Invesco Mortgage Capital Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes to our consolidated financial statements, which are included in Part IV, Item 15 of this Report. Overview We are a Maryland corporation primarily focused on investing in, financing and managing mortgage-backed securities (“MBS”) and other mortgage-related assets. Our objective is to provide attractive risk-adjusted returns to our stockholders, primarily through dividends and secondarily through capital appreciation. To achieve this objective, we have 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”); • 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 Fannie Mae or Freddie Mac (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”); 39 Table of Contents • To-be-announced securities forward contracts ("TBAs") to purchase Agency RMBS; • Residential and commercial mortgage loans; and • Other real estate-related financing arrangements. We conduct our business through IAS Operating Partnership L.P. (our “Operating Partnership”). We are externally managed and advised by Invesco Advisers, Inc. (our “Manager”), an indirect wholly-owned subsidiary of Invesco Ltd. (“Invesco”). We have 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 an “Investment Company” under the 1940 Act. In the first half of 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 in the latter part of March. We notified our financing counterparties on March 23, 2020 that we were not in a position to fund the margin calls we received and that we did not expect to be in a position to fund the anticipated volume of future margin calls under our financing arrangements. To generate liquidity and reduce leverage in the first half of 2020, we sold a substantial portion of our MBS and GSE CRT portfolio. During the year ended December 31, 2020, we repaid all of our repurchase agreements that may not have been in compliance under our borrowing agreements and repaid our secured borrowings from the FHLBI. We resumed investing in Agency RMBS in July 2020 with approximately 98% of our portfolio, excluding TBAs, invested in Agency RMBS at year end. We are financing our purchases of Agency RMBS with repurchase agreements and are in compliance with the terms of our financing arrangements as of December 31, 2020. We also began investing in TBAs as an alternative means of investing in and financing Agency RMBS in the third quarter of 2020. These TBAs are accounted for as derivative instruments under U.S. GAAP. We continue to hold unencumbered credit assets and 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. On March 24, 2020, we announced that we would delay the payment of quarterly dividends on our common and preferred stock to preserve liquidity until we could more accurately assess the impact of volatile market conditions related to the COVID-19 pandemic. On May 9, 2020, our board of directors approved payment of the previously declared common and preferred dividends. 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. We paid cash dividends of $0.02, $0.05 and $0.08 per share on our common stock for the second, third and fourth quarter of 2020, respectively. Dividends on our Series A Preferred, Series B Preferred and Series C Preferred Stock are current. While the Federal Reserve has taken a number of proactive measures to bolster liquidity, we expect market conditions to continue to be challenging due to the uncertainty around the duration and ultimate impact of the COVID-19 pandemic. Invesco 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, the majority of our Manager’s employees are working remotely. 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 to manage client assets. Additionally, our Manager’s operational, control and support teams have successfully transitioned to a remote working environment. Factors Impacting Our Operating Results Our operating results can be affected by a number of factors and primarily depend on the level of our net interest income and the market value of our assets. Our net interest income, which includes the amortization of purchase premiums and accretion of purchase discounts, varies primarily as a result of changes in market interest rates and prepayment speeds, as measured by the constant prepayment rate (“CPR”) on our assets. Interest rates and prepayment speeds vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. The market value of our assets can be impacted by credit spread premiums (yield advantage over U.S. Treasury notes) and the supply of, and demand for, assets in which we invest. 40 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 eased over the course of 2020, as conditions continued to improve during the third and fourth quarter. This reflected the continued economic recovery following the sharp declines brought on by the onset of the COVID-19 pandemic earlier in the year. The performance of U.S. equities also followed this pattern, with the S&P 500 Index increasing by almost 12% during the fourth quarter and over 16% for the year despite falling sharply during the first quarter. Investor confidence was bolstered through the year as the U.S. Government embarked on multiple stimulus packages. The Federal Reserve provided unprecedented support to the markets via direct securities purchases, implementing various lending programs and facilities, and pledging to keep the Federal Funds rate in a range of 0% to 0.25% for an extended period. Gains in nonfarm payrolls averaged 283,000 per month during the fourth quarter, and the unemployment rate ended the year at 6.7%, improving from the high of 14.7% that was recorded in April. The continued rebound in economic activity from the March and April trough can be seen across a number of measures, as consumer activity remained positive as evidenced by gains in spending, retail sales and consumer confidence metrics. While the continued economic recovery is encouraging, we remain cautious about the pace of near-term gains as the number of COVID-19 cases has remained elevated with the vaccine rollout underway. Interest rates fell sharply across the yield curve during 2020, reflecting both the effects of the Federal Reserve’s bond buying program and investor demand for safe-haven assets. The yield on the 2 year Treasury note fell 145 basis points to 0.12% while the yield on the 10 year Treasury bond fell by 100 basis points to 0.91%. During the fourth quarter, the yield curve steepened as investors began pricing in the impact of further stimulus along with positive news regarding multiple vaccine trials. During the quarter, the yield on the 2 year Treasury note fell one basis point while the yield on the 10 year bond increased by 23 basis points. 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 continues to forecast no change for the next several years. Interest rate volatility measures also reflect the view that rates will stay contained, as these remain near multi-year lows. While price data has broadly shown a rebound off the lows of March and April, most measures still show that inflation remains subdued. The consumer price index was 1.4% at year end, well off the low of 0.1% in May, but still lower than pre-COVID levels. The personal consumption expenditure index (1.5% at year end) also increased in the fourth quarter but remains close to pre-COVID lows. On the other hand, breakeven rates on inflation protected Treasuries have broken out to levels not seen in several years as investors price in the potential impact on prices of the recent stimulus measures and positive growth expectations. The inflation rate implied by 2 year and 5 year TIPs was 2.01% and 1.97%, respectively, at year end. The COVID-19 pandemic has negatively impacted most commercial real estate property types. The lodging and retail sectors have been the most impacted due to travel restrictions and accelerated growth in e-commerce. In the retail sector, many tenants 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 fourth quarter due to modest new issuance supply and increased investor demand. The United States Federal Reserve’s Term Asset-Backed Securities Loan Facility (“TALF”) that provides financing for triple-A rated conduit non-Agency CMBS also continued to contribute to stability in the CMBS market. While residential real estate fundamentals deteriorated significantly at the onset of the pandemic, low mortgage rates and tight housing supply have driven a dramatic recovery. Demographic trends and changes in housing preferences shaped by the COVID-19 pandemic have combined with improved affordability to generate robust demand, especially for single family homes. This strength is also reflected in home price appreciation, which accelerated in the second half of the year. Meanwhile, credit spreads on residential mortgage backed securities have largely recovered the widening that occurred at the onset of the pandemic. Nevertheless, many individual homeowners have been adversely impacted by the economic consequences of the COVID-19 pandemic. The U.S. Congress has responded 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 has and will continue to substantially reduce borrower defaults and loan losses relative to levels that would have likely occurred without these actions. 41 Table of Contents The performance of Agency RMBS was mixed during 2020, as sharp underperformance during the first quarter was mostly offset by significant gains resulting from the Federal Reserve’s strong response to the liquidity crisis, which included a bond purchase program beginning in March. The Agency RMBS sector also received support from commercial banks, as bank deposits overwhelmed tepid loan demand and left banks with significant amounts to invest in the sector. Lower coupon mortgages were the primary beneficiary of the Federal Reserve and commercial bank demand, as those bonds experienced significant spread tightening and a favorable dollar roll environment for most of the year. Higher coupon mortgages did not fare as well, as their relatively high dollar prices exacerbate the impact of increasing prepayment rates. Pay-ups on specified pool collateral remained elevated, reflecting strong demand for prepayment protection. We expect the market for Agency RMBS to remain positive, as the level of support from the Federal Reserve outweighs the negative impact of higher prepayment rates. As we move into 2021, investor concerns center around the pace of the recovery and the implementation of vaccines to combat and eventually bring an end to the COVID-19 pandemic. Our expectation is that growth in the U.S. will remain robust as the economy continues to reopen over the course of the year. In addition, the regulatory landscape for our repurchase agreement counterparties continues to evolve, which may affect funding methods and lending practices. While we are not directly subject to compliance with the implementation of rules regarding financial institutions, the effect of these regulations and others could impact our ability to finance our assets in the future. 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 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. Further, on November 30, 2020, ICE Benchmark Administration (“IBA”), the administrator of LIBOR, released a consultation on its intention to cease the publication of the one week and two month U.S. Dollar (“USD”)-LIBOR settings immediately following the LIBOR publication on December 31, 2021, and the five remaining USD-LIBOR settings (overnight and one, three, six and twelve months) immediately following the LIBOR publication on June 30, 2023. 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 or 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. We do not currently intend to amend our 7.75% Fixed-to-Floating Series B Cumulative Redeemable Preferred Stock or our 7.50% Fixed-to-Floating Series C Cumulative Redeemable Preferred Stock to change the existing USD-LIBOR cessation fallback language. Our Series B and Series C Preferred Stock each become callable at the time the stock begins to pay a USD-LIBOR-based rate. Should we choose to call the Series B or Series C Preferred Stock in order to avoid a dispute over the results of the USD-LIBOR fallbacks for that class, we may be forced to raise additional funds at an unfavorable time. 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. 42 Table of Contents The guidance can be applied as of January 1, 2020. We will evaluate our contracts that are eligible for modification relief and may apply the elections prospectively as needed. We are currently evaluating what impact the guidance will have on our consolidated financial statements. Investment Activities The table below shows the breakdown of our investment portfolio as of December 31, 2020 and 2019: $ in thousands As of December 31, 2020 2019 Agency RMBS: 30 year fixed-rate, at fair value 8,050,866 10,524,220 15 year fixed-rate, at fair value — 292,414 Hybrid ARM, at fair value — 56,893 Agency CMO, at fair value — 427,512 Agency CMBS, at fair value — 4,767,930 Non-Agency CMBS, at fair value 109,583 3,823,474 Non-Agency RMBS, at fair value 11,733 955,671 GSE CRT, at fair value — 923,672 Loan participation interest, at fair value — 44,654 Commercial loan 23,098 24,055 Investments in unconsolidated ventures 16,408 21,998 Subtotal 8,211,688 21,862,493 TBAs, at implied cost basis (1) 1,772,211 — Total investment portfolio, including TBAs 9,983,899 21,862,493 (1) TBAs that we do not intend to physically settle on the contractual settlement date are accounted for as derivative financial instruments and recorded on our consolidated balance sheets at net carrying value, which represents the difference between the fair market value and the implied cost basis of the TBAs. Refer to Note 8 "Derivatives and Hedging Activities" in Part IV. Item 15. of this report on Form 10-K. As of December 31, 2020 our holdings of 30 year fixed-rate Agency RMBS represented 81% of our total investment portfolio, including TBAs, versus 48% as of December 31, 2019. As previously discussed, we sold substantially all of our Agency RMBS portfolio in the first half of 2020 to generate liquidity and reduce leverage. We resumed investing in 30-year fixed-rate Agency RMBS in July 2020. Our Agency RMBS holdings as of December 31, 2020 consisted primarily of newly issued specified pools with coupon distributions as shown in the table below. $ in thousands Fair Value Percentage 1.5% 106,377 1.3 % 2.0% 3,492,399 43.4 % 2.5% 3,784,539 47.0 % 3.0% 667,551 8.3 % Total Agency RMBS 8,050,866 100.0 % Our purchases of Agency RMBS have been primarily focused on specified pools with prepayment protection, as low mortgage rates and a robust housing market have increased borrower incentives to prepay their mortgage loans. We seek to mitigate the negative impact of prepayments on our investment portfolio by purchasing specified pools with characteristics that diminish borrower incentive to prepay, such as a lower loan balance, higher loan-to-value ( “ LTV ” ) ratio, lower FICO score, higher percentage of non-owner occupied loans (investment and vacation properties) and newly originated loans. In addition, we focus a significant amount of purchases in specified pools that have higher geographic concentrations in states that exhibit slower prepayments such as New York, Florida and Texas. 43 Table of Contents We began investing in TBAs as an alternative means of investing in and financing Agency RMBS in the third quarter of 2020. As of December 31, 2020, the implied cost basis of TBAs represented approximately 18% of our total investment portfolio. Our investments consist of 30-year Agency RMBS TBAs with coupons that range from 2.0% to 2.5% in conventional and Ginnie Mae collateral. We maintain a meaningful allocation to TBAs given attractive implied financing rates in the Agency RMBS TBA dollar roll market. Implied financing rates in the dollar roll market were substantially below those available in the repurchase market due to the magnitude and persistence of the Federal Reserve's MBS purchase program, which began to increase holdings in March of 2020. We expect the purchase program to continue in 2021, as the Federal Reserve views the program as a key component of its stated objectives. We sold all of our holdings of Agency CMBS in the first half of 2020. Agency CMBS represented approximately 22% of our investment portfolio as of December 31, 2019. We historically focused our Agency CMBS investments in securities issued by Freddie Mac, Fannie Mae and Ginnie Mae that had characteristics that reduced prepayment risk. As of December 31, 2020, our holdings of non-Agency CMBS represented approximately 1% of our total investment portfolio, including TBAs, versus 17% as of December 31, 2019. Our non-Agency CMBS portfolio is collateralized by loans that were originated before 2015 that are secured by various property types located across the United States. Property types include but are not limited to office, retail, multifamily, industrial warehouses and hotels. The largest property geographic locations include Texas, Ohio, California, New York and Virginia as detailed in the table below. Most of our non-Agency CMBS portfolio is comprised of fixed-rate securities that are rated investment grade by a nationally recognized statistical rating organization. Approximately 75% of non-Agency CMBS are rated single-A (or equivalent) or higher by a nationally recognized statistical rating organization as of December 31, 2020. Further, approximately 59% of non-Agency CMBS are rated double-A (or equivalent) or higher by a nationally recognized statistical rating organization as of December 31, 2020. The table below illustrates the vintage distribution of our non-Agency CMBS portfolio as of December 31, 2020 as a percentage of fair value: 2010 2011 2012 2013 2014 Non-Agency CMBS 44.0 % — % 20.2 % 26.2 % 9.6 % The table below presents the geographic concentration of the underlying collateral for our non-Agency CMBS portfolio as of December 31, 2020. The geographic markets that we invest in have been and continue to be severely impacted by the ongoing COVID-19 pandemic. Non-Agency CMBS State Percentage Texas 22.1 % Ohio 10.8 % California 10.0 % New York 9.1 % Virginia 6.0 % Washington DC 5.5 % Florida 4.3 % Illinois 3.8 % Georgia 2.6 % Connecticut 2.5 % Other 23.3 % Total 100.0 % As of December 31, 2020, our holdings of non-Agency RMBS represented less than 1% of our total investment portfolio, including TBAs, versus 4% as of December 31, 2019. We historically held non-Agency RMBS securities collateralized by prime and Alt-A loans and invested in re-securitizations of real estate mortgage investment conduit ("Re-REMIC") RMBS and securitizations of reperforming mortgage loans. We did not hold any GSE CRTs as of December 31, 2020. Our holdings of GSE CRTs represented approximately 4% of our total investment portfolio, including TBAs, as of December 31, 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. 44 Table of Contents As of December 31, 2020, we held an investment in one commercial real estate mezzanine loan that matures in 2021 and has a LTV ratio of approximately 78.9%. Refer to Note 16 – “Subsequent Events” of our consolidated financial statements in Part IV of this Report for additional information on the contractual maturity of our commercial loan. As of December 31, 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 $6.8 million in additional capital in these unconsolidated ventures to fund future investments and cover future expenses should they occur. Financing and Other Liabilities. We have historically used repurchase agreements to finance the majority of our target assets and expect to continue 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 also used secured loans from the FHLBI to finance a portion of our investment portfolio. We repaid our secured loans during 2020 with proceeds from sales of assets that collateralized the secured loans. We terminated our membership in FHLBI in the third quarter of 2020. 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) March 31, 2019 18,474,387 17,229,809 18,474,387 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 September 30, 2020 5,243,288 3,373,356 5,243,288 December 31, 2020 7,228,699 6,883,773 7,237,496 (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 generally hedge as much of our interest rate and foreign exchange risk as we deem prudent because of market conditions. No assurance can be given that our hedging activities will have the desired beneficial impact on our results of operations or financial condition. Our investment policies do not contain specific requirements as to the percentages or amount of risk that we are required to hedge. Hedging may fail to protect or could adversely affect us because, among other things: • available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought; • the duration of the hedges may not match the duration of the related liabilities; • our counterparty in the hedging transaction may default on its obligation to pay; • the credit quality of our counterparty on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and • the value of derivatives used for hedging may be adjusted from time-to-time in accordance with accounting rules to reflect changes in fair value. 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 generally pay fixed interest rates and receive floating interest rates indexed off of one- or three-month LIBOR. 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 repositioned our portfolio in response to unprecedented market conditions associated with the COVID-19 pandemic. We realized a net loss of $904.7 million 45 Table of Contents on these swaps during the first half of 2020 due to falling interest rates. We entered into new swaps during the six months ended December 31, 2020 as we resumed investing in Agency RMBS and financing our investments with repurchase agreements. As of December 31, 2020, we had $6.3 billion of notional amount of interest rate swaps. All of these interest rate swaps are centrally cleared by a registered clearing organization. We realized a net gain of $47.0 million on these swaps during the second half of 2020. We enter into currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on investments denominated in foreign currencies. As of December 31, 2020, we had €27.8 million or $33.1 million (2019: €20.8 million or $23.1 million) of notional amount of forward contracts related to our investment in an unconsolidated venture. During the year ended December 31, 2020, we settled currency forward contracts of €83.4 million or $93.4 million (2019: €89.8 million or $101.6 million) in notional amount and realized a net loss of $1.3 million (2019: $1.5 million net gain). Capital Activities On February 6, 2020, we completed a public offering of 20,700,000 shares of common stock at the price of $16.78 per share. Total net proceeds were approximately $347.0 million after deducting offering costs. On February 4, 2021, we completed a public offering of 27,600,000 shares of common stock at the price of $3.75 per share. Total net proceeds were approximately $103.1 million after deducting estimated offering costs. As of December 31, 2020, we may sell up to 37,610,000 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 sold 21,849,740 shares of common stock for proceeds of $73.7 million, net of approximately $1.2 million in commissions and fees, under these agreements during the year ended December 31, 2020. For information on dividends declared and paid during the year ended December 31, 2020, including our common stock dividend paid on June 30, 2020 in a combination of cash and shares of our common stock, see Note 12 - "Stockholders' Equity" of our consolidated financial statements in Part IV. Item 15 of this report on Form 10-K. During the year ended December 31, 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: Years Ended December 31, In thousands except per share amounts 2020 2019 2018 Numerator (adjusted equity): Total equity 1,367,158 2,931,899 2,286,697 Less: Liquidation preference of Series A Preferred Stock (140,000) (140,000) (140,000) Less: Liquidation preference of Series B Preferred Stock (155,000) (155,000) (155,000) Less: Liquidation preference of Series C Preferred Stock (287,500) (287,500) (287,500) Total adjusted equity 784,658 2,349,399 1,704,197 Denominator (number of shares): Common stock outstanding 203,222 144,256 111,585 Book value per common share 3.86 16.29 15.27 Our book value per common share decreased 76.3% as of December 31, 2020 compared to December 31, 2019 primarily due to realized and unrealized losses on investments and derivatives during the year ended December 31, 2020 resulting from the unprecedented market disruption caused by the COVID-19 pandemic. Our book value per common share increased 6.7% as of December 31, 2019 compared to December 31, 2018 primarily due to interest rate spread tightening in both Agency and credit assets. Monetary policy eased notably in 2019, as the Federal Reserve pivoted from increasing in the Federal Funds rate in 2018 to an easing policy through a pause in the first half of 2019 and cutting the Federal Funds rate in the second half of 2019. This shift in monetary policy supported risk assets, with additional steps by the Federal Reserve, such as increasing the size of its balance sheet via asset purchases and supporting the repurchase market through temporary open market operations, supporting market liquidity. 46 Table of Contents Refer to Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” for interest rate risk and its impact on fair value. Critical Accounting Policies Our consolidated financial statements are prepared in accordance with U.S. GAAP, which requires the use of estimates and assumptions that involve the exercise of judgment and use of assumptions as to future uncertainties. Accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. All of these estimates reflect our best judgment about current, and for some estimates, future economic and market conditions and their effects based on information available as of the date of these financial statements. If conditions change from those expected, it is possible that the judgments and estimates described below could change, which may result in a change in valuation of our investment portfolio, allowances for credit losses on our available-for-sale MBS, change in our interest income recognition, and a change in our tax liability among other effects. Mortgage-Backed and Credit Risk Transfer Securities. We have elected the fair value option for all of our MBS purchased on or after September 1, 2016; our GSE CRTs purchased on or after August 24, 2015; and all of our RMBS IOs. Under the fair value option, changes in fair value are recognized in the consolidated statement of operations. In our view, the fair value option election more appropriately reflects the results of our operations because MBS and GSE CRT fair value changes are accounted for in the same manner as fair value changes in economic hedging instruments. As of December 31, 2020, $8.1 billion (December 31, 2019: $17.4 billion) or 99% (December 31, 2019: 80%) of our MBS and GSE CRT are accounted for under the fair value option. We record our MBS purchased before September 1, 2016, as available-for-sale and report these MBS at fair value. We recorded our GSE CRTs purchased before August 24, 2015 as hybrid financial instruments and reported these GSE CRTs at fair value. We did not hold any GSE CRTs as of December 31, 2020. We determine the fair value of our MBS and GSE CRTs by obtaining valuations from an independent source. If the fair value of a security is not available from a third-party pricing service, we may estimate the fair value of the security using a variety of methods including other pricing services, discounted cash flow analysis, matrix pricing, option adjusted spread models and other fundamental analysis of observable market factors. It is possible that changes in these inputs could change the valuation estimate and lead us to establish allowances for credit losses on our available-for-sale MBS. Further information is provided in Note 2 - “Summary of Significant Accounting Policies” and Note 4 - “Mortgage-Backed and Credit Risk Transfer Securities.” Interest Income Recognition. Interest income on MBS is accrued based on the outstanding principal or notional balance of the securities and their contractual terms. Premiums or discounts are amortized or accreted into interest income over the life of the investment using the effective interest method. Interest income on our MBS where we may not recover substantially all of our initial investment is based on estimated future cash flows. We estimate future expected cash flows at the time of purchase and determine the effective interest rate based on these estimated cash flows and our purchase price. Over the life of the investments, we update these estimated future cash flows and compute a revised yield based on the current amortized cost of the investment, unless those changes will be reflected in an allowance for credit losses. In situations where an allowance for credit losses is limited by the fair value of the investment, we compute the yield as the rate that equates expected future cash flows to the current fair value of the investment. In estimating these future cash flows, there are a number of assumptions that are subject to uncertainties and contingencies, including but not limited to the rate and timing of principal payments (prepayments, repurchases, defaults and liquidations), the pass through or coupon rate, and interest rate fluctuations. These uncertainties and contingencies are difficult to predict and are subject to future events that may impact our estimate and our interest income. Changes in our original or most recent cash flow projections may result in a prospective change in interest income recognized on these securities, or the amortized cost of these securities. For non-Agency RMBS not of high credit quality, when actual cash flows vary from expected cash flows, the difference is recorded as an adjustment to the amortized cost of the security, unless those changes will be reflected in an allowance for credit losses, and the security's yield is revised prospectively. For Agency RMBS and Agency CMBS that cannot be prepaid in such a way that we would not recover substantially all of our initial investment, interest income recognition is based on contractual cash flows. We do not estimate prepayments in applying the effective interest method. Interest income on GSE CRTs purchased before August 24, 2015 was accrued based on the coupon rate of the debt host contract which reflected the credit risk of GSE unsecured senior debt with a similar maturity. Premiums or discounts associated with the purchase of credit risk transfer securities were amortized or accreted into interest income over the life of the debt host contract using the effective interest method. Interest income on GSE CRTs purchased on or after August 24, 2015 is based on estimated future cash flows. 47 Table of Contents Interest income from our commercial and other loans is recognized when earned and deemed collectible or until a loan becomes past due based on the terms of the loan agreement. Accounting for Derivative Financial Instruments. We use derivatives to manage interest rate and currency exchange risk and as an alternative means of investing in and financing Agency RMBS. We record all derivatives on our consolidated balance sheets at fair value. Effective December 31, 2013, we voluntarily discontinued hedge accounting for our interest rate swap agreements by de-designating the interest rate swaps as cash flow hedges. As a result of discontinuing hedge accounting, changes in the fair value of the interest rate swaps are recorded in gain (loss) on derivative instruments, net in our consolidated statement of operations, rather than in accumulated other comprehensive income (loss). Further information is provided in Note 8 - “Derivatives and Hedging Activities.” of our consolidated financial statements included in Part IV of this Report. Income Taxes. We have elected to be taxed as a REIT. Accordingly, we generally will not be subject to U.S. federal and applicable state and local corporate income tax to the extent that we make qualifying distributions and provided we satisfy on a continuing basis, through actual investment and operating results, the REIT requirements including certain asset, income, distribution and stock ownership tests. The REIT qualifications rules are complex and failure to apply them correctly could subject us to U.S. federal, state and local income taxes. Expected Impact of New Authoritative Guidance on Future Financial Information In January 2021, the Financial Accounting Standards Board expanded existing accounting guidance for evaluating the effects of reference rate reform on financial reporting. The new guidance expands the temporary optional expedients and exceptions to U.S. GAAP for contract modifications, hedge accounting and other relationships that reference London Interbank Overnight Financing Rate ("LIBOR") to apply to all derivative instruments affected by the market-wide change in the interest rates used for discounting, margining or contract price alignment (commonly referred to as the discounting transition). The guidance can be applied as of January 1, 2020. We will evaluate our contracts that are eligible for modification relief and may apply the elections prospectively as needed. We are currently evaluating what impact the guidance will have on our consolidated financial statements . 48 Table of Contents Results of Operations Our consolidated results of operations for the years ended December 31, 2020, 2019 and 2018 are summarized below: Years Ended December 31, $ in thousands except share data 2020 2019 2018 Interest income Mortgage-backed and credit risk transfer securities 277,400 772,657 631,478 Commercial and other loans 2,766 5,710 11,538 Total interest income 280,166 778,367 643,016 Interest expense Repurchase agreements 73,607 430,697 301,794 Secured loans 8,655 41,623 35,453 Exchangeable senior notes — — 1,621 Total interest expense 82,262 472,320 338,868 Net interest income 197,904 306,047 304,148 Other income (loss) Gain (loss) on investments, net (961,938) 624,466 (327,700) (Increase) decrease in provision for credit losses (1,768) — — Equity in earnings of unconsolidated ventures 1,163 2,224 3,402 Gain (loss) on derivative instruments, net (851,050) (534,755) (5,277) Realized and unrealized credit derivative income (loss), net (35,312) 8,343 (151) Net gain (loss) on extinguishment of debt 14,742 — (26) Other investment income (loss), net 2,137 3,950 2,860 Total other income (loss) (1,832,026) 104,228 (326,892) Expenses Management fee — related party 29,367 38,173 40,722 General and administrative 10,863 8,001 7,070 Total expenses 40,230 46,174 47,792 Net income (loss) (1,674,352) 364,101 (70,536) Net income attributable to non-controlling interest — — 254 Net income (loss) attributable to Invesco Mortgage Capital Inc. (1,674,352) 364,101 (70,790) Dividends to preferred stockholders 44,426 44,426 44,426 Net income (loss) attributable to common stockholders (1,718,778) 319,675 (115,216) Earnings (loss) per share: Net income (loss) attributable to common stockholders Basic (9.89) 2.42 (1.03) Diluted (9.89) 2.42 (1.03) Weighted average number of shares of common stock: Basic 173,730,389 132,305,568 111,637,035 Diluted 173,730,389 132,317,853 111,637,035 49 Table of Contents Interest Income and Average Earning Asset Yields The table below presents information related to our average earning assets and earning asset yields as of and for the years ended December 31, 2020, 2019 and 2018. As of and for the Years Ended December 31, $ in thousands 2020 2019 2018 Average earning assets (1) 7,895,394 20,566,255 18,088,843 Average earning asset yields (2) 3.55 % 3.78 % 3.55 % (1) Average balances for each period are based on weighted month-end balances. (2) Average earning asset yields for the period were calculated by dividing interest income, including amortization of premiums and discounts, by average earning assets based on the amortized cost of the investments. All yields are annualized. Our primary source of income is interest earned on our investment portfolio. We had average earning assets of approximately $7.9 billion during the year ended December 31, 2020 (2019: $20.6 billion; 2018: $18.1 billion). As previously discussed, we experienced unprecedented market conditions as a result of the COVID-19 pandemic and sold a substantial portion of our MBS and GSE CRT portfolio in the first half of 2020 to generate liquidity and reduce leverage. Average earning assets decreased during the year ended December 31, 2020 compared to the same periods in 2019 primarily due to these asset sales. We resumed investing in Agency RMBS in July 2020. Due to the magnitude of changes in our investment portfolio since December 31, 2019, our average earning assets and asset yields for the year ended December 31, 2020 are not indicative of our future ability to generate interest income. Average earning assets increased during the year ended December 31, 2019 compared to 2018 primarily because we invested and leveraged $508.9 million in net proceeds from 2019 common stock issuances and $168.5 million in proceeds from commercial loan repayments since the beginning of 2018 into newly issued 30 year fixed-rate Agency RMBS and Agency CMBS securities. We earned interest income of $280.2 million (2019: $778.4 million; 2018: $643.0 million) during 2020. Our interest income consists of 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. Years Ended December 31, $ in thousands 2020 2019 2018 Interest Income MBS and GSE CRT - coupon interest 298,613 833,376 689,240 MBS and GSE CRT - net premium amortization (21,213) (60,719) (57,762) MBS and GSE CRT - interest income 277,400 772,657 631,478 Commercial and other loans 2,766 5,710 11,538 Total interest income 280,166 778,367 643,016 MBS and GSE CRT interest income decreased $495.3 million during the year ended December 31, 2020 compared to 2019 primarily due to a $534.8 million decrease in coupon interest reflecting lower average earning assets. Lower coupon interest was offset by a $39.5 million decrease in net premium amortization during the year ended December 31, 2020 primarily due to sales of assets purchased at premiums. Interest income on our commercial and other loans decreased $2.9 million during the year ended December 31, 2020, primarily due to the sale of our loan participation interest in April 2020 and repayments on commercial loans. MBS and GSE CRT interest income increased $141.2 million during the year ended December 31, 2019 compared to 2018 primarily due to higher coupon interest rates on our higher average earning assets. Interest income on commercial and other loans decreased $5.8 million during 2019 primarily due to commercial loan payoffs. The yield on our average earning assets during the year ended December 31, 2020 was 3.55% (2019: 3.78%; 2018: 3.55%). Our average earning asset yields decreased during the year ended December 31, 2020 compared to 2019 primarily due to changes in portfolio composition. Our average earning asset yields increased during the year ended December 31, 2019 compared to 2018 primarily due to purchases of new securities at higher yields and higher index rates on floating and adjustable rate assets. 50 Table of Contents Prepayment Speeds Our RMBS portfolio (and previously our 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 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 following table presents net (premium amortization) discount accretion recognized on our MBS and GSE CRT portfolio during 2020, 2019 and 2018. Years Ended December 31, $ in thousands 2020 2019 2018 Agency RMBS (32,737) (76,676) (80,750) Agency CMBS (1,744) (4,712) (591) Non-Agency CMBS 14,721 15,347 6,682 Non-Agency RMBS 1,107 13,164 19,968 GSE CRT (2,560) (7,842) (3,071) Net (premium amortization) discount accretion (21,213) (60,719) (57,762) Net premium amortization decreased $39.5 million during 2020 compared to 2019 due to sales of assets purchased at premiums and slower prepayment speeds on newly issued Agency RMBS purchased in the second half of 2020. Net premium amortization increased $3.0 million during 2019 compared to 2018 primarily due to purchases of Agency CMBS at premiums and faster prepayment speeds on Agency RMBS and GSE CRTs. Higher premium amortization was partially offset by changes in asset mix and discount accretion on non-Agency RMBS and non-Agency CMBS. Our interest income is subject to interest rate risk. Refer to Item 7A. “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 years ended December 31, 2020, 2019 and 2018. For the Years Ended December 31, $ in thousands 2020 2019 2018 Interest Expense Interest expense on repurchase agreement borrowings 97,401 454,426 327,633 Amortization of net deferred (gain) loss on de-designated interest rate swaps (23,794) (23,729) (25,839) Repurchase agreements interest expense 73,607 430,697 301,794 Secured loans 8,655 41,623 35,453 Exchangeable senior notes — — 1,621 Total interest expense 82,262 472,320 338,868 Our interest expense on repurchase agreement borrowings decreased $357.0 million for the year ended December 31, 2020 compared to 2019 primarily 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 repayments of repurchase agreements in the first half of 2020 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 $1.65 billion of secured loans during 2020. 51 Table of Contents Our interest expense on repurchase agreement borrowings rose $126.8 million for the year ended December 31, 2019 compared to 2018 primarily due to higher average borrowings and a higher average cost of funds in 2019. We increased our average borrowings in 2019 after investing and leveraging $508.9 million in net proceeds from 2019 common stock issuances and $168.5 million in proceeds from commercial loan repayments since the beginning of 2018 primarily into newly issued 30 year fixed-rate Agency RMBS and Agency CMBS. Our repurchase agreements interest expense includes amortization of deferred gains and losses on de-designated interest rate swaps as summarized in the table above. Amounts recorded in accumulated other comprehensive income (“AOCI”) before we discontinued cash flow hedge accounting for our interest rate swaps are reclassified to interest expense on repurchase agreements on the 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. Amortization of net deferred gains on de-designated interest rate swaps decreased our total interest expense by $23.8 million, $23.7 million and $25.8 million during the years ended December 31, 2020, December 31, 2019 and December 31, 2018, respectively. During the next twelve months, we estimate that $22.0 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. Interest expense for our secured loans decreased for the year ended December 31, 2020 compared to 2019 primarily due to the repayment of $1.65 billion of secured loans during 2020 and lower borrowing rates. Before modification as discussed in Note 6 - “Borrowings” in Part IV of this Report, borrowing rates on our secured loans were based on the three-month FHLB swap rate plus a spread. After modification, borrowing rates on our secured loans were based on the FHLBI's short-term cost of funds. For the year ended December 31, 2020, our secured loans had a weighted average borrowing rate of 1.47% as compared to 2.52% for the year ended December 31, 2019. Interest expense on our secured loans increased for the year ended December 31, 2019 compared to 2018 primarily due to higher borrowing rates as a result of increases in the federal funds target interest rate. For the year ended December 31, 2019, our secured loans had a weighted average borrowing rate of 2.52% as compared to 2.15% for the year ended December 31, 2018. During 2020 and 2019, we did not incur interest expense on exchangeable senior notes (the “Notes”) because the Notes were retired on March 15, 2018. We retired $143.4 million of the Notes in 2018. Our total interest expense during the year ended December 31, 2020 decreased $390.1 million compared to 2019 primarily due to a $390.0 million decrease in interest expense on repurchase agreement borrowings and secured loans. Our total interest expense during the year ended December 31, 2019 increased $133.5 million compared to 2018 primarily due to a $133.0 million increase in interest expense on repurchase agreement borrowings and secured loans that was partially offset by a $1.6 million decrease in interest expense on exchangeable senior notes. The table below presents our average borrowings and cost of funds as of and for the years ended December 31, 2020, 2019 and 2018. As of and for the Years Ended December 31, $ in thousands 2020 2019 2018 Total average borrowings (1) 6,926,790 18,748,843 15,684,869 Maximum borrowings during the period (2) 23,132,234 20,377,801 16,144,062 Cost of funds (3) 1.19 % 2.52 % 2.16 % (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. Total average borrowings decreased $11.8 billion in 2020 compared to 2019 because we repaid $10.3 billion of net repurchase agreements and $1.65 billion of secured loans during 2020 as discussed above. Our cost of funds decreased in 2020 compared to 2019 due to decreases in the Federal Funds rate. Total average borrowings rose $3.1 billion in 2019 compared to 2018 because we entered into repurchase agreements to finance our increased holdings of 30 year fixed-rate Agency RMBS, Agency CMBS, and non-Agency CMBS. The increase in our cost of funds for 2019 versus 2018 was primarily due to increases in the Federal Funds rate throughout 2018. 52 Table of Contents Net Interest Income The table below presents the components of net interest income for the years ended December 31, 2020, 2019 and 2018. For the Years Ended December 31, $ in thousands 2020 2019 2018 Interest Income Mortgage-backed and credit risk transfer securities 277,400 772,657 631,478 Commercial and other loans 2,766 5,710 11,538 Total interest income 280,166 778,367 643,016 Interest Expense Interest expense on repurchase agreement borrowings 97,401 454,426 327,633 Amortization of net deferred (gain) loss on de-designated interest rate swaps (23,794) (23,729) (25,839) Repurchase agreements interest expense 73,607 430,697 301,794 Secured loans 8,655 41,623 35,453 Exchangeable senior notes — — 1,621 Total interest expense 82,262 472,320 338,868 Net interest income 197,904 306,047 304,148 Net interest rate margin 2.36 % 1.26 % 1.39 % Our net interest income, which equals total interest income less total interest expense, totaled $197.9 million (2019: $306.0 million; 2018: $304.1 million) for the year ended December 31, 2020. The decrease in net interest income for the year ended December 31, 2020 compared to 2019 was primarily due the sale of MBS and GSE CRTs in the first half of 2020 as previously discussed. The increase in net interest income for the year ended December 31, 2019 compared to 2018 was primarily due to an increase in interest income driven by higher average assets that exceeded the increase in interest expense driven by higher average borrowings. 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 2.36% (2019: 1.26%; 2018: 1.39%) for the year ended December 31, 2020. The increase in net interest rate margin for 2020 versus 2019 was primarily due to the change in our portfolio composition, including related repurchase agreement borrowings, due to assets sales and decreases in the Federal Funds rate that had a greater impact on our average cost of funds than on our average earning asset yields. The decrease in net interest rate margin for 2019 versus 2018 was primarily due to increases in the federal funds rate throughout 2018 that had a greater impact on our average cost of funds than on our average earning asset yields. Gain (Loss) on Investments, net The table below summarizes the components of gain (loss) on investments, net for the years ended December 31, 2020, 2019 and 2018. Years Ended December 31, $ in thousands 2020 2019 2018 Net realized gains (losses) on sale of investments (363,781) 8,039 (218,136) Impairment of investments the Company intends to sell or more likely than not will be required to sell before recovery of amortized cost basis and other impairments (101,138) — — Other-than-temporary impairment losses — (7,731) (7,846) Net unrealized gains (losses) on MBS and GSE CRT accounted for under the fair value option (492,047) 624,158 (101,697) Net unrealized gains (losses) on commercial loan and loan participation interest (1,164) — — Realized loss on loan participation interest (3,808) — — Net unrealized gains (losses) on trading securities — — (21) Total gain (loss) on investments, net (961,938) 624,466 (327,700) 53 Table of Contents As previously discussed, we experienced unprecedented market conditions as a result of the COVID-19 pandemic in 2020. During the year ended December 31, 2020, we sold MBS and GSE CRTs for cash proceeds of $25.0 billion (2019: $3.3 billion; 2018: $4.7 billion) and realized net losses of $363.8 million (2019: net gains of $8.0 million; 2018: net losses of $218.1 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, particularly during the first half of 2020. 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 $94.1 million of impairment on non-Agency RMBS and non-Agency CMBS during the year ended December 31, 2020 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 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 consolidated financial statements included in Part IV of this Report. We have elected the fair value option for all of our MBS purchased on or after September 1, 2016 and all of our GSE CRTs purchased on or after August 24, 2015. Before September 1, 2016, we had also elected the fair value option for our RMBS IOs. Under the fair value option, changes in fair value are recognized in income in the consolidated statements of operations. As of December 31, 2020, $8.1 billion or 99% (December 31, 2019: $17.4 billion or 80%) of our MBS and GSE CRTs are accounted for under the fair value option. Our percentage of MBS and GSE CRTs accounted for under the fair value option increased as of December 31, 2020 due to a change in portfolio composition. During the first half of 2020, we sold MBS and GSE CRTs previously accounted for as available-for-sale securities primarily to generate liquidity and reduce leverage given unprecedented market conditions as a result of the COVID-19 pandemic. We resumed investing in Agency RMBS in July 2020 and elected the fair value option for these securities. We recorded net unrealized losses on our MBS and GSE CRT portfolio accounted for under the fair value option of $492.0 million in 2020 compared to net unrealized gains of $624.2 million in 2019 and unrealized losses of $101.7 million in 2018. Net unrealized losses in 2020 reflect declines in valuations due to wider interest rate spreads. Net unrealized gains in 2019 reflect lower interest rates, tighter interest rate spreads on the Company's credit assets and Agency CMBS and valuation gains in the Company's specified pool Agency RMBS. Most of our holdings of 30 year fixed-rate Agency RMBS are in specified pools with attractive prepayment characteristics. We recorded a realized loss of $3.8 million on our loan participation interest during year ended December 31, 2020 and unrealized losses of $1.2 million on our commercial loan during the year ended December 31, 2020. We sold the loan participation interest on April 1, 2020. We valued our commercial loan based upon a valuation from an independent pricing service. (Increase) Decrease in Provision for Credit Losses On January 1, 2020, we adopted accounting guidance that requires us to estimate an allowance for credit losses on available-for-sale securities in unrealized loss positions. As of December 31, 2020, approximately $116.9 million of our $8.2 billion of MBS are classified as available-for-sale and subject to evaluation for credit losses. For the year ended December 31, 2020, we recorded a $1.8 million provision for credit losses on a single non-Agency CMBS based on a comparison of the security's amortized cost basis to discounted expected cash flows. Refer to Note 2 – “Summary of Significant Accounting Policies” of our consolidated financial statements included in Part IV of this Report for additional information on how we calculate our provision for credit losses. Equity in Earnings (Losses) of Unconsolidated Ventures For the year ended December 31, 2020, we recorded equity in earnings of unconsolidated ventures of $1.2 million (2019: $2.2 million; 2018: $3.4 million). We recorded equity in earnings for the year ended December 31, 2020, 2019 and 2018 primarily due to realized and unrealized gains on portfolio investments. Gain (Loss) on Derivative Instruments, net We record all derivatives on our consolidated balance sheets at fair value. Changes in the fair value of our derivatives are recorded in gain (loss) on derivative instruments, net in our consolidated statements of operations. Net interest paid or received under our interest rate swaps is also recognized in gain (loss) on derivative instruments, net in our consolidated statements of operations. 54 Table of Contents The tables below summarize the components of our gain (loss) on derivative instruments, net for the years ended December 31, 2020, 2019 and 2018: $ in thousands Year ended December 31, 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 (857,753) 8,047 (24,068) (873,774) Currency Forward Contracts (1,301) — (345) (1,646) TBAs 14,477 — 9,893 24,370 Total (844,577) 8,047 (14,520) (851,050) $ in thousands Year ended December 31, 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 (440,626) 35,840 18,826 (385,960) Futures Contracts (157,929) — 7,836 (150,093) Currency Forward Contracts 1,478 — (180) 1,298 Total (597,077) 35,840 26,482 (534,755) $ in thousands Year ended December 31, 2018 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 81,417 (20,015) 24,358 85,760 Futures Contracts (86,318) — (7,836) (94,154) Currency Forward Contracts 2,088 — 1,046 3,134 TBAs (17) — — (17) Total (2,830) (20,015) 17,568 (5,277) As of December 31, 2020 and 2019, we held the following interest rate swaps whereby we receive interest at a one-month or three-month LIBOR rate: $ in thousands December 31, 2020 December 31, 2019 Derivative instrument Notional Amounts Average Fixed Pay Rate Average Receive Rate Average Maturity (Years) Notional Amounts Average Fixed Pay Rate Average Receive Rate Average Maturity (Years) Interest Rate Swaps 6,300,000 0.41 % 0.15 % 6.7 14,000,000 1.47 % 1.79 % 5.2 We terminated all of our outstanding interest rate swaps in March 2020 as we repositioned our portfolio in response to unprecedented market conditions associated with the COVID-19 pandemic. 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 these interest rate swaps during the first half of 2020 primarily due to falling interest rates. We resumed entering into interest rate swaps in July 2020 as we resumed investing in Agency RMBS and financing our investments with repurchase agreements. As of December 31, 2020, we had $7.2 billion of repurchase agreement borrowings with a weighted average remaining maturity of 14 days. We typically refinance each repurchase agreement at market interest rates upon maturity. We use interest rate swaps to manage our exposure to changing interest rates and add stability to interest rate expense. 55 Table of Contents During the year ended December 31, 2019, we terminated existing swaps with a notional amount of $25.3 billion and entered into new swaps with a notional amount of $27.0 billion to hedge repurchase agreement debt associated with purchases of Agency RMBS and Agency CMBS securities. We realized a net loss of $440.6 million on interest rate swaps in 2019 primarily due to falling interest rates. We recognized contractual net interest income on swaps of $35.8 million for the year ended December 31, 2019 compared to contractual net interest expense of $20.0 million for the year ended December 31, 2018 primarily as a result of higher average LIBOR. Our average interest rate swap receive rate was 2.29% for the year ended 2019 versus 2.10% for the year ended December 31, 2018. We also repositioned our interest rate swap portfolio as LIBOR declined in the second half of 2019 to take advantage of lower interest rate swap fixed pay rates. Our average interest swap fixed pay rate was 2.03% for the year ended December 31, 2019 versus 2.30% for the year ended December 31, 2018. We also use futures contracts to manage our exposure to interest rate risk. As of December 31, 2020 and December 31, 2019, we were not a party to any futures contracts. During the years ended December 31, 2019 and December 31, 2018, we realized net losses of $157.9 million and $86.3 million, respectively, on the settlement of futures contracts due to falling interest rates. D aily 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 consolidated statement of operations. We use currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates. As of December 31, 2020, we had $33.1 million (December 31, 2019: $23.1 million) of notional amount of currency forward contracts related to an investment in an unconsolidated venture denominated in euro. We primarily use TBAs that we do not intend to physically settle on the contractual settlement date as an alternative means of investing in and financing Agency RMBS. As of December 31, 2020, we had $1.7 billion notional amount of TBAs and recorded $24.4 million of realized and unrealized gains during the year ended December 31, 2020. We were not a party to any TBAs accounted for as derivatives as of December 31, 2019 or 2018. 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 years ended December 31, 2020, 2019 and 2018. Years Ended December 31, $ in thousands 2020 2019 2018 GSE CRT embedded derivative coupon interest 6,323 20,833 22,478 Gain (loss) on settlement of GSE CRT embedded derivatives (31,354) — — Change in fair value of GSE CRT embedded derivatives (10,281) (12,490) (22,629) Total realized and unrealized credit derivative income (loss), net (35,312) 8,343 (151) During the year ended December 31, 2020, we recorded realized and unrealized credit derivative losses of $41.6 million, excluding embedded derivative coupon interest. T he decrease from 2019 was primarily driven by a decline in the fair value of our GSE CRT embedded derivatives as asset prices declined due to spread widening. We sold all of our GSE CRTs that were accounted for as hybrid financial instruments with embedded derivatives during the year ended December 31, 2020. During the year ended December 31, 2019, we recorded an unrealized loss on the change in the fair value of our GSE CRT embedded derivatives of $12.5 million because the decreases in valuation of the GSE CRT debt host contracts exceeded the decreases in valuation of the hybrid financial instruments.. Net Gain (Loss) on Extinguishment of Debt As discussed in Note 6 - "Borrowings" of our consolidated financial statements in Part IV of this Report, during 2020, 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 consolidated statement of operations. During the year ended December 31, 2018, we retired $143.4 million of the Notes for a repurchase price of $143.4 million and realized a net loss on extinguishment of debt of $26,000. 56 Table of Contents Other Investment Income (Loss), net Other investment income (loss), net in 2020 and 2019 primarily consists of quarterly dividends from FHLBI stock. Other investment income (loss), net in 2018 primarily consists of (i) quarterly dividends from FHBLI stock and an investment in an exchange-traded fund and (ii) foreign exchange rate gains and losses related to a commercial loan investment denominated in a foreign currency. The table below summarizes the components of other investment income (loss), net for the years ended December 31, 2020, 2019 and 2018. Years Ended December 31, $ in thousands 2020 2019 2018 Dividend income 2,072 3,944 3,790 Gain (loss) on foreign currency transactions, net 65 6 (930) Total 2,137 3,950 2,860 We were required to purchase and hold a certain amount of FHLBI stock, which was based, in part, upon the outstanding principal balance of secured loans from the FHLBI. We earned dividend income on our investment in FHLBI stock, and the amount of our dividend income varied based upon the number of shares that we were required to own and the dividend declared per share. Other investment income (loss), net decreased during the year ended December 31, 2020 compared to 2019 because the FHLBI redeemed our stock at cost during 2020 in connection with the repayment of our secured loans. We terminated our membership in the FHLBI in the third quarter of 2020. We incurred foreign currency losses on the revaluation of a commercial loan investment (notional amount of £34.5 million) for the year ended December 31, 2018 due to a decline in the Pound Sterling/U.S. Dollar foreign exchange rate. This commercial loan was repaid by the borrower during 2018. Expenses For the year ended December 31, 2020, we incurred management fees of $29.4 million (2019: $38.2 million), which are payable to our Manager under our management agreement. Management fees decreased for the year ended December 31, 2020 compared to 2019 due to a lower stockholders' equity management fee base in 2020. Our management fees are calculated quarterly in arrears. Refer to Note 11 – “Related Party Transactions” of our consolidated financial statements in Part IV of this Report for a discussion of our relationship with our Manager and a description of how our fees are calculated. For the year ended December 31, 2019, we incurred management fees of $38.2 million (2018: $40.7 million) that are payable to our Manager under our management agreement. Management fees decreased for the year ended December 31, 2019 compared to 2018 due to a lower stockholders' equity management fee base in 2019. The calculation of the management fee was amended in the fourth quarter of 2019. For the year ended December 31, 2020, our general and administrative expenses not covered under our management agreement amounted to $10.9 million (2019: $8.0 million; 2018: $7.1 million). General and administrative expenses not covered under our management agreement 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 year ended December 31, 2020 compared to 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 $2.6 million. General and administrative costs were higher for the year ended December 31, 2019 compared to 2018 primarily due to higher fees for derivative transactions in 2019 and the write-off of previously deferred costs associated with the Company's at-the-market program in the first quarter of 2019. Net Income (Loss) attributable to Common Stockholders For the year ended December 31, 2020, our net loss attributable to common stockholders was $1.7 billion (2019: $319.7 million net income attributable to common stockholders; 2018: $115.2 million net loss attributable to common stockholders) or $9.89 basic and diluted net loss per average share available to common stockholders (2019: $2.42 basic and diluted net income per average share available to common stockholders; 2018: $1.03 basic and diluted net loss per average share available to common stockholders). 57 Table of Contents For the year ended December 31, 2020, we reported a net loss attributable to common stockholders compared to net income attributable to common stockholders in 2019 primarily due to: (i) net losses on investments of $961.9 million versus net gains on investments of $624.5 million in the 2019 period; (ii) net losses on derivative instruments of $851.1 million versus $534.8 million in the 2019 period; (iii) net losses on credit derivatives of $35.3 million versus net gains on credit derivatives of $8.3 million in the 2019 period; (iv) lower net interest income of $197.9 million versus $306.0 million in the 2019 period and (v) net gains on debt extinguishment of $14.7 million in the 2020 period. For the year ended December 31, 2019, we reported net income attributable to common stockholders compared to a net loss attributable to common stockholders in 2018 primarily due to: (i) net gains on investment of $624.5 million versus net losses on investments of $327.7 million in the 2018 period; (ii) net losses on derivative instruments of $534.8 million versus $5.3 million in the 2018 period; (iii) net gains on credit derivatives of $8.3 million versus net losses on credit derivatives of $151,000 in the 2018 period; (iv) higher net interest income of $306.0 million versus $304.1 million in the 2018 period. For further information on the changes in net gain (loss) on investments, net gain (loss) on derivative instruments, realized and unrealized credit derivative income (loss), net changes in net interest income and net gain (loss) on extinguishment of debt in the 2020, 2019 and 2018 periods, see preceding discussion under “Gain (loss) on Investments, net”, “Gain (Loss) on Derivative Instruments, net”, “Realized and Unrealized Credit Derivative Income (Loss), net”, “Net Interest Income” and “Net Gain (Loss) on Extinguishment of Debt”. Non-GAAP Financial Measures We use 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 • economic 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-equity ratio. We are not presenting core earnings for the year ended December 31, 2020 because core earnings excludes the material adverse impact of the market disruption caused by the COVID-19 pandemic on our financial condition. In addition, core earnings for the year ended December 31, 2020 is not indicative of the reduced earnings potential of our current investment portfolio. We intend to resume reporting annual core earnings for the year ended December 31, 2021. We calculate core earnings as U.S. GAAP net income (loss) attributable to common stockholders adjusted for (gain) loss on investments, net; realized (gain) loss on derivative instruments, net; unrealized (gain) loss on derivative instruments, net; TBA dollar roll income; realized and unrealized (gain) loss on GSE CRT embedded derivatives, net; (gain) loss on foreign currency transactions, net; amortization of net deferred (gain) loss on de-designated interest rate swaps; and net (gain) loss on extinguishment of debt. Core earnings for the year ended December 31, 2020 is distortive because it excludes significant realized losses on investments and derivative instruments that the Company incurred as it navigated the market disruption caused by the COVID-19 pandemic. Additionally, as of December 31, 2020, the Company no longer holds a substantial portion of the MBS and GSE CRT that contributed to core earnings during the first half of 2020. We began investing in TBAs as an alternative means of investing in and financing Agency RMBS in the third quarter of 2020 and are presenting an economic debt-to-equity ratio, a non-GAAP financial measure, that considers the impact of TBAs that are accounted for as derivative instruments under U.S. GAAP on leverage as discussed further below. 58 Table of Contents 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 before 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 did not hold any GSE CRTs as of December 31, 2020. 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 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, net; the amortization of net deferred gains (losses) on de-designated interest rate swaps that is recorded as repurchase agreement 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 table reconciles total interest income to effective interest income and yield to effective yield for the following periods: Years Ended December 31, 2020 2019 2018 $ in thousands Reconciliation Yield/Effective Yield Reconciliation Yield/Effective Yield Reconciliation Yield/Effective Yield Total interest income 280,166 3.55 % 778,367 3.78 % 643,016 3.55 % Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net 6,323 0.08 % 20,833 0.11 % 22,478 0.13 % Effective interest income 286,489 3.63 % 799,200 3.89 % 665,494 3.68 % Our effective interest income decreased for the year ended December 31, 2020 versus 2019 primarily due to lower average earnings assets. Our average earning assets decreased to $7.9 billion for the year ended December 31, 2020 from $20.6 billion for the year ended December 31, 2019 primarily because we sold a substantial portion of our MBS and GSE CRT portfolio during the first half of 2020 due to disruption in the financial markets caused by the COVID-19 pandemic as previously discussed. Changes in effective yield for the year ended December 31, 2020 versus 2019 are primarily due to changes in our portfolio composition as discussed in Investment Activities above. 59 Table of Contents Our effective interest income increased for the year ended December 31, 2019 versus 2018 primarily due to higher average earning assets and higher effective yield. Our average earning assets increased to $20.6 billion for the year ended December 31, 2019 from $18.1 billion for the year ended December 31, 2018 primarily because we invested and leveraged $508.9 million in net proceeds from 2019 common stock issuances and $168.5 million in proceeds from commercial loan repayments since the beginning of 2018 into newly issued 30 year fixed-rate Agency RMBS and Agency CMBS securities. The increase in effective yield for the year ended December 31, 2019 versus 2018 was primarily due to the purchase of new securities at higher yields and higher index rates on floating and adjustable rate assets. The following table reconciles total interest expense to effective interest expense and cost of funds to effective cost of funds for the following periods: Years Ended December 31, 2020 2019 2018 $ in thousands Reconciliation Cost of Funds / Effective Cost of Funds Reconciliation Cost of Funds / Effective Cost of Funds Reconciliation Cost of Funds / Effective Cost of Funds Total interest expense 82,262 1.19 % 472,320 2.52 % 338,868 2.16 % Add: Amortization of net deferred gain (loss) on de-designated interest rate swaps 23,794 0.34 % 23,729 0.13 % 25,839 0.16 % Add (Less): Contractual net interest expense (income) on interest rate swaps recorded as gain (loss) on derivative instruments, net (8,047) (0.12) % (35,840) (0.19) % 20,015 0.13 % Effective interest expense 98,009 1.41 % 460,209 2.46 % 384,722 2.45 % Our effective interest expense and effective cost of funds decreased for the year ended December 31, 2020 compared to the same period in 2019 primarily due to lower interest expense paid on repurchase agreements. We recorded total interest expense of $82.3 million for the year ended December 31, 2020 compared to $472.3 million for the same period in 2019 due to lower average borrowings and a lower Federal Funds target interest rate. Our effective interest expense and effective cost of funds increased for the year ended December 31, 2019 compared to the same period in 2018 primarily due to increased borrowings and increases in the Federal Funds rate throughout 2018. Effective interest expense was also impacted by a change in contractual net interest expense (income) on interest rate swaps from $20.0 million of contractual net interest expense for the year ended December 31, 2018 to $35.8 million of contractual net interest income for the year ended December 31, 2019 primarily as a result of higher LIBOR. Our average interest rate swap receive rate was 2.29% for the year ended December 31, 2019 versus 2.10% for the year ended December 31, 2018. See the preceding caption “Interest Expense and Cost of Funds” for further discussion of these variances. 60 Table of Contents The following table reconciles net interest income to effective net interest income and net interest rate margin to effective interest rate margin for the following periods: Years Ended December 31, 2020 2019 2018 $ in thousands Reconciliation Net Interest Rate Margin / Effective Interest Rate Margin Reconciliation Net Interest Rate Margin / Effective Interest Rate Margin Reconciliation Net Interest Rate Margin / Effective Interest Rate Margin Net interest income 197,904 2.36 % 306,047 1.26 % 304,148 1.39 % Less: Amortization of net deferred (gain) loss on de-designated interest rate swaps (23,794) (0.34) % (23,729) (0.13) % (25,839) (0.16) % Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net 6,323 0.08 % 20,833 0.11 % 22,478 0.13 % Add (Less): Contractual net interest income (expense) on interest rate swaps recorded as gain (loss) on derivative instruments, net 8,047 0.12 % 35,840 0.19 % (20,015) (0.13) % Effective net interest income 188,480 2.22 % 338,991 1.43 % 280,772 1.23 % Effective net interest income for the year ended December 31, 2020 decreased 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. Effective interest rate margin for the year ended December 31, 2020 increased due to changes in portfolio composition, including related repurchase agreement borrowings, and a lower Federal Funds target interest rate. Effective net interest income and effective interest rate margin for the year ended December 31, 2019 increased primarily due to earning contractual net interest income on interest rate swaps of $35.8 million compared to incurring contractual net interest expense on interest rate swaps of $20.0 million in the same period in 2018, primarily as a result of higher LIBOR rates in 2019. 61 Table of Contents Economic Debt-to-Equity Ratio The tables below show the allocation of our stockholders' equity to our target assets, our debt-to-equity ratio, and our economic debt-to-equity ratio as of December 31, 2020 and December 31, 2019. Our debt-to-equity ratio is calculated in accordance with U.S. GAAP and is the ratio of total debt to total stockholders' equity. As of December 31, 2020, approximately 88% of our equity is allocated to Agency RMBS. We present an economic debt-to-equity ratio, a non-GAAP financial measure of leverage that considers the impact of the off-balance sheet financing of our investments in TBAs that are accounted for as derivative instruments under U.S. GAAP. We include our TBAs at implied cost basis in our measure of leverage because a forward contract to acquire Agency RMBS in the TBA market carries similar risks to Agency RMBS purchased in the cash market and funded with on-balance sheet liabilities. Similarly, a contract for the forward sale of Agency RMBS has substantially the same effect as selling the underlying Agency RMBS and reducing our on-balance sheet funding commitments. We believe that presenting our economic debt-to-equity ratio, when considered together with our U.S. GAAP financial measure of debt-to-equity ratio, provides information that is useful to investors in understanding how management evaluates our at-risk leverage and gives investors a comparable statistic to those other mortgage REITs who also invest in TBAs and present a similar non-GAAP measure of leverage. December 31, 2020 $ in thousands Agency RMBS Credit Portfolio (1) Total Mortgage-backed and credit risk transfer securities 8,050,865 121,317 8,172,182 Cash and cash equivalents (2) 148,011 — 148,011 Restricted cash (3) 243,963 610 244,573 Derivative assets, at fair value (3) 9,893 111 10,004 Other assets 17,606 40,475 58,081 Total assets 8,470,338 162,513 8,632,851 Repurchase agreements 7,228,699 — 7,228,699 Derivative liabilities, at fair value (3) 5,537 807 6,344 Other liabilities 27,114 3,536 30,650 Total liabilities 7,261,350 4,343 7,265,693 Total stockholders' equity (allocated) 1,208,988 158,170 1,367,158 Debt-to-equity ratio (4) 6.0 — 5.3 Economic debt-to-equity ratio (5) 7.4 — 6.6 (1) Investments in non-Agency CMBS, non-Agency RMBS, commercial loans and unconsolidated joint ventures are included in credit portfolio. (2) Cash and cash equivalents are allocated based on our financing strategy for each class. (3) Restricted cash and derivative assets and liabilities are allocated based on the hedging strategy for each asset class. (4) Debt-to-equity ratio is calculated as the ratio of total repurchase agreements to total stockholders' equity. (5) Economic debt-to-equity ratio is calculated as the ratio of total repurchase agreements and TBAs at implied cost basis ($1.8 billion as of December 31, 2020 ) to total stockholders' equity. 62 Table of Contents December 31, 2019 $ in thousands Agency RMBS Agency CMBS Credit Portfolio (1) Total Mortgage-backed and credit risk transfer securities 11,301,037 4,767,930 5,702,819 21,771,786 Cash and cash equivalents (2) 73,927 27,881 70,699 172,507 Restricted cash (3) 81,830 34,441 724 116,995 Derivative assets, at fair value (3) 13,034 5,499 — 18,533 Other assets 94,525 12,460 159,739 266,724 Total assets 11,564,353 4,848,211 5,933,981 22,346,545 Repurchase agreements 9,666,964 4,246,359 3,618,980 17,532,303 Secured loans (4) 540,299 — 1,109,701 1,650,000 Derivative liabilities, at fair value (3) — — 352 352 Other liabilities 65,353 124,305 42,333 231,991 Total liabilities 10,272,616 4,370,664 4,771,366 19,414,646 Total stockholders' equity (allocated) 1,291,737 477,547 1,162,615 2,931,899 Debt-to-equity ratio (5) 7.9 8.9 4.1 6.5 Economic debt-to-equity ratio (6) 7.9 8.9 4.1 6.5 (1) Investments in non-Agency RMBS, non-Agency CMBS, GSE CRT, commercial loans, unconsolidated joint ventures and loan participation interest are included in credit portfolio. (2) Cash and cash equivalents are allocated based on a percentage of stockholders' equity for each asset class. (3) Restricted cash and derivative assets and liabilities are allocated based on the hedging strategy for each asset class. (4) Secured loans are allocated based on amount of collateral pledged. (5) Debt-to-equity ratio is calculated as the ratio of total debt (sum of repurchase agreements and secured loans) to total stockholders' equity. (6) Economic debt-to-equity ratio is calculated as the ratio of total repurchase agreements, secured loans and TBAs at implied cost basis to total stockholders' equity. 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. We currently believe that we have sufficient liquidity and capital resources available for the acquisition of additional investments, repayments on borrowings, margin requirements and the payment of cash dividends as required for continued qualification as a REIT. We generally maintain liquidity to pay down borrowings under repurchase arrangements to reduce borrowing costs and otherwise efficiently manage our long-term investment capital. Because the level of these borrowings can be adjusted on a daily basis, the level of cash and cash equivalents carried on our consolidated balance sheets is significantly less important than our potential liquidity available under borrowing arrangements or through the sale of liquid investments. However, there can be no assurance that we will maintain sufficient levels of liquidity to meet any margin calls. The COVID-19 pandemic-driven disruptions in the real estate, mortgage and financial markets negatively affected our liquidity during the year ended December 31, 2020. Under the terms of our repurchase agreements, 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. We sold portfolio assets to generate liquidity, in many cases at significantly distressed market prices. Additionally, our lenders raised required haircuts on our collateral for new repurchase agreements, driving further liquidity needs. These events have led us to seek to avoid financing less liquid assets, such as non-Agency securities, with repurchase agreements. See Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and Part I. Item 1A. Risk Factors in 63 Table of Contents this 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 $392.6 million at December 31, 2020 (2019: $289.5 million). As previously discussed, we increased our cash, cash equivalents and restricted cash balances at December 31, 2020 to improve our liquidity because of market disruption created by the COVID-19 pandemic. Our operating activities provided net cash of approximately $170.5 million for the year ended December 31, 2020 (2019: $343.4 million; 2018: $304.3 million). Our investing activities provided net cash of $11.6 billion for the year ended December 31, 2020 (2019: used net cash of $4.3 billion; 2018: provided net cash of $621.6 million). Our primary source of cash from investing activities for the year ended December 31, 2020 was proceeds from the sale of MBS and GSE CRT of $25.0 billion. We also generated $892.6 million from principal payments of MBS and GSE CRT during the year ended December 31, 2020. We used cash to purchase $13.6 billion of MBS and GSE CRT securities. We also used cash of $844.6 million on derivative contracts during the year ended December 31, 2020 primarily as we sold Agency securities and our sensitivity to interest rates decreased. During the year ended December 31, 2019, we used cash to purchase $9.2 billion of MBS and GSE CRT securities. Purchases were partially funded by principal payments from MBS and GSE CRT securities of $2.2 billion, proceeds from MBS and GSE CRT sales of $3.3 billion, and through investing and leveraging proceeds of common stock offerings. During the year ended December 31, 2018, we used cash to purchase $6.2 billion of MBS and GSE CRT securities. Purchases were partially funded by principal payments from MBS and GSE CRT securities of $2.0 billion, proceeds from MBS and GSE CRT sales of $4.7 billion, and principal payments from commercial loans held-for investment of $160.9 million. Our financing activities used net cash of $11.6 billion for the year ended December 31, 2020 (2019: provided net cash of $4.1 billion; 2018: used net cash of $879.2 million). Our financing activities for the year ended December 31, 2020 primarily consisted of net principal repayments on our repurchase agreements of $10.3 billion. In addition, we repaid secured loans of $1.65 billion and paid dividends of $137.5 million. Proceeds from the issuance of common stock provided $420.7 million during the year ended December 31, 2020. Our financing activities for the year ended December 31, 2019 primarily consisted of net proceeds from repurchase agreements of $3.9 billion. We also raised proceeds of $509.1 million from the issuance of common stock and paid dividends of $271.2 million. Our financing activities for the year ended December 31, 2018 primarily consisted of net principal repayments on our repurchase agreements of $478.3 million. We used cash of $143.4 million to extinguish our exchangeable senior notes that matured in March 2018. In addition, we paid dividends of $234.4 million and redeemed Operating Partnership Units of $21.8 million. As of December 31, 2020, the average margin requirement (weighted by borrowing amount), or the haircut, under our repurchase agreements was 5.0% for Agency RMBS. Declines in the value of our securities portfolio can trigger margin calls by our lenders under our repurchase agreements. An event of default or termination event may give our counterparties the option to terminate all repurchase transactions outstanding with us and require any amount due from us to the counterparties to be payable immediately. Effects of Margin Requirements, Leverage and Credit Spreads Our securities have values that fluctuate according to market conditions and the market value of our securities will decrease as prevailing interest rates or credit spreads increase. When the value of the securities pledged to secure a repurchase loan decreases to the point where the positive difference between the collateral value and the loan amount is less than the haircut, our lenders may issue a “margin call,” which means that the lender will require us to pay cash or pledge additional collateral. Under our repurchase facilities, our lenders have full discretion to determine the value of the securities we pledge to them. Most of our lenders will value securities based on recent trades in the market. Lenders also issue margin calls as the published current principal balance factors change on the pool of mortgages underlying the securities pledged as collateral when scheduled and unscheduled paydowns are announced monthly. We experience margin calls and increased collateral requirements in the ordinary course of our business. In seeking to effectively manage the margin requirements established by our lenders, we maintain a position of cash and unpledged securities. We refer to this position as our liquidity. The level of liquidity we have available to meet margin calls is directly affected by our leverage levels, our haircuts and the price changes on our securities. If interest rates increase as a result of a yield curve shift or for another reason or if credit spreads widen, then the prices of our collateral (and our unpledged assets that constitute our liquidity) will decline, we will experience margin calls, and we will seek to use our liquidity to meet the margin calls. There can be no assurance that we will maintain sufficient levels of liquidity to meet any margin calls or increased 64 Table of Contents collateral requirements. If our haircuts increase, our liquidity will proportionately decrease. In addition, if we increase our borrowings, our liquidity will decrease by the amount of additional haircut on the increased level of indebtedness. We intend to maintain a level of liquidity in relation to our assets that enables us to meet reasonably anticipated margin calls and increased collateral requirements but that also allows us to be substantially invested in securities. We may misjudge the appropriate amount of our liquidity by maintaining excessive liquidity, which would lower our investment returns, or by maintaining insufficient liquidity, which would force us to liquidate assets into unfavorable market conditions and harm our results of operations and financial condition. We are subject to financial covenants in connection with our lending, derivatives and other agreements we enter into in the normal course of our business. We intend to operate in a manner which complies with all of our financial covenants. Our lending and derivative agreements provide that we may be declared in default of our obligations if our leverage ratio exceeds certain thresholds and we fail to maintain stockholders’ equity or market value above certain thresholds over specified time periods. Forward-Looking Statements Regarding Liquidity As of December 31, 2020, we held $7.6 billion of Agency securities that are financed by repurchase agreements. We also had approximately $596.8 million of unencumbered investments and unrestricted cash of $148.0 million as of December 31, 2020. Based upon our current portfolio and existing borrowing arrangements, 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 consolidated financial statements in Part IV of this Report 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 consolidated financial statements in Part IV of this Report for details of our reimbursements to our Manager. As of December 31, 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 Obligations of Invesco Mortgage Capital Inc. Repurchase agreements 7,228,699 7,228,699 — — — Interest expense on repurchase agreements 1,420 1,420 — — — Total contractual obligations (1) 7,230,119 7,230,119 — — — (1) Excluded from total contractual obligations are the amounts due to our Manager under our management agreement, as those obligations do not have fixed and determinable payments. Off-Balance Sheet Arrangements We have invested in unconsolidated ventures that are sponsored by an affiliate of our Manager. The unconsolidated ventures are structured as partnerships, and we invest in the partnerships as a limited partner. The entities are structured such 65 Table of Contents that capital commitments are to be drawn down over the life of the partnership as investment opportunities are identified. As of December 31, 2020, our undrawn capital commitments were $6.8 million. 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 REIT 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 REIT 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 REIT 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 REIT 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 consolidated financial statements in Part IV of this Report. 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. Exposure to Financial Counterparties We finance a substantial portion of our investment portfolio through repurchase agreements. Under these agreements, we pledge assets from our investment portfolio as collateral. Additionally, certain counterparties may require us to provide cash collateral in the event the market value of the assets declines to maintain a contractual repurchase agreement collateral ratio. If a counterparty were to default on its obligations, we would be exposed to potential losses to the extent the fair value of collateral pledged by us to the counterparty including any accrued interest receivable on such collateral exceeded the amount loaned to us by the counterparty plus interest due to the counterparty. As of December 31, 2020, one counterparty held collateral that exceeded the amounts borrowed under the related repurchase agreements by more than $68.4 million, or 5% of our stockholders’ equity. The following table summarizes our exposure to counterparties by geographic concentration as of December 31, 2020. The information is based on the geographic headquarters of the counterparty or counterparty's parent company. However, our repurchase agreements are generally denominated in U.S. dollars. $ in thousands Number of Counterparties Repurchase Agreement Financing Exposure North America 10 4,526,586 245,969 Europe (excluding United Kingdom) 2 690,144 36,912 Asia 4 2,011,969 110,959 Total 16 7,228,699 393,840 66 Table of Contents 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”) at the end of each calendar quarter in 2020. We also believe that our revenue qualifies for the 75% source of income test and for the 95% source of income test rules for the year ended December 31, 2020. Consequently, we believe we met the REIT income and asset test as of December 31, 2020. We also met all REIT requirements regarding the stock ownership and distribution of dividends of our taxable income as of December 31, 2020. Therefore, as of December 31, 2020, we believe that we qualified as a REIT under the Code. 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. 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). We calculate that as of December 31, 2020, we conducted our business so as not to be regulated as an investment company under the 1940 Act.