration of LIBOR could result in adverse consequences to the rate of interest payable and receivable on, market value of and market liquidity for LIBOR-based financial instruments. Our Manager is finalizing its global assessment of exposure in relation to our LIBOR-based instruments and benchmarks and is prioritizing the mitigation of risks associated with the forecasted changes to financial instruments and performance benchmarks referencing existing LIBOR rates. In October 2019, the IRS and Treasury proposed regulations that are expected to provide taxpayers relief from adverse impacts resulting from the transition away from LIBOR to an alternative reference rate. The proposed regulations make clear that a change in the reference rate (and associated alterations to payment terms) of a financial instrument is generally not considered a taxable event, provided the fair value of the modified instrument is substantially equivalent to the fair value of the unmodified instrument. The Financial Accounting Standards Board has also issued accounting guidance that provides optional expedients and exceptions to contracts, hedging relationships and other transactions impacted by LIBOR transition if certain criteria are met. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. 38 Table of Contents Investment Activities As previously discussed, the COVID-19 pandemic caused unprecedented market disruption in the six months ended June 30, 2020. To raise liquidity and reduce leverage, we sold MBS and GSE CRTs for cash proceeds of $23.1 billion . The table below shows the breakdown of our investment portfolio as of June 30, 2020, December 31, 2019 and June 30, 2019: As of $ in thousands June 30, 2020 December 31, 2019 June 30, 2019 Agency RMBS: 30 year fixed-rate, at fair value 6,828 10,524,220 12,077,091 15 year fixed-rate, at fair value 3,125 292,414 337,920 Hybrid ARM, at fair value — 56,893 107,125 Agency CMO, at fair value — 427,512 413,164 Agency CMBS, at fair value — 4,767,930 2,926,243 Non-Agency CMBS, at fair value 1,457,915 3,823,474 3,651,587 Non-Agency RMBS, at fair value 14,404 955,671 1,118,073 GSE CRT, at fair value 101,886 923,672 904,844 Loan participation interest, at fair value — 44,654 47,885 Commercial loan, at amortized cost 21,792 24,055 24,321 Investments in unconsolidated ventures 19,246 21,998 25,675 Total investment portfolio 1,625,196 21,862,493 21,633,928 As of June 30, 2020, our holdings of 30-year fixed-rate Agency RMBS represented less than 1% of our total investment portfolio versus 48% as of December 31, 2019 and 56% as of June 30, 2019. We historically focused our purchases of 30 year fixed-rate Agency RMBS on specified pools priced at modest pay-ups to generic Agency RMBS because those securities have characteristics that reduce prepayment risk. We resumed investing in 30-year fixed-rate Agency RMBS in July 2020. As of June 30, 2020, we sold all of our holdings of Agency CMBS. Agency CMBS represented approximately 22% of our holdings as of December 31, 2019 and 14% of our holdings as of June 30, 2019. We historically focused our Agency CMBS investments in securities issued by Freddie Mac, Fannie Mae and Ginnie Mae that have characteristics that reduce prepayment risk. Our investments that have credit exposure include non-Agency CMBS, non-Agency RMBS, GSE CRTs and a commercial real estate loan. Rather than relying on the rating agencies, we utilize proprietary models as well as third party applications to quantify and monitor the credit risk associated with these holdings. Our analysis generally begins at the underlying asset level, where we gather detailed information on loan, borrower, and property characteristics that inform our expectations for future performance. In addition to base case cash flow projections, we perform a range of scenario stresses to gauge the sensitivity of returns to potential deviations in underlying asset behavior. We perform this detailed credit analysis at the time of initial purchase and regularly throughout the holding period of each investment. As of June 30, 2020, our holdings of non-Agency CMBS represented approximately 90% of our total investment portfolio versus 17% as of December 31, 2019 and 17% as of June 30, 2019. Our non-Agency CMBS portfolio is collateralized by loans secured by various property types located across the United States including office, retail, multifamily, industrial warehouses and hotels. The largest property geographic locations are in California, New York, Texas, Florida and Illinois as detailed in the tables below. The majority of our non-Agency CMBS portfolio is comprised of fixed rate credits that are rated investment grade by a nationally recognized statistical rating organizati on. Approximately 87% of non-Agency CMBS are rated single-A (or equivalent) or higher by a nationally recognized statistical rating organization as of June 30, 2020. Further, approximately 74% of non-Agency CMBS are rated double-A (or equivalent) or higher by a nationally recognized statistical rating organization as of June 30, 2020. As of June 30, 2020, our holdings of non-Agency RMBS represented approximately 1% of our total investment portfolio versus 4% as of December 31, 2019 and 5% as of June 30, 2019. We primarily hold non-Agency RMBS securities collateralized by prime and Alt-A loans. In addition, we have invested in re-securitizations of real estate mortgage investment 39 Table of Contents conduit ("Re-REMIC") RMBS and securitizations of reperforming mortgage loans that we expect to provide attractive risk adjusted returns. As of June 30, 2020, our holdings of GSE CRTs represented approximately 6% of our total investment portfolio versus 4% as of December 31, 2019 and 4% as of June 30, 2019. GSE CRTs are unsecured general obligations of the GSEs that are structured to provide credit protection to the issuer with respect to defaults and other credit events within pools of mortgage loans that collateralize MBS issued and guaranteed by the GSEs. The majority of our GSE CRT holdings are concentrated in 2013 and 2014 vintages, where reference loans have significant embedded home price appreciation. GSE CRTs have the added benefit of paying a floating rate coupon that reduces our need to hedge interest rate risk. As of June 30, 2020, we held an investment in one commercial real estate mezzanine loan that matures in 2021 and has a loan-to-value r atio of approxim ately 68.3%. As of June 30, 2020, we held investments in two unconsolidated ventures that are managed by an affiliate of our Manager. The unconsolidated ventures invest in our target assets. We are committed to invest $6.5 million in additional capital in these unconsolidated ventures to fund future investments and cover future expenses should they occur. Portfolio Characteristics The table below illustrates the vintage distribution of our non-Agency RMBS, GSE CRT and non-Agency CMBS portfolio as of June 30, 2020 as a percentage of the fair value: 2003-2007 2008-2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Total Prime 0.9 % — % — % — % 57.6 % 2.8 % 0.1 % — % — % 7.2 % — % — % 68.6 % Alt-A 30.5 % — % — % — % — % — % — % — % — % — % — % — % 30.5 % Re-REMIC — % 0.9 % — % — % — % — % — % — % — % — % — % — % 0.9 % Total Non-Agency RMBS 31.4 % 0.9 % — % — % 57.6 % 2.8 % 0.1 % — % — % 7.2 % — % — % 100.0 % GSE CRT — % — % — % — % 45.5 % 29.1 % — % — % — % — % 4.7 % 20.7 % 100.0 % Non-Agency CMBS — % 2.7 % 14.5 % 8.9 % 9.0 % 52.1 % 3.7 % — % 0.9 % 3.5 % 3.8 % 0.9 % 100.0 % 40 Table of Contents The tables below represent the geographic concentration of the underlying collateral for our non-Agency RMBS, GSE CRT and non-Agency CMBS portfolio as of June 30, 2020. The geographic markets that we invest in have been and continue to be severely impacted by the ongoing COVID-19 pandemic. Non-Agency RMBS State Percentage GSE CRT State Percentage Non-Agency CMBS State Percentage California 46.4 % California 22.6 % California 15.4 % New York 8.5 % Texas 5.5 % New York 15.2 % Massachusetts 5.3 % New York 4.6 % Texas 9.0 % Virginia 4.5 % Illinois 4.2 % Florida 5.7 % Maryland 4.0 % Florida 4.0 % Illinois 4.6 % Florida 3.8 % Virginia 4.0 % New Jersey 4.1 % Texas 3.2 % Washington 3.6 % Pennsylvania 3.7 % New Jersey 3.2 % Massachusetts 3.6 % Virginia 3.6 % Illinois 3.0 % New Jersey 3.5 % Ohio 3.5 % Colorado 2.8 % Colorado 3.1 % Michigan 3.3 % Other 15.3 % Other 41.3 % Other 31.9 % Total 100.0 % Total 100.0 % Total 100.0 % Financing and Other Liabilities We have historically used repurchase agreements to finance the majority of our target assets and expect to use repurchase agreements to finance Agency investments in the future. Repurchase agreements are generally settled on a short-term basis, usually from one to six months, and bear interest at rates that have historically moved in close relationship to LIBOR. We repaid all of our repurchase agreements as of May 7, 2020 with proceeds from asset sales and the return of cash margin previously pledged on our repurchase agreements. Our wholly-owned subsidiary, IAS Services LLC, is a member of the Federal Home Loan Bank of Indianapolis ("FHLBI") and has borrowed funds from the FHLBI in the form of secured loans. As of June 30, 2020, IAS Services LLC had $740.0 million in outstanding secured loans that are due by December 2020. As of July 31, 2020, we reduced the balance of our secured loans to $305.0 million. We intend to repay the remaining balance of our secured loans with proceeds from sales of assets collateralizing the secured loans by December 2020. As discussed in Note 5 - "Other Assets," IAS Services LLC is required to purchase and hold a certain amount of FHLBI stock, which is based, in part, upon the outstanding principal balance of secured loans from the FHLBI. The following table presents the amount of collateralized borrowings outstanding under repurchase agreements and secured loans as of the end of each quarter, the average amount outstanding during the quarter and the maximum balance outstanding during the quarter: $ in thousands Collateralized borrowings under repurchase agreements and secured loans Quarter Ended Quarter-end balance Average quarterly balance (1) Maximum balance (2) June 30, 2019 18,725,065 19,019,503 19,365,413 September 30, 2019 19,722,032 19,535,263 19,898,863 December 31, 2019 19,182,303 19,842,868 20,377,801 March 31, 2020 7,637,746 16,673,939 23,132,234 June 30, 2020 740,000 983,599 1,373,296 (1) Average quarterly balance for each period is based on month-end balances. (2) Amount represents the maximum borrowings at month-end during each of the respective periods. Hedging Instruments We enter into interest rate swap agreements that are designed to mitigate the effects of increases in interest rates for a portion of our borrowings. Under these swap agreements, we pay fixed interest rates and receive floating interest rates indexed off of one- or three-month LIBOR. 41 Table of Contents We actively manage our swap portfolio by terminating and entering into new swaps as the size and composition of our investment portfolio changes. We terminated all of our interest rate swaps in March 2020 as we positioned our portfolio in response to unprecedented market conditions associated with the COVID-19 pande mic. W e did not enter into new swaps during the three months ended June 30, 2020 because our exposure to interest rate risk decreased as we sold Agency assets and repaid borrowings. We realized a net loss of $904.7 million on interest rate swaps during the six months ended June 30, 2020 primarily due to falling interest rates. We enter into currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on investments denominated in foreign curr encies. As of June 30, 2020, we had €20.8 million or $22.9 million (December 31, 2019: €20.8 million or $23.1 million) of notional amount of forward contracts denominated in Euro related to our investment in an unconsolidated venture. During the six months ended June 30, 2020, we settled currency forward contracts of €41.7 million or $45.8 million (June 30, 2019:€42.6 million or $48.7 million) in notional amount and realized a net gain of $346,000 (June 30, 2019: $738,000 net gain). Capital Activities We may sell up to 17,000,000 shares of our common stock and 7,000,000 shares of our preferred stock from time to time in at-the-market or privately negotiated transactions under our equity distribution agreements. We did not sell any shares under these agreements during the six months ended June 30, 2020. For information on dividends declared and paid during the six months ended June 30, 2020, see Note 12 - "Stockholders' Equity" of our condensed consolidated financial statements in Part I. Item 1 of this report on Form 10-Q. During the six months ended June 30, 2020, we did not repurchase any shares of our common stock. Book Value per Common Share We calculate book value per common share as follows: As of $ in thousands except per share amounts June 30, 2020 December 31, 2019 Numerator (adjusted equity): Total equity 1,157,792 2,931,899 Less: Liquidation preference of Series A Preferred Stock (140,000) (140,000) Less: Liquidation preference of Series B Preferred Stock (155,000) (155,000) Less: Liquidation preference of Series C Preferred Stock (287,500) (287,500) Total adjusted equity 575,292 2,349,399 Denominator (number of shares): Common stock outstanding 181,327 144,256 Book value per common share 3.17 16.29 Our book value per common share decreased 80.5% as of June 30, 2020 compared to December 31, 2019 primarily due to realized and unrealized losses on derivatives and investments in the six months ended June 30, 2020 resulting from the unprecedented market disruption caused by the COVID-19 pandemic. ”Re fer to Item 3. "Quantitative and Qualitative Disclosures About Market Risk" for interest rate risk and its impact on fair value. Critical Accounting Policies There have been no significant changes to our critical accounting policies that are disclosed in our most recent Form 10-K for the year ended December 31, 2019 except as discussed in Note 2 - "Summary of Significant Accounting Polices" to our condensed consolidated financial statements included in Part I, Item 1 of this report on Form 10-Q. Recent Accounting Standards See Part I, Item 1, Financial Statements Note 2 - "Accounting Pronouncements Recently Adopted". 42 Table of Contents Results of Operations The table below presents certain information from our condensed consolidated statements of operations for the three and six months ended June 30, 2020 and 2019. Three Months Ended June 30, Six Months Ended June 30, $ in thousands, except share data 2020 2019 2020 2019 Interest Income Mortgage-backed and credit risk transfer securities 29,628 200,737 215,164 386,229 Commercial and other loans 545 1,484 1,708 3,066 Total interest income 30,173 202,221 216,872 389,295 Interest Expense Repurchase agreements (1,270) 117,978 77,772 219,853 Secured loans 1,712 11,258 8,358 22,402 Total interest expense 442 129,236 86,130 242,255 Net interest income 29,731 72,985 130,742 147,040 Other Income (loss) Gain (loss) on investments, net (306,366) 302,182 (1,061,849) 570,564 Equity in earnings (losses) of unconsolidated ventures 318 702 488 1,394 Gain (loss) on derivative instruments, net (343) (344,733) (911,122) (546,193) Realized and unrealized credit derivative income (loss), net (2,738) (2,438) (35,790) 5,446 Net loss on extinguishment of debt 3,701 — (1,107) — Other investment income (loss), net 731 1,007 1,534 2,036 Total other income (loss) (304,697) (43,280) (2,007,846) 33,247 Expenses Management fee – related party 9,793 9,370 20,746 18,904 General and administrative 4,080 1,999 7,181 4,257 Total expenses 13,873 11,369 27,927 23,161 Net income (loss) (288,839) 18,336 (1,905,031) 157,126 Dividends to preferred stockholders 11,106 11,106 22,213 22,213 Net income (loss) attributable to common stockholders (299,945) 7,230 (1,927,244) 134,913 Earnings (loss) per share: Net income (loss) attributable to common stockholders Basic (1.80) 0.06 (11.91) 1.08 Diluted (1.80) 0.06 (11.91) 1.08 Weighted average number of shares of common stock: Basic 166,943,073 128,658,546 161,857,175 124,900,484 Diluted 166,943,073 128,671,066 161,857,175 124,912,532 Interest Income and Average Earning Asset Yields The table below presents information related to our average earning assets and earning asset yields for the three and six months ended June 30, 2020 and 2019. Three months ended June 30, Six Months Ended June 30, $ in thousands 2020 2019 2020 2019 Average earning assets (1) 1,905,555 20,803,193 9,871,653 19,982,393 Average earning asset yields (2) 6.33 % 3.89 % 4.39 % 3.90 % (1) Average balances for each period are based on weighted month-end average earning assets. (2) Average earning asset yields for the period were calculated by dividing interest income, including amortization of premiums and discounts, by the average month-end earning assets based on the amortized cost of the investments. All yields are annualized. 43 Table of Contents Our primary source of income is interest earned on our investment portfolio. We had average earning assets of approximately $1.9 billion for the three months ended June 30, 2020 (June 30, 2019: $20.8 billion) and $9.9 billion for the six months ended June 30, 2020 (June 30, 2019: $20.0 billion). Average earning assets decreased for the three and six months ended June 30, 2020 primarily due to the sale of MBS and GSE CRTs for cash proceeds of $6.9 billion and $23.1 billion in the three and six months ended June 30, 2020, respectively. Due to the magnitude of the reduction in our investment portfolio since December 31, 2019, our average earning assets and asset yields for the three and six months ended June 30, 2020 are not indicative of our future ability to generate interest income. We earned total interest income of $30.2 million and $216.9 million (June 30, 2019: $202.2 million and $389.3 million) for the three and six months ended June 30, 2020, respectively. Our interest income includes coupon interest and net premium amortization on MBS and GSE CRTs as well as interest income on commercial and other loans as shown in the table below. Three months ended June 30, Six Months Ended June 30, $ in thousands 2020 2019 2020 2019 Interest Income MBS and GSE CRT - coupon interest 26,841 214,501 228,950 406,943 MBS and GSE CRT - net premium amortization 2,787 (13,764) (13,786) (20,714) MBS and GSE CRT - interest income 29,628 200,737 215,164 386,229 Commercial and other loans 545 1,484 1,708 3,066 Total interest income 30,173 202,221 216,872 389,295 MBS and GSE CRT interest income decreased $171.1 million in both the three and six months ended June 30, 2020, compared to the same periods in 2019 primarily due to a $187.7 million and $178.0 million decrease in coupon interest reflecting lower average earning assets. Lower coupon interest was offset by a $16.6 million and $6.9 million decrease in net premium amortization during the three and six months ended June 30, 2020, respectively, due to sales of assets purchased at premiums. Interest income on our commercial and other loans decreased $939,000 and $1.4 million during the three and six months ended June 30, 2020, respectively, due to the sale of our loan participation interest in April 2020 and principal payments on commercial loans totaling $7.3 million in the six months ended June 30, 2019. Prepayment Speeds Our RMBS and GSE CRT portfolio is subject to inherent prepayment risk primarily driven by changes in interest rates, which impacts the amount of premium and discount on the purchase of these securities that is recognized into interest income. Expected future prepayment speeds on our RMBS and GSE CRT portfolio are estimated on a quarterly basis. Generally, in an environment of falling interest rates, prepayment speeds will increase as homeowners are more likely to prepay their existing mortgage and refinance into a lower borrowing rate. If the actual prepayment speed during the period is faster than estimated, the amortization on securities purchased at a premium to par value will be accelerated, resulting in lower interest income recognized. Conversely, for securities purchased at a discount to par value, interest income will be reduced in periods where prepayment speeds were slower than expected. The standard measure of prepayment speeds is the constant prepayment rate, also known as the conditional prepayment rate or "CPR". The table below provides the three month constant prepayment rate for our RMBS and GSE CRTs as of June 30, 2020, December 31, 2019, and June 30, 2019. As of June 30, 2020 December 31, 2019 June 30, 2019 15 year fixed-rate Agency RMBS 7.4 12.5 11.1 30 year fixed-rate Agency RMBS 8.0 18.1 8.5 Hybrid ARM Agency RMBS — 28.7 18.2 Non-Agency RMBS 29.5 17.2 11.4 GSE CRT 21.1 20.1 9.8 Weighted average CPR 21.0 18.1 9.0 44 Table of Contents The following table presents net premium amortization recognized on our MBS and GSE CRT portfolio for the three and six months ended June 30, 2020 and 2019. Three months ended June 30, Six Months Ended June 30, $ in thousands, except share data 2020 2019 2020 2019 Agency RMBS (894) (17,153) (21,807) (29,347) Agency CMBS (78) (909) (1,744) (1,440) Non-Agency CMBS 4,473 3,350 9,531 6,381 Non-Agency RMBS (178) 2,800 2,520 6,722 GSE CRT (536) (1,852) (2,286) (3,030) Net (premium amortization) discount accretion 2,787 (13,764) (13,786) (20,714) Net premium amortization decreased $16.6 million and $6.9 million for the three and six months ended June 30, 2020, respectively, compared to the same periods in 2019 primarily due to sales of assets purchased at premiums. Our interest income is subject to interest rate risk. Refer to Item 3. "Quantitative and Qualitative Disclosures about Market Risk" for more information relating to interest rate risk and its impact on our operating results. Interest Expense and Cost of Funds The table below presents the components of interest expense for the three and six months ended June 30, 2020 and 2019: Three months ended June 30, Six Months Ended June 30, $ in thousands 2020 2019 2020 2019 Interest Expense Interest expense on repurchase agreement borrowings 3,233 123,894 92,342 231,620 Amortization of net deferred (gain) loss on de-designated interest rate swaps (4,503) (5,916) (14,570) (11,767) Repurchase agreements interest expense (1,270) 117,978 77,772 219,853 Secured loans 1,712 11,258 8,358 22,402 Total interest expense 442 129,236 86,130 242,255 We have historically entered into repurchase agreements to finance the majority of our target assets. These agreements are secured by our mortgage-backed and credit risk transfer securities. These agreements are generally settled on a short-term basis, usually from one to six months, and bear interest at rates that have historically moved in close relationship to LIBOR. At each settlement date, we typically refinance each repurchase agreement at the market interest rate at that time. Our interest expense on repurchase agreement borrowings decreased $120.7 million and $139.3 million for the three and six months ended June 30, 2020, respectively, compared to 2019 due to lower average borrowings and a lower average cost of funds reflecting decreases in the Federal Funds interest rate. Average borrowings decreased primarily due to repayment of $17.5 billion of repurchase agreements with proceeds from asset sales due to financial market disruption caused by the COVID-19 pandemic as previously discussed in this Management's Discussion and Analysis of Financial Condition and Results of Operations. Average borrowings also decreased due to repayment of $910.0 million of secured loans during the six months ended June 30, 2020. Our repurchase agreement interest expense as reported in our condensed consolidated statement of operations includes amortization of net deferred gains and losses on de-designated interest rate swaps as summarized in the table above. Amortization of net deferred gains on de-designated interest rate swaps decreased our total interest expense by $4.5 million and $14.6 million during the three and six months ended June 30, 2020, respectively, and $5.9 million and $11.8 million during the three and six months ended June 30, 2019, respectively. Amounts recorded in AOCI before we discontinued cash flow hedge accounting for our interest rate swaps are reclassified to interest expense on repurchase agreements on the condensed consolidated statements of operations as interest is accrued and paid on the related repurchase agreements over the remaining life of the interest rate swap agreements. We increased the amount of gains and losses reclassified as a decrease to interest expense during the six months ended June 30, 2020 by $2.7 million because it is probable the original forecasted transactions will not occur by the end of the originally specified time period. During the next twelve months, we estimate that $20.0 million of net deferred gains on de-designated interest rate swaps will be reclassified from other comprehensive income and recorded as a decrease to interest expense. 45 Table of Contents During the three and six months ended June 30, 2020, interest expense for our secured loans decreased $9.5 million and $14.0 million, respectively, compared to the same periods in 2019 due to repayment of $910.0 million of secured loans during the six months ended June 30, 2020 and lower borrowing rates. Borrowing rates on our secured loans are based on FHLBI's short-term cost of funds. For the three and six months ended June 30, 2020, the weighted average borrowing rate on our secured loans was 0.85% and 1.48%, as compared to 2.73% and 2.72% for the three and six months ended June 30, 2019, respectively. Our total interest expense during the three and six months ended June 30, 2020 decreased $128.8 million and $156.1 million, respectively, from the same periods in 2019 primarily due to the $130.2 million and $153.3 million decrease in interest expense on repurchase agreements borrowings and secured loans in the 2020 periods as discussed above. The table below presents information related to our borrowings and cost of funds for the three and six months ended June 30, 2020 and 2019: Three months ended June 30, Six Months Ended June 30, $ in thousands 2020 2019 2020 2019 Total average borrowings (1) 981,992 18,908,927 8,756,995 17,983,666 Maximum borrowings during the period (2) 1,373,296 19,365,413 23,132,234 19,365,413 Cost of funds (3) 0.18 % 2.73 % 1.97 % 2.69 % (1) Average borrowings for each period are based on weighted month-end balances. (2) Amount represents the maximum borrowings at month-end during each of the respective periods. (3) Average cost of funds is calculated by dividing annualized interest expense excluding amortization of net deferred gain (loss) on de-designated interest rate swaps by our average borrowings. All percentages are annualized. Total average borrowings decreased $17.9 billion and $9.2 billion in the three and six months ended June 30, 2020, respectively, compared to 2019 primarily because we repaid $17.5 billion of repurchase agreements and $910.0 million of secured loans during the six months ended June 30, 2020 as discussed above. Our average cost of funds decreased 255 basis points and 72 basis points for three and six months ended June 30, 2020, respectively, versus 2019 primarily due to decreases in the Federal Funds rate over the past twelve months. Our average borrowings for the three and six months ended June 30, 2020 are not indicative of our future interest expense because we repaid $17.5 billion of repurchase agreements and $910.0 million of secured loans during the six months ended June 30, 2020. Net Interest Income The table below presents the components of net interest income for the three and six months ended June 30, 2020 and 2019: Three months ended June 30, Six Months Ended June 30, $ in thousands 2020 2019 2020 2019 Interest Income Mortgage-backed and credit risk transfer securities 29,628 200,737 215,164 386,229 Commercial and other loans 545 1,484 1,708 3,066 Total interest income 30,173 202,221 216,872 389,295 Interest Expense Interest expense on repurchase agreement borrowings 3,233 123,894 92,342 231,620 Amortization of net deferred (gain) loss on de-designated interest rate swaps (4,503) (5,916) (14,570) (11,767) Repurchase agreements interest expense (1,270) 117,978 77,772 219,853 Secured loans 1,712 11,258 8,358 22,402 Total interest expense 442 129,236 86,130 242,255 Net interest income 29,731 72,985 130,742 147,040 Net interest rate margin 6.15 % 1.16 % 2.42 % 1.21 % Our net interest income, which equals interest income less interest expense, totaled $29.7 million and $130.7 million (June 30, 2019: $73.0 million and $147.0 million) for the three and six months ended June 30, 2020, respectively. The decrease 46 Table of Contents in net interest income for the three and six months ended June 30, 2020 was primarily due the sale of MBS and GSE CRTs to generate liquidity and reduce leverage as previously discussed. Our net interest rate margin, which equals the yield on our average assets for the period less the average cost of funds for the period, was 6.15% and 2.42% (June 30, 2019: 1.16% and 1.21%) for the three and six months ended June 30, 2020, respectively. The increase in net interest rate margin for the three and six months ended June 30, 2020 compared to the same periods in 2019 was primarily due to the change in our portfolio composition due to assets sales and decreases in the Federal Funds rate throughout 2019 that had a greater impact on our average cost of funds than on our average earning asset yields. Our cost of funds on all of our borrowings is influenced by changes in short-term interest rates, whereas approximately 92% o f the Company’s investments were fixed rate assets as of June 30, 2020. Gain (Loss) on Investments, net The table below summarizes the components of gain (loss) on investments, net for the three and six months ended June 30, 2020 and 2019: Three months ended June 30, Six Months Ended June 30, $ in thousands 2020 2019 2020 2019 Net realized gains (losses) on sale of investments (404,739) 2,029 (409,024) (9,086) Impairment of investments the Company intends to sell or more likely than not will be required to sell before recovery of amortized cost basis (6,287) — (85,121) — Other-than-temporary impairment losses — (1,200) — (2,976) Net unrealized gains (losses) on MBS accounted for under the fair value option (34,498) 304,692 (549,001) 584,731 Net unrealized gains (losses) on GSE CRT accounted for under the fair value option 139,943 (3,339) (12,426) (2,105) Net unrealized gains (losses) on commercial loan and loan participation interest 3,023 — (2,469) — Realized loss on loan participation interest (3,808) — (3,808) — Total gain (loss) on investments, net (306,366) 302,182 (1,061,849) 570,564 As previously discussed, we experienced unprecedented market conditions as a result of the COVID-19 pandemic during the six months ended June 30, 2020. To generate liquidity and reduce leverage, we sold MBS and GSE CRTs for cash proceeds of $23.1 billion (June 30, 2019: $1.7 billion) and realized net losses of $409.0 million (June 30, 2019: net losses of $9.1 million). Sales prices of our holdings were severely impacted by the lack of liquidity and uncertainty surrounding the economic impact of the COVID-19 pandemic. A portion of these sales were involuntary liquidations at significantly distressed market prices as certain of our repurchase agreement counterparties seized and sold our securities when we were unable to meet margin calls in March 2020. We recorded $6.3 million and $85.1 million of impairment on non-Agency RMBS and CMBS securities during the three and six months ended June 30, 2020, respectively, because we intended to sell or more likely than not would be required to sell these securities before recovery of their amortized cost basis. We assess our investment securities for credit losses and impairment on a quarterly basis. For additional information regarding our accounting policy for credit losses and impairment, refer to Note 2 – “Summary of Significant Accounting Policies” of our condensed consolidated financial statements included in Part I. Item 1. of this Quarterly Report. We have elected the fair value option for all of our RMBS interest-only securities, our MBS purchased on or after September 1, 2016 and our GSE CRTs purchased on or after August 24, 2015. Under the fair value option, changes in fair value are recognized in income in the condensed consolidated statements of operations and are reported as a component of gain (loss) on investments, net. As of June 30, 2020, $230.9 million (December 31, 2019: $17.4 billion) or 15% (December 31, 2019: 80%) of our MBS and GSE CRT are accounted for under the fair value option. Our percentage of MBS and GSE CRTs accounted for under the fair value option declined as of June 30, 2020 due to sales of securities accounted for under the fair value option during the six months ended June 30, 2020. We recorded net unrealized losses on our MBS portfolio accounted for under the fair value option of $34.5 million and $549.0 million in the three and six months ended June 30, 2020, respectively, compared to net unrealized gains of $304.7 million and $584.7 million in the three and six months ended June 30, 2019, respectively. Net unrealized losses in the three and six months ended June 30, 2020 reflect lower interest rates and wider interest rate spreads on our Agency and non-Agency 47 Table of Contents assets. We also recorded net unrealized gains on our GSE CRT portfolio accounted for under the fair value option of $139.9 million and $12.4 million net unrealized losses in the three and six months ended June 30, 2020, respectively, compared to net unrealized losses of $3.3 million and $2.1 million in the three and six months ended June 30, 2019, respectively. Net unrealized losses in the six months ended June 30, 2020 reflect declines in valuations due to wider interest rate spreads. We recorded a realized loss of $3.8 million on our loan participation interest during the three and six months ended June 30, 2020 and unrealized losses of $785,000 and $2.5 million on our commercial loan during the three and six months ended June 30, 2020, respectively. We sold the loan participation interest on April 1, 2020. We valued our commercial loan based upon a valuation from an independent pricing service. Equity in Earnings (Losses) of Unconsolidated Ventures For the three and six months ended June 30, 2020, we recorded equity in earnings of unconsolidated ventures of $318,000 and $488,000 (June 30, 2019: equity in earnings of $702,000 and $1.4 million), respectively. We recorded equity in earnings for the three and six months ended June 30, 2020 and 2019 primarily due to realized and unrealized gains on the underlying portfolio investments. Gain (Loss) on Derivative Instruments, net Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements on our floating rate repurchase agreements and secured loans. To accomplish these objectives, we primarily use interest rate derivative instruments, including interest rate swaps and U.S. Treasury futures contracts as part of our interest rate risk management strategy. We also use currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on our unconsolidated joint venture investment denominated in Euros. The tables below summarize our realized and unrealized gain (loss) on derivative instruments, net for the following periods: $ in thousands Three months ended June 30, 2020 Derivative not designated as hedging instrument Realized gain (loss) on derivative instruments, net Contractual net interest income (expense) Unrealized gain (loss), net Gain (loss) on derivative instruments, net Currency Forward Contracts (138) — (205) (343) Total (138) — (205) (343) $ in thousands Three months ended June 30, 2019 Derivative not designated as hedging instrument Realized gain (loss) on derivative instruments, net Contractual net interest income (expense) Unrealized gain (loss), net Gain (loss) on derivative instruments, net Interest Rate Swaps (241,839) 7,525 (39,922) (274,236) Futures Contracts (65,953) — (4,490) (70,443) Currency Forward Contracts 553 — (607) (54) Total (307,239) 7,525 (45,019) (344,733) $ in thousands Six Months Ended June 30, 2020 Derivative not designated as hedging instrument Realized gain (loss) on derivative instruments, net Contractual net interest income (expense) Unrealized gain (loss), net Gain (loss) on derivative instruments, net Interest Rate Swaps (904,704) 11,924 (18,532) (911,312) Currency Forward Contracts 346 — (156) 190 Total (904,358) 11,924 (18,688) (911,122) 48 Table of Contents $ in thousands Six Months Ended June 30, 2019 Derivative not designated as hedging instrument Realized gain (loss) on derivative instruments, net Contractual net interest income (expense) Unrealized gain (loss), net Gain (loss) on derivative instruments, net Interest Rate Swaps (407,723) 12,034 (26,931) (422,620) Futures Contracts (132,641) — 8,454 (124,187) Currency Forward Contracts 738 — (124) 614 Total (539,626) 12,034 (18,601) (546,193) During the six months ended June 30, 2020, we terminated existing swaps with a notional amount of $106.2 billion and entered into new swaps with a notional amount of $92.2 billion to hedge repurchase agreement debt associated with purchases of Agency RMBS and Agency CMBS securities. We terminated all outstanding interest rate swaps in March 2020 as we positioned our portfolio in response to unprecedented market conditions associated with the COVID-19 pandemic and did not have any swaps outstanding as of June 30, 2020. Our exposure to interest rate risk decreased as we sold Agency assets and repaid borrowings. We realized a net loss of $904.7 million on the termination of interest rate swaps during the six months ended June 30, 2020 primarily due to falling interest rates. As of December 31, 2019, we held the following interest rate swaps whereby we receive interest at a one-month and three-month LIBOR rate: $ in thousands As of December 31, 2019 Derivative instrument Notional Amounts Average Fixed Pay Rate Average Receive Rate Average Maturity (Years) Interest Rate Swaps 14,000,000 1.47 % 1.79 % 5.2 We were not a party to any futures contracts during the six months ended June 30, 2020. During the six months ended June 30, 2019, we settled futures contracts with a notional amount of $4.3 billion. We realized a net loss of $132.6 million on the settlement of futures contracts during the six months ended June 30, 2019 due to falling interest rates. Daily variation margin payment for futures is characterized as settlement of the derivative itself rather than collateral and is recorded as a realized gain or loss in our condensed consolidated statement of operations. Realized and Unrealized Credit Derivative Income (Loss), net The table below summarizes the components of realized and unrealized credit derivative income (loss), net for the three and six months ended June 30, 2020 and 2019. Three months ended June 30, Six Months Ended June 30, $ in thousands 2020 2019 2020 2019 GSE CRT embedded derivative coupon interest 1,127 5,300 5,845 10,650 Gain (loss) on settlement of GSE CRT embedded derivatives (16,414) — (14,131) — Change in fair value of GSE CRT embedded derivatives 12,549 (7,738) (27,504) (5,204) Total realized and unrealized credit derivative income (loss), net (2,738) (2,438) (35,790) 5,446 In the three and six months ended June 30, 2020, we recorded a decrease of $300,000 and $41.2 million in realized and unrealized credit derivative income (loss), net compared to the same periods in 2019. The decrease was primarily driven by a decline in the fair value of our GSE CRT embedded derivatives in the three and six months ended June 30, 2020 as asset prices declined due to spread widening. 49 Table of Contents Net Gain (Loss) on Extinguishment of Debt As discussed in Note 6 - "Borrowings" of our condensed consolidated financial statements include in Part I. Item 1. of this report on Form 10-Q, certain of our counterparties seized and sold securities that we had posted as collateral for our repurchase agreements. We recorded early termination and legal fees paid to our counterparties that were associated with the termination of these repurchase agreements as a loss on extinguishment of debt and settlements of counterparty claims for less than the principal balance of our repurchase agreements as a gain on extinguishment of debt in our condensed consolidated statement of operations. Other Investment Income (Loss), net Our other investment income (loss), net during the three and six months ended June 30, 2020 and 2019 primarily consists of quarterly dividends from FHLBI stock. We are required to purchase and hold a certain amount of FHLBI stock, which is based, in part, upon the outstanding principal balance of secured advances from the FHLBI. We earn dividend income on our investment in FHLBI stock, and the amount of our dividend income varies based upon the number of shares that we are required to own and the dividend declared per share. Expenses We incurred management fees of $9.8 million and $20.7 million (June 30, 2019: $9.4 million and $18.9 million) for the three and six months ended June 30, 2020, respectively. Management fees increased for the three and six months ended June 30, 2020 compared to the same period in 2019 due to a higher management fee base. Our management fees are calculated quarterly in arrears. Our management fee will be lower in the three months ended September 30, 2020 because our average month-end stockholders' equity decreased during the three months ended June 30, 2020 primarily due to realized losses on sales of investments. Refer to Note 11 – "Related Party Transactions" of our condensed consolidated financial statements for a discussion of our relationship with our Manager and a description of how our fees are calculated. Our general and administrative expenses not covered under our management agreement amounted to $4.1 million and $7.2 million (June 30, 2019: $2.0 million and $4.3 million) for the three and six months ended June 30, 2020, respectively. General and administrative expenses primarily consist of directors and officers insurance, legal costs, accounting, auditing and tax services, filing fees, and miscellaneous general and administrative costs. General and administrative costs were higher for the three and six months ended June 30, 2020 compared to the same periods in 2019 primarily due to fees paid for third-party legal and advisory services in connection with navigating market disruption associated with the COVID-19 pandemic totaling $1.5 million and $2.6 million, respectively. Net Income (Loss) attributable to Common Stockholders For the three months ended June 30, 2020, our net loss attributable to common stockholders was $299.9 million (June 30, 2019: $7.2 million net income attributable to common stockholders) or $1.80 basic and diluted net loss per average share available to common stockholders (June 30, 2019: $0.06 basic and diluted net income per average share available to common stockholders). The change in net income (loss) attributable to common stockholders was primarily due to (i) a net loss on derivative instruments of $343,000 in the 2020 period compared to a net loss on derivative instruments of $344.7 million in the 2019 period; (ii) a net loss on investments of $306.4 million in the 2020 period compared to a net gain on investments of $302.2 million in the 2019 period; and (iii) a $43.3 million decrease in net interest income. For the six months ended June 30, 2020, our net loss attributable to common stockholders was $1.9 billion (June 30, 2019: $134.9 million net income attributable to common stockholders) or $11.91 basic and diluted net loss per average share available to common stockholders (June 30, 2019: $1.08 basic and diluted net income per average share available to common stockholders). The change in net income (loss) attributable to common stockholders was primarily due to (i) a net loss on derivative instruments of $911.1 million in the 2020 period compared to a net loss on derivative instruments of $546.2 million in the 2019 period; (ii) a net loss on investments of $1.1 billion in the 2020 period compared to a net gain on investments of $570.6 million in the 2019 period; (iii) a credit derivative net loss of $35.8 million in the 2020 period compared to credit derivative net income of $5.4 million in the 2019 period; and (iv) a $16.3 million decrease in net interest income. For further information on the changes in net gain (loss) on derivative instruments, net gain (loss) on investments, realized and unrealized credit derivative income (loss), net and net interest income, see preceding discussion under "Gain (Loss) on Derivative Instruments, net," "Gain (Loss) on Investments, net," "Realized and Unrealized Credit Derivative Income (Loss), net," and "Net Interest Income." 50 Table of Contents Non-GAAP Financial Measures We have historically used the following non-GAAP financial measures to analyze the Company's operating results and believe these financial measures are useful to investors in assessing our performance as further discussed below: • core earnings (and by calculation, core earnings per common share), • effective interest income (and by calculation, effective yield), • effective interest expense (and by calculation, effective cost of funds), • effective net interest income (and by calculation, effective interest rate margin), and • repurchase agreement debt-to-equity ratio. The most directly comparable U.S. GAAP measures are: • net income (loss) attributable to common stockholders (and by calculation, basic earnings (loss) per common share), • total interest income (and by calculation, earning asset yields), • total interest expense (and by calculation, cost of funds), • net interest income (and by calculation, net interest rate margin), and • debt-to-equit y ratio. We are not presenting core earnings for the three and six months ended June 30, 2020 because core earnings excludes the material adverse impact that the market disruption caused by the COVID-19 pandemic has had on our financial condition. In addition, core earnings for the three and six months ended June 30, 2020 are not indicative of the reduced earnings potential of our current investment portfolio. We intend to resume reporting core earnings when its presentation provides a useful measure of our portfolio’s earning capacity. The non-GAAP financial measures used by management should be analyzed in conjunction with U.S. GAAP financial measures and should not be considered substitutes for U.S. GAAP financial measures. In addition, the non-GAAP financial measures may not be comparable to similarly titled non-GAAP financial measures of our peer companies. Effective Interest Income / Effective Yield / Effective Interest Expense / Effective Cost of Funds / Effective Net Interest Income / Effective Interest Rate Margin We calculate effective interest income (and by calculation, effective yield) as U.S. GAAP total interest income adjusted for GSE CRT embedded derivative coupon interest that is recorded as realized and unrealized credit derivative income (loss), net. We include our GSE CRT embedded derivative coupon interest in effective interest income because GSE CRT coupon interest is not accounted for consistently under U.S. GAAP. We account for GSE CRTs purchased prior to August 24, 2015 as hybrid financial instruments, but we have elected the fair value option for GSE CRTs purchased on or after August 24, 2015. Under U.S. GAAP, coupon interest on GSE CRTs accounted for using the fair value option is recorded as interest income, whereas coupon interest on GSE CRTs accounted for as hybrid financial instruments is recorded as realized and unrealized credit derivative income (loss). We add back GSE CRT embedded derivative coupon interest to our total interest income because we consider GSE CRT embedded derivative coupon interest a current component of our total interest income irrespective of whether we elected the fair value option for the GSE CRT or accounted for the GSE CRT as a hybrid financial instrument. We calculate effective interest expense (and by calculation, effective cost of funds) as U.S. GAAP total interest expense adjusted for contractual net interest income (expense) on our interest rate swaps that is recorded as gain (loss) on derivative instruments, net and the amortization of net deferred gains (losses) on de-designated interest rate swaps that is recorded as repurchase agreements interest expense. We view our interest rate swaps as an economic hedge against increases in future market interest rates on our floating rate borrowings. We add back the net payments we make on our interest rate swap agreements to our total U.S. GAAP interest expense because we use interest rate swaps to add stability to interest expense. We exclude the amortization of net deferred gains (losses) on de-designated interest rate swaps from our calculation of effective interest expense because we do not consider the amortization a current component of our borrowing costs. We calculate effective net interest income (and by calculation, effective interest rate margin) as U.S. GAAP net interest income adjusted for contractual net interest income (expense) on our interest rate swaps that is recorded as gain (loss) on derivative instruments, amortization of net deferred gains (losses) on de-designated interest rate swaps that is recorded as 51 Table of Contents repurchase agreements interest expense and GSE CRT embedded derivative coupon interest that is recorded as realized and unrealized credit derivative income (loss), net. We believe the presentation of effective interest income, effective yield, effective interest expense, effective cost of funds, effective net interest income and effective interest rate margin measures, when considered together with U.S. GAAP financial measures, provide information that is useful to investors in understanding our borrowing costs and operating performance. The following tables reconcile total interest income to effective interest income and yield to effective yield for the following periods: Three months ended June 30, 2020 2019 $ in thousands Reconciliation Yield/Effective Yield Reconciliation Yield/Effective Yield Total interest income 30,173 6.33 % 202,221 3.89 % Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net 1,127 0.24 % 5,300 0.10 % Effective interest income 31,300 6.57 % 207,521 3.99 % Six Months Ended June 30, 2020 2019 $ in thousands Reconciliation Yield/Effective Yield Reconciliation Yield/Effective Yield Total interest income 216,872 4.39 % 389,295 3.90 % Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net 5,845 0.12 % 10,650 0.10 % Effective interest income 222,717 4.51 % 399,945 4.00 % Our effective interest income decreased $176.2 million and $177.2 million in the three and six months ended June 30, 2020, respectively, versus the same period in 2019 due to lower average earning assets. Our average earning assets decreased to $1.9 billion and $9.9 billion from $20.8 billion and $20.0 billion for three and six months ended June 30, 2020, respectively, primarily because we sold MBS and GSE CRT or cash proceeds of $23.1 billion during the six months ended June 30, 2020 due to disruption in the financial markets caused by the COVID-19 pandemic as previously discussed. The following tables reconcile total interest expense to effective interest expense and cost of funds to effective cost of funds for the following periods. Three months ended June 30, 2020 2019 $ in thousands Reconciliation Cost of Funds / Effective Cost of Funds Reconciliation Cost of Funds / Effective Cost of Funds Total interest expense 442 0.18 % 129,236 2.73 % Add (Less): Amortization of net deferred gain (loss) on de-designated interest rate swaps 4,503 1.83 % 5,916 0.13 % Add (Less): Contractual net interest expense (income) on interest rate swaps recorded as gain (loss) on derivative instruments, net — — % (7,525) (0.16) % Effective interest expense 4,945 2.01 % 127,627 2.70 % 52 Table of Contents Six Months Ended June 30, 2020 2019 $ in thousands Reconciliation Cost of Funds / Effective Cost of Funds Reconciliation Cost of Funds / Effective Cost of Funds Total interest expense 86,130 1.97 % 242,255 2.69 % Add (Less): Amortization of net deferred gain (loss) on de-designated interest rate swaps 14,570 0.33 % 11,767 0.13 % Add (less): Contractual net interest expense (income) on interest rate swaps recorded as gain (loss) on derivative instruments, net (11,924) (0.27) % (12,034) (0.13) % Effective interest expense 88,776 2.03 % 241,988 2.69 % Our effective interest expense and effective cost of funds decreased during the three and six months ended June 30, 2020 compared to the same period in 2019 primarily due to lower interest expense paid on our repurchase agreements. We paid interest expense of $442,000 and $86.1 million during the three and six months ended June 30, 2020, respectively, compared to $129.2 million and $242.3 million for the same periods in 2019, respectively, due to lower average borrowings and a lower Federal Funds target interest rate. The following tables reconcile net interest income to effective net interest income and net interest rate margin to effective interest rate margin for the following periods. Six Months Ended June 30, 2020 2019 $ in thousands Reconciliation Net Interest Rate Margin / Effective Interest Rate Margin Reconciliation Net Interest Rate Margin / Effective Interest Rate Margin Net interest income 29,731 6.15 % 72,985 1.16 % Add (Less): Amortization of net deferred (gain) loss on de-designated interest rate swaps (4,503) (1.83) % (5,916) (0.13) % Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net 1,127 0.24 % 5,300 0.10 % Add (Less): Contractual net interest income (expense) on interest rate swaps recorded as gain (loss) on derivative instruments, net — — % 7,525 0.16 % Effective net interest income 26,355 4.56 % 79,894 1.29 % 53 Table of Contents Six Months Ended June 30, 2020 2019 $ in thousands Reconciliation Net Interest Rate Margin / Effective Interest Rate Margin Reconciliation Net Interest Rate Margin / Effective Interest Rate Margin Net interest income 130,742 2.42 % 147,040 1.21 % Add (Less): Amortization of net deferred (gain) loss on de-designated interest rate swaps (14,570) (0.33) % (11,767) (0.13) % Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net 5,845 0.12 % 10,650 0.10 % Add (Less): Contractual net interest income (expense) on interest rate swaps recorded as gain (loss) on derivative instruments, net 11,924 0.27 % 12,034 0.13 % Effective net interest income 133,941 2.48 % 157,957 1.31 % Effective net interest income decreased during the three and six months ended June 30, 2020 compared to the same periods in 2019 primarily due to lower average earning asset balances that were partially offset by lower average borrowings and a lower effective cost of funds driven by cuts in the Federal Funds interest rate. Liquidity and Capital Resources Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to pay dividends, fund investments, repay borrowings and fund other general business needs. Our primary sources of funds for liquidity consist of the net proceeds from our common and preferred equity offerings, net cash provided by operating activities, proceeds from repurchase agreements and other financing arrangements and future issuances of equity and/or debt securities. The COVID-19 pandemic-driven disruptions in the real estate, mortgage and financial markets have negatively affected and are expected to continue to negatively affect our liquidity. Under the terms of our repurchase agreements and secured loans, our lenders have the contractual right to mark the underlying securities that we post as collateral to fair value as determined in their sole discretion. In addition, our lenders have the contractual right to increase the "haircut", or percentage amount by which collateral value must exceed the amount of borrowings, as market conditions become more volatile. As a result of significant spread widening in both Agency and non-Agency securities in the latter part of the first quarter of 2020, valuations of our portfolio assets declined sharply in a short period of time, leading to an exceptional increase in the frequency and magnitude of margin calls. Additionally, our lenders raised required haircuts on our collateral for new repurchase agreements, driving further liquidity needs. We sold portfolio assets in order to generate liquidity, in many cases at significantly distressed market prices. These events have led us to seek to maintain higher levels of cash and unencumbered assets. See Part I. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations and Part II. Other Information - Item 1A. Risk Factors in this Quarterly Report for more information on how the COVID-19 pandemic has impacted and may continue to impact our liquidity and capital resources. We held cash, cash equivalents and restricted cash of $271.6 million at June 30, 2020 (June 30, 2019: $154.9 million). As previously discussed, we increased our cash, cash equivalents and restricted cash balances at June 30, 2020 to improve our liquidity in light of market disruption created by the COVID-19 pandemic. Our operating activities provided net cash of $130.6 million for the six months ended June 30, 2020 (June 30, 2019: $157.0 million). Our investing activities provided net cash of $18.0 billion in the six months ended June 30, 2020 compared to net cash used by investing activities of $3.7 billion in the six months ended June 30, 2019. Our primary source of cash from investing activities for the six months ended June 30, 2020 was proceeds from sales of MBS and GSE CRTs of $23.1 billion (June 30, 2019: $1.7 billion) to improve liquidity. We also generated $690.1 million from principal payments of MBS and GSE CRTs during the six months ended June 30, 2020 (June 30, 2019: $760.6 million). Prior to disruption in the financial markets caused by the COVID-19 pandemic, we invested $5.0 billion in MBS and GSE CRTs during the six months ended June 30, 2020 (June 30, 2019: $5.6 billion). We used cash of $904.4 million to terminate derivative contracts in the six months ended June 30, 2020 (June 30, 2019: $539.6 million) as we sold our Agency securities and our sensitivity to interest rates decreased. Our financing activities used net cash of $18.2 billion for the six months ended June 30, 2020 primarily because we repaid our repurchase agreement borrowings with proceeds from asset sales (June 30, 2019: net cash provided by financing 54 Table of Contents activities of $3.6 billion). We repaid net repurchase agreement borrowing of $17.5 billion (June 30, 2019: net proceeds provided $3.5 billion). In addition, we repaid $910.0 million of secured loans from the FHLBI. We also used cash of $102.6 million for the six months ended June 30, 2020 (June 30, 2019: $126.8 million) to pay dividends. Proceeds from issuance of common stock provided $347.1 million for the six months ended June 30, 2020 (June 30, 2019: $266.9 million). Forward-Looking Statements Regarding Liquidity As of June 30, 2020, our investment portfolio is primarily composed of credit assets that are financed by FHLBI. Our secured loans are due by December 2020, and we intend to repay FHLBI with proceeds from sales of assets that are currently collateralizing our secured loans. We repaid $435.0 million of our secured loans in July 2020. We have approximately $554.3 million of unencumbered investments as of June 30, 2020 and unrestricted cash of $270.2 million. We resumed investing in Agency RMBS in July 2020 and financed the purchase of these Agency investments with a moderate amount of repurchase agreement borrowings. We determine the amount of leverage on new investments based upon the type of investment and market conditions at the time of investment. Based upon our current portfolio, existing borrowing arrangements and anticipated proceeds from sales of assets that are currently collateralizing our secured loans, we believe that cash flow from operations and available borrowing capacity will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity requirements to fund our investment activities, pay fees under our management agreement, fund our required distributions to stockholders and fund other general corporate expenses. Our ability to meet our long-term (greater than one year) liquidity and capital resource requirements will be subject to obtaining additional debt financing. We may increase our capital resources by obtaining long-term credit facilities or through public or private offerings of equity or debt securities, possibly including classes of preferred stock, common stock, senior or subordinated notes and convertible notes. Such financing will depend on market conditions for capital raises and our ability to invest such offering proceeds. If we are unable to renew, replace or expand our sources of financing on substantially similar terms, it may have an adverse effect on our business and results of operations. Contractual Obligations We have entered into an agreement with our Manager under which our Manager is entitled to receive a management fee and the reimbursement of certain operating expenses incurred on our behalf. The management fee is calculated and payable quarterly in arrears in an amount equal to 1.50% of our stockholders’ equity, per annum. Refer to Note 11 - "Related Party Transactions" of our condensed consolidated financial statements for additional information on how our management fee is calculated. Our Manager uses the proceeds from its management fee in part to pay compensation to its officers and personnel who, notwithstanding that certain of those individuals are also our officers, receive no cash compensation directly from us. We are required to reimburse our Manager for operating expenses related to us incurred by our Manager, including certain salary expenses and other expenses relating to legal, accounting, due diligence and other services. Our reimbursement obligation is not subject to any dollar limitation. Refer to Note 11 – "Related Party Transactions" of our condensed consolidated financial statements for details of our reimbursements to our Manager. As of June 30, 2020, we had the following contractual obligations: Payments Due by Period $ in thousands Total Less than 1 year 1-3 years 3-5 years After 5 years Secured loans 740,000 740,000 — — — Interest expense on secured loans (1) 2,141 2,141 — — — Total (2) 742,141 742,141 — — — (1) Interest expense is calculated based on variable rates in effect at June 30, 2020 . (2) Excluded from total contractual obligations are the amounts due to our Manager under the management agreement, as those obligations do not have fixed and determinable payments. Off-Balance Sheet Arrangements As of June 30, 2020, we held investments in two unconsolidated joint ventures that are managed by an affiliate of our Manager. We are committed to invest $6.5 million in these unconsolidated joint ventures to fund future investments and cover future expenses should they occur. 55 Table of Contents Dividends To maintain our qualification as a REIT, U.S. federal income tax law generally requires that we distribute at least 90% of our REIT taxable income annually, determined without regard to the deduction for dividends paid and excluding net capital gains. We must pay tax at regular corporate rates to the extent that we annually distribute less than 100% of our taxable income. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on our repurchase agreements and other debt payable. If our cash available for distribution is less than our taxable income, we could be required to sell assets or borrow funds to make cash distributions, or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities. As discussed above, our distribution requirements are based on REIT taxable income rather than U.S. GAAP net income. The primary differences between our REIT taxable income and U.S. GAAP net income are: (i) unrealized gains and losses on investments that we have elected the fair value option for that are included in current U.S. GAAP income but are excluded from taxable income until realized or settled; (ii) gains and losses on derivative instruments that are included in current U.S. GAAP net income but are excluded from taxable income until realized; and (iii) temporary differences related to amortization of premiums and discounts on investments. For additional information regarding the characteristics of our dividends, refer to Note 12 – “Stockholders' Equity” of our annual report on Form 10-K for the year ended December 31, 2019. Inflation Virtually all of our assets and liabilities are sensitive to interest rates. As a result, interest rates and other factors influence our performance far more than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Unrelated Business Taxable Income We have not engaged in transactions that would result in a portion of our income being treated as unrelated business taxable income. Other Matters We believe that we satisfied each of the asset tests in Section 856(c)(4) of the Internal Revenue Code of 1986, as amended (the "Code") for the period ended June 30, 2020, and that our proposed method of operation will permit us to satisfy the asset tests, gross income tests, and distribution and stock ownership requirements for our taxable year that will end on December 31, 2020. At all times, we intend to conduct our business so that neither we nor our Operating Partnership nor the subsidiaries of our Operating Partnership are required to register as an investment company under the 1940 Act. If we were required to register as an investment company, then our use of leverage would be substantially reduced. Because we are a holding company that conducts our business through our Operating Partnership and the Operating Partnership’s wholly-owned or majority-owned subsidiaries, the securities issued by these subsidiaries that are excepted from the definition of "investment company" under Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any other investment securities the Operating Partnership may own, may not have a combined value in excess of 40% of the value of the Operating Partnership’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis, which we refer to as the 40% test. This requirement limits the types of businesses in which we are permitted to engage in through our subsidiaries. In addition, we believe neither we nor the Operating Partnership are considered an investment company under Section 3(a)(1)(A) of the 1940 Act because they do not engage primarily or hold themselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through the Operating Partnership’s wholly-owned or majority-owned subsidiaries, we and the Operating Partnership are primarily engaged in the non-investment company businesses of these subsidiaries. IAS Asset I LLC and certain of the Operating Partnership’s other subsidiaries that we may form in the future rely upon the exclusion from the definition of "investment company" under the 1940 Act provided by Section 3(c)(5)(C) of the 1940 Act, which is available for entities "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." This exclusion generally requires that at least 55% of each subsidiary’s portfolio be comprised of qualifying assets and at least 80% be comprised of qualifying assets and real estate-related assets (and no more than 20% comprised of miscellaneous assets). (“percentage tests”). The SEC staff has issued a “no-action” letter in which it confirmed that it would not recommend enforcement action if an issuer continues to rely on the exclusion provided by Section 3(c)(5)(C) of the 1940 Act if the issuer does not meet the percentage tests if: (1) the inability to meet those tests is the result of the sale of an underlying asset; (2) proceeds from the sale are invested in government securities, certificates of deposit, or other securities appropriate for the purpose of preserving value pending the investment of the proceeds in assets that meet the percentage tests; and (3) the issuer intends to purchase assets that meet the percentage tests as soon as possible but generally within one year. (Medidentic Mortgage Investors, SEC No-Action Letter (May 23, 1984)). In light of this analysis, we believe that as of June 30, 2020, we conducted our business so as not to be regulated as an investment company under the 1940 Act. 56 Table of Contents