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While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and we seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.
+Added: For additional discussion of market risk associated with the COVID-19 pandemic, see Item Part I.
+Added: Item 1A - Risk Factors of this Report.
Interest Rate Risk
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We are subject to interest rate risk in connection with our investments and our repurchase agreements.
−Removed: Our repurchase agreements are typically of limited duration and will be periodically refinanced at current market rates.
−Removed: We mitigate this risk through utilization of derivative contracts, primarily interest rate swap agreements, TBAs and futures contracts.
+Added: Our repurchase agreements are typically of short-term in nature and are periodically refinanced at current market rates.
+Added: We typically mitigate this interest rate risk by utilizing derivative contracts, primarily interest rate swap agreements, futures contracts and TBAs.
Interest Rate Effect on Net Interest Income
Our operating results depend in large part upon differences between the yields earned on our investments and our cost of borrowing and interest rate hedging activities.
−Removed: Most of our repurchase agreements provide financing based on a floating rate of interest calculated on a fixed spread over LIBOR.
−Removed: The fixed spread will vary depending on the type of underlying asset which collateralizes the financing.
−Removed: Accordingly, the portion of our portfolio which consists of floating interest rate assets are match-funded utilizing our expected sources of short-term financing, while our fixed interest rate assets are not match-funded.
During periods of rising interest rates, the borrowing costs associated with our investments tend to increase while the income earned on our fixed interest rate investments may remain substantially unchanged.
This increase in borrowing costs results in the narrowing of the net interest spread between the related assets and borrowings and may even result in losses.
−Removed: Further, during this portion of the interest rate and credit cycles, defaults could increase and result in credit losses to us, which could adversely affect our liquidity and operating results.
+Added: Further, defaults could increase and result in credit losses to us, which could adversely affect our liquidity and operating results.
Such delinquencies or defaults could also have an adverse effect on the spread between interest-earning assets and interest-bearing liabilities.
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We generally calculate duration using various financial models and empirical data.
−Removed: Different models and methodologies can produce different duration numbers for the same securities.
+Added: Different models and methodologies can produce different duration values for the same securities.
The impact of changing interest rates on fair value can change significantly when interest rates change materially.
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Accordingly, changes in actual interest rates may have a material adverse effect on us.
−Removed: We employ a variety of spread risk management techniques that seek to mitigate the influences of spread changes on our book value per diluted common share and our liquidity to help us achieve our investment objectives.
+Added: We employ a variety of spread risk management techniques that seek to mitigate the influences of spread changes on our book value and our liquidity to help us achieve our investment objectives.
We refer to the difference between interest rates on our investments and interest rates on risk free instruments as spreads.
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We manage spread risk through careful asset selection, sector allocation, regulating our portfolio value-at-risk, and maintaining adequate liquidity.
−Removed: Changes in spreads impact our book value per diluted common share and our liquidity and could cause us to sell assets and to change our investment strategy in order to maintain liquidity and preserve book value per diluted common share.
+Added: Changes in spreads impact our book value and our liquidity and could cause us to sell assets and to change our investment strategy to maintain liquidity and preserve book value.
+Added: Uncertainties related to the COVID-19 pandemic caused credit spreads to widen significantly in the second half of March 2020 and into April 2020.
+Added: Unprecedented government responses, including fiscal stimulus, monetary policy actions, and various purchase and financing programs have had and will continue to impact credit spreads.
Prepayment Risk
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In general, an increase in prepayment rates will accelerate the accretion of purchase discounts, thereby increasing the interest income earned on the investments.
+Added: Historically low interest rates, high interest rate volatility, uncertainties related to government policies on mortgage finance in response to the COVID-19 pandemic, social distancing, and other factors have made it more difficult to predict prepayment levels for the securities in our portfolio.
+Added: As a result, it is possible that realized prepayment behavior will be materially different from our expectations.
Extension Risk
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Market Value Risk
−Removed: Our available-for-sale securities are reflected at their estimated fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income in accordance with ASC Topic 320.
+Added: Our available-for-sale securities are reflected at their estimated fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income under ASC Topic 320.
The estimated fair value of these securities fluctuates primarily due to changes in interest rates and other factors.
Generally, in a rising interest rate environment, the estimated fair value of these securities would be expected to decrease;
−Removed: conversely, in a decreasing interest rate environment, the estimated fair value of these securities would be expected to increase.
−Removed: The sensitivity analysis table presented below shows the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments and net interest income, including net interest paid or received under interest rate swaps, at December 31, 2019 , assuming a static portfolio.
+Added: conversely, in a falling interest rate environment, the estimated fair value of these securities would be expected to increase.
+Added: The COVID-19 pandemic and related preventative measures have caused unprecedented volatility and illiquidity in fixed income markets.
+Added: The amount of financing we receive under our repurchase agreements is directly related to our counterparties’ valuation of our assets that collateralize the outstanding repurchase agreement financing.
+Added: As a result, if these market conditions persist, margin call risk remains elevated and our operating results and financial condition may be materially impacted.
+Added: The sensitivity analysis table presented below shows the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments and net interest income, including net interest paid or received under interest rate swaps, at December 31, 2020, assuming a static portfolio and constant financing and credit spreads.
When evaluating the impact of changes in interest rates, prepayment assumptions and principal reinvestment rates are adjusted based on our Manager’s expectations.
The analysis presented utilized assumptions, models and estimates of our Manager based on our Manager’s judgment and experience.
−Removed: Change in Interest Rates
−Removed: Percentage Change in Projected
−Removed: Net Interest Income
−Removed: Percentage Change in Projected
+Added: Change in Interest Rates Percentage Change in Projected
+Added: Net Interest Income Percentage Change in Projected
Portfolio Value
+Added: +1.00% 29.73 % (1.91) %
+Added: +0.50% 20.76 % (0.61) %
+Added: -0.50% (23.01) % (0.73) %
+Added: -1.00% (46.95) % (1.59) %
Certain assumptions have been made in connection with the calculation of the information set forth in the foregoing interest rate sensitivity table and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes.
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Furthermore, while we generally expect to retain such assets and the associated interest rate risk to maturity, future purchases and sales of assets could materially change our interest rate risk profile.
−Removed: Given the low interest rates at December 31, 2019 , we applied a floor of 0% for all anticipated interest rates included in our assumptions.
−Removed: Because of this floor, we anticipate that any hypothetical interest rate shock decrease would have a limited positive impact on our funding costs;
−Removed: however, because prepayment speeds are unaffected by this floor, we expect that any increase in our prepayment speeds (occurring as a result of any interest rate decrease or otherwise) could result in an acceleration of our premium amortization on securities purchased at a premium, and accretion of discount on our securities purchased at a discount.
−Removed: As a result, because this floor limits the positive impact of any interest rate decrease on our funding costs, hypothetical interest rate decreases could cause the fair value of our financial instruments and our net interest income to decline.
+Added: Our scenario analysis assumes a floor of 0% for U.S.
+Added: Treasury yields.
+Added: Given the relatively low interest rates at December 31, 2020, to be consistent, we also applied a floor of 0% for all related funding costs.
+Added: Due to this floor, we anticipate that declines in funding costs resulting from a significant interest rate decrease would be limited.
+Added: At the same time, increases in prepayment speed forecasts resulting from lower rates are also limited by this assumption.
+Added: For purposes of our calculations, the net interest income projections are determined for each specific security.
+Added: In contrast, for the market value analysis, this floor may limit the gains in market values in scenarios where the interest rate drops significantly.
The information set forth in the interest rate sensitivity table above and all related disclosures constitutes forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act.
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national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors);
−Removed: local real estate conditions (such as the supply of housing stock);
+Added: local real estate conditions (such as the supply of housing stock or other property sectors);
changes or continued weakness in specific industry segments;
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In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could also cause us to suffer losses.
−Removed: We believe that our investment strategy will generally keep our credit losses and financing costs low.
−Removed: However, we retain the risk of potential credit losses on all of our residential and commercial mortgage investments.
+Added: We retain the risk of potential credit losses on all of our residential and commercial mortgage investments.
We seek to manage this risk through our pre-acquisition due diligence process.
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We also review key loan credit metrics including, but not limited to, payment status, current loan-to-value ratios, current borrower credit scores and debt yields.
−Removed: These characteristics assist in determining the likelihood and severity of loan loss as well as prepayment and extension expectations.
+Added: These characteristics assist in determining the likelihood and severity of loan loss as well as prepayment and
+Added: extension expectations.
We then perform structural analysis under multiple scenarios to establish likely cash flow profiles and credit enhancement levels relative to collateral performance projections.
This analysis allows us to quantify our opinions of credit quality and fundamental value, which are key drivers of portfolio management decisions.
+Added: The conditions related to the COVID-19 pandemic have adversely affected the fundamentals of many of our portfolio investments.
+Added: The significant decrease in economic activity and/or resulting decline in the housing market could have an adverse effect on the value of our investments in mortgage real estate-related assets.
+Added: Further, because of the COVID-19 pandemic’s impact on the overall economy, such as rising unemployment levels or changes in consumer behavior related to loans as well as government policies and pronouncements, borrowers may experience difficulties meeting their obligations or seek to forbear or further forbear payment on or refinance their mortgage loans to avail themselves of lower rates.
+Added: In addition to residential mortgage-related assets, the adverse economic conditions could negatively impact tenants underlying our commercial property assets resulting in potential delinquencies, defaults or declines in asset values.
+Added: In many instances, tenants are foregoing rent payments or seeking forbearance.
+Added: As a result, loans may experience increased delinquencies and defaults, which could impact the fundamental performance of our mortgage-backed securities.
+Added: Further, we expect credit rating agencies to reassess transactions that are negatively impacted by these adverse changes.
+Added: This may result in our investments being downgraded by credit rating agencies.
Foreign Exchange Rate Risk
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• attempting to structure our financing agreements to have a range of different maturities, terms, amortizations and interest rate adjustment periods;
+Added: • exploring options to obtain financing arrangements that are not marked to market;
• using hedging instruments, primarily interest rate swap agreements but also financial futures, options, interest rate cap agreements, floors and forward sales to adjust the interest rate sensitivity of our target assets and our borrowings;
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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.