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 currently invest 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 not guaranteed by a U.S. government agency or a federally chartered corporation (“non-Agency CMBS”); • RMBS that are not guaranteed by a U.S. government agency or a federally chartered corporation (“non-Agency RMBS”); • To-be-announced securities forward contracts (“TBAs”) to purchase Agency RMBS; • Commercial mortgage loans; and • Other real estate-related financing arrangements. We have also historically invested in the following: • 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”); • Credit risk transfer securities that are unsecured obligations issued by government-sponsored enterprises (“GSE CRT”); and • Residential mortgage loans. We continuously evaluate new investment opportunities to complement our current investment portfolio by expanding our target assets and portfolio diversification. We conduct our business through our wholly-owned subsidiary, 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. 40 Table of Contents 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. 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 significantly over the first half of 2021, as markets responded to an encouraging decrease in COVID-19 cases and deaths. However, the easing of conditions peaked at mid-year and tightened during the second half of the year as a resurgence of COVID-19 cases and concerns over large increases in inflation caused investors to turn cautious. These concerns have only increased as we enter the first weeks of 2022, as more aggressive removal of stimulus by the Federal Reserve becomes priced into the market and is reflected in tighter financial conditions. Despite the tighter conditions of the second half of 2021, the equity markets were strong throughout the year, with the S&P 500 Index increasing by 26.9% during 2021, including a gain of 10.6% during the fourth quarter. The NASDAQ gained 21.4% for the year, including an increase of 8.3% during the fourth quarter. Equities have dropped sharply to start 2022, however, with the S&P down 5.3% and the NASDAQ down 9.0% through the end of January. The employment picture improved steadily throughout the course of 2021, with gains in nonfarm payrolls averaging 537,000 for the year and 365,000 during the fourth quarter. The unemployment rate also improved markedly, declining from 6.7% at end of 2020 to 3.9% at the end of 2021. Consumer activity was positive during the year, with most of the increases in consumer spending and retail sales skewed towards the first half of the year, as the resurgence in COVID-19 cases and sharp increases in price levels took their toll during the second half of 2021. Consumer confidence measures also reflected this dynamic, showing confidence levels peaking around mid-year before dropping during the second half of 2021. Interest rates rose across the yield curve during 2021, as market expectations of increases to the Federal Funds target rate by the Federal Open Market Committee ( “ FOMC ” ) impacted shorter maturities and increases in inflation affected longer dated maturities. During 2021, the yield on the 2 year Treasury note increased 61 basis points to 0.73%, the yield on the 5 year Treasury increased 90 basis points to 1.26% and the yield on the 10 year Treasury ended the year at 1.51%, up 60 basis points. Most of the rate increases that occurred on the short end of the curve occurred during the fourth quarter, as the 2 year increased 46 basis points during the quarter, reflecting a dramatic repricing of Federal Funds futures contracts caused by an equally dramatic increase in prices. At year-end, the pricing of these contracts reflected an expectation that the FOMC will increase the Federal Funds target rate by approximately 125 basis points by mid-2023 as compared to an expectation of no increases at the end of 2020. Unsurprisingly, interest rate volatility also increased drastically throughout the year, particularly when measured against shorter term interest rates. One of the largest concerns for both the markets and the FOMC during 2021 has been the severe rise in inflation. The personal consumption expenditure index ended 2021 with an increase to 4.9% compared to 1.5% at the end of 2020. L ikewise, commodities also saw significant increases during 2021, with West Texas Intermediate crude oil recording a 58.8% increase and the Commodity Research Bureau commodity index gaining 38.5%. Breakeven rates on U.S Treasury inflation-protected securities (“TIPs”) , which reflect investors' expectations of future inflation, have broken out to levels not seen in several years. The inflation rate implied by 2 year and 5 year TIPs was 3.22% and 2.91%, respectively, at the end of the year. CMBS risk premiums increased in the fourth quarter of 2021 due to elevated new issuance, renewed COVID-19 concerns resulting from the Omicron variant, higher inflation and increased interest rate volatility. Despite these concerns, the economy continued to show signs of improvement. This pick-up in economic activity has translated to improving employment levels, increased commercial real estate activity and continued property price appreciation. While commercial mortgage loan delinquencies remain elevated across many property types, they continue to decline from their post-pandemic peak levels. The lodging and retail sectors have experienced the highest level of loan delinquencies due to travel restrictions and a severe slowdown in activity. Office, multi-family and industrial property sectors continue to post relatively lower delinquency levels. Loans secured by office properties have benefited from long-term tenant leases and industrial warehouse properties have benefited from growing online shopping, as online retailers have demanded more space to support their fulfillment process. The housing market has staged a robust recovery since the onset of the COVID-19 pandemic, driven in part by low mortgage rates and tight supply conditions. Demographic trends and changes in housing preferences shaped by the pandemic 41 Table of Contents have contributed to solid demand, especially for single family homes. This strength is reflected in rapid home price appreciation, which has only recently begun to moderate. Meanwhile, credit spreads on residential mortgage-backed securities have reversed the widening that occurred in March 2020, but finished 2021 well off the lows reached earlier in the year. Nevertheless, many individual homeowners have been adversely impacted by the economic consequences of the COVID-19 pandemic. The U.S. government has responded by passing a number of fiscal stimulus measures and relief programs for households and businesses directly or indirectly impacted by the virus. Stimulus payments and the provision of borrower relief including forbearance and loan modifications have substantially reduced borrower defaults and loan losses relative to levels that would have likely occurred without these actions. Agency RMBS significantly underperformed over the course of 2021, marking the sector’s worst total return since 2013 and the worst year of performance relative to U.S. Treasuries since 2011. Increased interest rate volatility and elevated market expectations for more restrictive monetary policy were particularly harmful for low coupon 30 year Agency RMBS, which benefited the most from the Federal Reserve’s response to the COVID-19 pandemic. In addition, net purchases of $580 billion from the Federal Reserve and nearly $400 billion by commercial banks was mostly offset by heavy supply from mortgage originators, which eclipsed record levels in 2021 reaching approximately $870 billion of net issuance. During the second half of 2021, Agency RMBS performance was negatively impacted by the market’s anticipation that the Federal Reserve’s MBS purchase program would be slowed or stopped in an effort to remove accommodative policies in its fight against inflation. While prepayment speeds remained elevated, premiums on specified pool Agency RMBS fell in 2021 as investor demand for prepayment protection waned given higher mortgage rates. Prepayment speeds should moderate in the months ahead, as seasonal factors and higher mortgage rates dampen housing and refinancing activity. The dollar roll market for low coupon TBAs continues to be attractive, as implied financing rates remained negative given persistent demand from the Federal Reserve and commercial banks. Overall, we remain cautious on the Agency RMBS sector, as more restrictive monetary policy and worsening supply and demand technicals may weigh on valuations. As we move into 2022, investors are focused first and foremost on the Federal Reserve and how their removal of policy accommodation to fight persistent inflation will impact rates and risk assets. Another concern is the impact of the ongoing COVID-19 pandemic, and how the trajectory of new cases might impact economic activity. These concerns leave us with a cautious outlook for the coming year. Proposed Changes to LIBOR The FCA, which regulates LIBOR announced on March 5, 2021 that it will cease to publish the overnight, one-month, three-month, six-month and 12-month USD LIBOR settings on July 1, 2023. The ARRC, the U.S. working group tasked with assisting in the industry wide transition away from LIBOR, has supported the FCA’s announcement of USD LIBOR cessation and has recommended the market adopt SOFR. To accelerate the transition away from LIBOR, the Federal Reserve Board, Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency issued joint supervisory guidance to cease entering into new contracts referencing USD LIBOR after December 31, 2021 (note there are limited exceptions related to derivative product use). We, similar to the broader industry, are transitioning away from LIBOR to alternative risk-free rates, such as SOFR. We continue to actively monitor and adjust our LIBOR transition strategy and timeline as necessary. Switching existing financial instruments from LIBOR to SOFR requires calculations of a spread. There is no assurance that the calculated spread will be fair and accurate or that all financial instruments will use the same spread. We have an investment in a commercial loan indexed to LIBOR that is scheduled to mature in 2022. In addition, our 7.75% Fixed-to-Floating Series B Cumulative Redeemable Preferred Stock and our 7.50% Fixed-to-Floating Series C Cumulative Redeemable Preferred Stock each begin to pay a USD LIBOR-based rate at the time the stock becomes callable. Our Series B and Series C Preferred Stock are governed by New York state law that provides for USD LIBOR-linked contracts to transition to an alternative reference rate for contracts. 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. The Financial Accounting Standards Board has issued accounting guidance that provides optional expedients and exceptions to contracts, hedging relationships and other transactions impacted by LIBOR transition if certain criteria are met. The guidance can be applied through December 31, 2022. In the fourth quarter of 2021, we transitioned our interest rate swaps that were indexed to LIBOR to interest rate swaps that are indexed to SOFR in a manner that allowed us to qualify for contract modification relief and maintain the same accounting for and presentation of interest rate swaps that was in place prior to modification. 42 Table of Contents Investment Activities The table below shows the breakdown of our investment portfolio as of December 31, 2021 and 2020: $ in thousands As of December 31, 2021 2020 Agency RMBS: 30 year fixed-rate, at fair value 7,701,523 8,050,866 Agency CMO, at fair value 30,757 — Non-Agency CMBS, at fair value 62,909 109,583 Non-Agency RMBS, at fair value 9,070 11,733 Commercial loan, at fair value 23,515 23,098 Investments in unconsolidated ventures 12,476 16,408 Subtotal 7,840,250 8,211,688 TBAs, at implied cost basis (1) 1,636,906 1,772,211 Total investment portfolio, including TBAs 9,477,156 9,983,899 (1) Our presentation of TBAs in the table above represents management's view of our investment portfolio and does not reflect how we record TBAs on our consolidated balance sheets under U.S. GAAP. Under U.S. GAAP, we record TBAs that we do not intend to physically settle on the contractual settlement date as derivative financial instruments. We value TBAs 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. For further details of our U.S GAAP accounting for TBAs, refer to Note 8 “ Derivatives and Hedging Activities” in Part IV, Item 15 of this Report. Our TBA dollar roll transactions are a form of off-balance sheet financing. For further information on how management evaluates our at-risk leverage, see Non-GAAP Financial Measures below. We sold $16.3 billion and purchased $17.1 billion of Agency RMBS during the year ended December 31, 2021. We rotated our Agency RMBS throughout the year into securities that have higher yields, in some cases to change coupon rate or the type of specified pool collateral. Purchases were funded with proceeds from the sales, paydowns of securities and by leveraging proceeds from the issuance of common stock. As of December 31, 2021 and 2020 our holdings of 30 year fixed-rate Agency RMBS represented 81% of our total investment portfolio, including TBAs. Our 30 year fixed-rate Agency RMBS holdings as of December 31, 2021 and 2020 consisted of specified pools with coupon distributions as shown in the table below. As of December 31, 2021 2020 $ in thousands Fair Value Percentage Fair Value Percentage 1.5% — — % 106,377 1.3 % 2.0% 2,408,404 31.3 % 3,492,399 43.4 % 2.5% 2,877,568 37.3 % 3,784,539 47.0 % 3.0% 2,178,476 28.3 % 667,551 8.3 % 3.5% 237,075 3.1 % — — % Total 30 year fixed-rate Agency RMBS 7,701,523 100.0 % 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. We invest in TBAs as an alternative means of investing in and financing Agency RMBS. As of December 31, 2021, the implied cost basis of TBAs represented approximately 17% of our total investment portfolio, versus 18% as of December 31, 2020. Our investments consist of 30-year Agency RMBS TBAs with coupons that range from 2.5% to 3.0% in conventional 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 below those available in the repurchase market due to 43 Table of Contents the magnitude and persistence of the Federal Reserve's MBS purchase program, which began to increase holdings in March 2020. The Federal Reserve began reducing net purchases of Agency RMBS in the fourth quarter of 2021, and net purchases are expected to end in March 2022. It is likely the Federal Reserve will continue to reinvest all or a portion of paydowns on their MBS portfolio in the subsequent quarters, which would continue to support the Agency RMBS TBA dollar roll market. As of December 31, 2021 and 2020, our holdings of non-Agency CMBS represented approximately 1% of our total investment portfolio, including TBAs. Our non-Agency CMBS portfolio is comprised of fixed-rate securities that are rated single-A (or equivalent) or higher by a nationally recognized statistical rating organization as of December 31, 2021. Approximately 72.4% of non-Agency CMBS are rated double-A (or equivalent) or higher by a nationally recognized statistical rating organization as of December 31, 2021. As of December 31, 2021 and 2020, our holdings of non-Agency RMBS represented less than 1% of our total investment portfolio, including TBAs. 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. As of December 31, 2021, we held an investment in one commercial real estate mezzanine loan that is due in February 2022 and has a LTV ratio of approximately 68.0%. In February 2022, we received a request from the borrower to extend the contractual maturity of the commercial loan investment to May 29, 2022. Refer to Note 15 – “Subsequent Events” of our consolidated financial statements in Part IV, Item 15 of this Report for additional information. As of December 31, 2021, we held investments in two unconsolidated ventures that are managed by an affiliate of our Manager. Both of the unconsolidated ventures are in liquidation and plan to sell or settle their remaining investments as expeditiously as possible. Until the ventures complete their liquidation, we are committed to fund $6.5 million in additional capital to 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 are expected to move in close relationship to SOFR. 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, 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 March 31, 2021 8,240,887 8,359,010 8,708,686 June 30, 2021 7,851,204 7,945,494 8,004,924 September 30, 2021 7,873,798 7,846,536 7,886,360 December 31, 2021 6,987,834 7,442,784 7,776,070 (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. 44 Table of Contents 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 to SOFR. To a lesser extent, we also enter into interest rate swap agreements whereby we make floating interest rate payments indexed to SOFR and receive fixed interest rate payments as part of our overall risk management strategy. Prior to the transition of our swap portfolio to swaps that are indexed to SOFR in the fourth quarter of 2021, our interest rate swaps were generally indexed to 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. During the year ended December 31, 2021, we terminated existing swaps with a notional amount of $2.5 billion and entered into new swaps with a notional amount of $4.3 billion as part of our overall risk management strategy. These amounts exclude $7.3 billion of terminations and additions related to the transition of our swap portfolio from swaps that were indexed to LIBOR to swaps that are indexed to SOFR in the fourth quarter of 2021, as well as terminations and additions of forward starting swaps. Daily variation margin payment for interest rate swaps 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 operati ons. We realized a net gain of $185.2 million on interest rate swaps during the year ended December 31, 2021 primarily due to rising interest rates. We enter into currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on investments denominated in foreign currencies. As of December 31, 2021, we had €11.7 million or $13.6 million (2020: €27.8 million or $33.1 million) of notional amount of forward contracts related to our investment in an unconsolidated venture. During the year ended December 31, 2021, we settled currency forward contracts of €70.8 million or $84.8 million (2020: €83.4 million or $93.4 million) in notional amount and realized a net gain of $209,000 (2020: $1.3 million net loss). Capital Activities In February 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. In June 2021, we completed a public offering of 43,125,000 shares of common stock at the price of $3.39 per share. Total net proceeds were approximately $145.9 million after deducting offering expenses. On June 16, 2021, we redeemed all issued and outstanding shares of our Series A Preferred Stock for $140.0 million plus accrued and unpaid dividends. The cash redemption price for each share of Series A Preferred Stock was 25.00. The excess of the consideration transferred over carrying value was accounted for as a deemed dividend and resulted in a reduction of $4.7 million in net income (loss) attributable to common stockholders during the year ended December 31, 2021. As of December 31, 2021, we may sell up to 56,865,980 shares of our common stock and 5,500,000 shares of our preferred stock from time to time in at-the-market or privately negotiated transactions under our equity distribution agreement with placement agents. During the year ended December 31, 2021, we sold 55,744,020 shares of common stock for proceeds of $180.5 million, net of approximately $2.6 million in commissions and fees, under our equity distribution agreements. During the year ended December 31, 2020, 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 our equity distribution agreements. 45 Table of Contents For information on dividends declared and paid during the year ended December 31, 2021, 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, 2021, 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 2021 2020 2019 Numerator (adjusted equity): Total equity 1,402,135 1,367,158 2,931,899 Less: Liquidation preference of Series A Preferred Stock — (140,000) (140,000) Less: Liquidation preference of Series B Preferred Stock (155,000) (155,000) (155,000) Less: Liquidation preference of Series C Preferred Stock (287,500) (287,500) (287,500) Total adjusted equity 959,635 784,658 2,349,399 Denominator (number of shares): Common stock outstanding 329,875 203,222 144,256 Book value per common share 2.91 3.86 16.29 Our book value per common share decreased 24.6% as of December 31, 2021 compared to December 31, 2020. The increase in interest rate volatility and prepayment speeds, combined with reduced investor demand for prepayment protection and the potential for an earlier than expected taper of MBS purchases from the Federal Reserve resulted in Agency RMBS sharply underperforming interest rate swap hedges during the first half of 2021. Book value per common share further decreased in the second half of 2021 as the Federal Reserve's announced tapering and subsequent acceleration of the pace of tapering in December 2021 negatively impacted Agency RMBS valuations. 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. Refer to Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” for interest rate risk and its impact on fair value. Critical Accounting Policies and Estimates 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, and a change in our interest income recognition 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, 2021, $7.7 billion (December 31, 2020: $8.1 billion) or 99% (December 31, 2020: 99%) of our MBS 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, 2021 or December 31, 2020. 46 Table of Contents We determine the fair value of our MBS 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. One of the most significant factors impacting our projected cash flows is changes in long-term interest rates. When interest rates fall, prepayments will generally increase and when interest rates rise, prepayments will generally decrease. However, there are a variety of factors that may impact the rate of prepayments on our securities. Accordingly, under different conditions, we could report materially different amounts. Refer to Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” for an estimate of the percentage change in our net interest income, including interest paid or received under interest rate swaps, caused by an instantaneous 50 and 100 basis points increase or decrease in interest rates. 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 was based on estimated future cash flows. 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. Our interest rate swaps, currency forward contracts and TBAs are valued using a market approach through the use of quoted prices available in an active market. All of our interest rate swaps were centrally cleared by a registered clearing organization as of December 31, 2021. 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, Item 15 of this Report. 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 LIBOR to apply to 47 Table of Contents 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 new guidance can be applied through December 31, 2022. We have an investment in a commercial loan indexed to LIBOR that is scheduled to mature in 2022. In addition, our 7.75% Fixed-to-Floating Series B Cumulative Redeemable Preferred Stock and our 7.50% Fixed-to-Floating Series C Cumulative Redeemable Preferred Stock each become callable at the time the stock begins to pay a LIBOR-based rate. Our Series B and Series C Preferred Stock are governed by New York state law. The state of New York has approved legislative solutions for U.S. dollar LIBOR-linked contracts to transition to an alternative rate for contracts that are governed by New York state law. We do not currently intend to amend our Series B or Series C Preferred Stock to change the existing LIBOR cessation fallback language. 48 Table of Contents Results of Operations Our consolidated results of operations for the years ended December 31, 2021, 2020 and 2019 are summarized below: Years Ended December 31, $ in thousands except share data 2021 2020 2019 Interest income Mortgage-backed and credit risk transfer securities 167,056 277,400 772,657 Commercial and other loans 2,146 2,766 5,710 Total interest income 169,202 280,166 778,367 Interest expense Repurchase agreements (1) (11,290) 73,607 430,697 Secured loans — 8,655 41,623 Total interest expense (11,290) 82,262 472,320 Net interest income 180,492 197,904 306,047 Other income (loss) Gain (loss) on investments, net (366,509) (961,938) 624,466 (Increase) decrease in provision for credit losses 1,768 (1,768) — Equity in earnings of unconsolidated ventures 870 1,163 2,224 Gain (loss) on derivative instruments, net 122,611 (851,050) (534,755) Realized and unrealized credit derivative income (loss), net — (35,312) 8,343 Net gain (loss) on extinguishment of debt — 14,742 — Other investment income (loss), net 1 2,137 3,950 Total other income (loss) (241,259) (1,832,026) 104,228 Expenses Management fee — related party 21,080 29,367 38,173 General and administrative 8,153 10,863 8,001 Total expenses 29,233 40,230 46,174 Net income (loss) attributable to Invesco Mortgage Capital Inc. (90,000) (1,674,352) 364,101 Dividends to preferred stockholders 37,795 44,426 44,426 Issuance and redemption costs of redeemed preferred stock 4,682 — — Net income (loss) attributable to common stockholders (132,477) (1,718,778) 319,675 Earnings (loss) per share: Net income (loss) attributable to common stockholders Basic (0.48) (9.89) 2.42 Diluted (0.48) (9.89) 2.42 Weighted average number of shares of common stock: Basic 275,132,233 173,730,389 132,305,568 Diluted 275,132,233 173,730,389 132,317,853 (1) Negative interest expense on repurchase agreements in 2021 is due to amortization of net deferred gains on de-designated interest rate swaps that exceeds current period interest expense on repurchase agreements. For further information on amortization of amounts classified in accumulated other comprehensive income before we discontinued hedge accounting, see Note 8 - “Derivatives and Hedging Activities” and Note 12 - “Stockholders' Equity” in Part IV, Item 15 of this report on Form 10-K. 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 for the years ended December 31, 2021, 2020 and 2019. Years ended December 31, $ in thousands 2021 2020 2019 Average earning assets (1) 8,808,105 7,895,394 20,566,255 Average earning asset yields (2) 1.92 % 3.55 % 3.78 % (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 $8.8 billion during the year ended December 31, 2021 (2020: $7.9 billion; 2019: $20.6 billion). Average earning assets increased for the year ended December 31, 2021 compared to 2020 as we resumed investing in Agency RMBS during the third quarter of 2020 after selling a substantial portion of our MBS and GSE CRT portfolio in the first half of 2020 to generate liquidity and reduce leverage in response to the financial market disruption caused by the COVID-19 pandemic. Average earning assets decreased during the year ended December 31, 2020 compared to 2019. 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. The yield on our average earning assets during the year ended December 31, 2021 was 1.92% (2020: 3.55%; 2019: 3.78%). Our average earning asset yields decreased during the year ended December 31, 2021 compared to 2020 and during the year ended December 31, 2020 compared to 2019 primarily due to changes in our portfolio composition. We earned interest income of $169.2 million (2020: $280.2 million; 2019: $778.4 million) during 2021. 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 2021 2020 2019 Interest Income MBS and GSE CRT - coupon interest 207,506 298,613 833,376 MBS and GSE CRT - net premium amortization (40,450) (21,213) (60,719) MBS and GSE CRT - interest income 167,056 277,400 772,657 Commercial and other loans 2,146 2,766 5,710 Total interest income 169,202 280,166 778,367 MBS and GSE CRT interest income decreased $110.3 million for the year ended December 31, 2021 compared to 2020 primarily due to a 163 basis point decrease in average earning asset yields. Almost all of our investment portfolio (excluding TBAs) was invested in Agency RMBS during the year ended December 31, 2021. We did not hold any GSE CRTs as of December 31, 2021 or December 31, 2020. 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 partially 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 loan investments. 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 2021, 2020 and 2019. Years Ended December 31, $ in thousands 2021 2020 2019 Agency RMBS (41,881) (32,737) (76,676) Agency CMBS — (1,744) (4,712) Non-Agency CMBS 2,695 14,721 15,347 Non-Agency RMBS (1,264) 1,107 13,164 GSE CRT — (2,560) (7,842) Net (premium amortization) discount accretion (40,450) (21,213) (60,719) Net premium amortization increased $19.2 million during 2021 compared to 2020 primarily due to sales of non-Agency CMBS purchased at discounts and the purchase of Agency RMBS at premiums during the second half of 2020 and in 2021. 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. 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, 2021, 2020 and 2019. Years ended December 31, $ in thousands 2021 2020 2019 Interest Expense Interest expense on repurchase agreement borrowings 10,710 97,401 454,426 Amortization of net deferred (gain) loss on de-designated interest rate swaps (22,000) (23,794) (23,729) Repurchase agreements interest expense (11,290) 73,607 430,697 Secured loans — 8,655 41,623 Total interest expense (11,290) 82,262 472,320 Our interest expense on repurchase agreement borrowings decreased $86.7 million for the year ended December 31, 2021 compared to 2020 primarily due to a lower average cost of funds reflecting decreases in the Federal Funds rate. 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 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. Average borrowings also decreased due to repayment of $1.65 billion of secured loans during 2020. 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 51 Table of Contents 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 $22.0 million, $23.8 million and $23.7 million during the years ended December 31, 2021, December 31, 2020 and December 31, 2019, respectively. During the next twelve months, we estimate that $19.7 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. We repaid our secured loans during 2020 and did not incur interest expense for secured loans during the year ended December 31, 2021. 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, 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. Our total interest expense during the year ended December 31, 2021 decreased $93.6 million compared to 2020 primarily due to a decrease of $95.3 million in interest expense on repurchase agreement borrowings and secured loans. 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. The table below presents our average borrowings and cost of funds for the years ended December 31, 2021, 2020 and 2019. Years ended December 31, $ in thousands 2021 2020 2019 Total average borrowings (1) 7,892,617 6,926,790 18,748,843 Maximum borrowings during the period (2) 8,708,686 23,132,234 20,377,801 Cost of funds (3) (0.14) % 1.19 % 2.52 % (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, including amortization of net deferred gain (loss) on de-designated interest rate swaps, by our average borrowings. Total average borrowings increased $965.8 million in 2021 compared to 2020 because we resumed investing in Agency RMBS in July 2020 and financing purchases with repurchase agreements. The increase in repurchase agreement borrowings was partially offset by the repayment of $1.65 billion of secured loans during 2020. 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. Our cost of funds decreased in 2021 compared to 2020 and in 2020 compared to 2019 primarily due to decreases in the Federal Funds rate. 52 Table of Contents Net Interest Income The table below presents the components of net interest income for the years ended December 31, 2021, 2020 and 2019. Years ended December 31, $ in thousands 2021 2020 2019 Interest Income Mortgage-backed and credit risk transfer securities 167,056 277,400 772,657 Commercial and other loans 2,146 2,766 5,710 Total interest income 169,202 280,166 778,367 Interest Expense Interest expense on repurchase agreement borrowings 10,710 97,401 454,426 Amortization of net deferred (gain) loss on de-designated interest rate swaps (22,000) (23,794) (23,729) Repurchase agreements interest expense (11,290) 73,607 430,697 Secured loans — 8,655 41,623 Total interest expense (11,290) 82,262 472,320 Net interest income 180,492 197,904 306,047 Net interest rate margin 2.06 % 2.36 % 1.26 % Our net interest income, which equals total interest income less total interest expense, totaled $180.5 million for the year ended December 31, 2021 (2020: $197.9 million; 2019: $306.0 million). The decrease in net interest income for the year ended December 31, 2021 compared to 2020 and for the year ended December 31, 2020 compared to 2019 was primarily due to the sale of MBS and GSE CRTs in the first half of 2020 as previously discussed. Our net interest rate margin, which equals the yield on our average assets for the period less the average cost of funds for the period, was 2.06% for the year ended December 31, 2021 (2020: 2.36%; 2019: 1.26%). The decrease in net interest rate margin for 2021 compared to 2020 was primarily due to the change in our portfolio composition, including related repurchase agreements borrowings. The increase in net interest rate margin for 2020 compared to 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. Gain (Loss) on Investments, net The table below summarizes the components of gain (loss) on investments, net for the years ended December 31, 2021, 2020 and 2019. Years Ended December 31, $ in thousands 2021 2020 2019 Net realized gains (losses) on sale of investments (281,224) (363,781) 8,039 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) Net unrealized gains (losses) on MBS and GSE CRT accounted for under the fair value option (85,702) (492,047) 624,158 Net unrealized gains (losses) on commercial loan 417 (1,164) — Realized loss on loan participation interest — (3,808) — Total gain (loss) on investments, net (366,509) (961,938) 624,466 53 Table of Contents During the year ended December 31, 2021, we sold MBS for cash proceeds of $16.3 billion (2020: MBS and GSE CRTs of $25.0 billion; 2019: MBS and GSE CRTs of $3.3 billion) and realized net losses of $281.2 million (2020: net losses of $363.8 million; 2019: net gains of $8.0 million). Realized net losses during the year ended December 31, 2021 primarily reflect sales of lower yielding Agency RMBS to purchase higher yielding Agency RMBS. We sold securities during the year ended December 31, 2020 to generate liquidity and reduce leverage in response to the financial market disruption caused by the COVID-19 pandemic. A portion of these sales were involuntary liquidations at significantly distressed market prices as certain of our repurchase agreement counterparties seized and sold our securities when we were unable to meet margin calls in March 2020. We did not record any impairment during the years ended December 31, 2021 or 2019 because we intended to sell or more likely than not would be required to sell the securities before recovery of amortized cost basis. We recorded $94.1 million of impairment on non-Agency RMBS and CMBS securities during the year ended December 31, 2020, because we intended to sell or more likely than not would be required to sell the securities before recovery of amortized cost basis. For additional information regarding our accounting policy for impairment, refer to Note 2 – “Summary of Significant Accounting Policies” of our consolidated financial statements included in Part IV, Item 15 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, 2021, $7.7 billion or 99% (December 31, 2020: $8.1 billion or 99%) of our MBS are accounted for under the fair value option. We recorded net unrealized losses on our MBS and GSE CRT portfolio accounted for under the fair value option of $85.7 million in 2021 compared to net unrealized losses of $492.0 million in 2020 and unrealized gains of $624.2 million in 2019. Net unrealized losses in 2021 primarily reflect wider interest rate spreads on our Agency RMBS. Net unrealized losses in the year ended December 31, 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 credit assets and Agency CMBS and valuation gains in specified pool Agency RMBS. We recorded unrealized gains of $417,000 and unrealized losses of $1.2 million on our commercial loan investment during the years ended December 31, 2021 and 2020, respectively. We value our commercial loan investment based upon a valuation from an independent pricing service. We recorded a realized loss of $3.8 million on our loan participation interest during year ended December 31, 2020. We sold the loan participation interest on April 1, 2020. (Increase) Decrease in Provision for Credit Losses As of December 31, 2021, approximately $70.2 million of our $7.8 billion of MBS are classified as available-for-sale and subject to evaluation for credit losses. We recorded a provision for credit losses of $1.8 million on single non-Agency CMBS for the year ended December 31, 2020 based on a comparison of the security's amortized cost basis to discounted expected cash flows. We recorded a $1.8 million decrease in the provision for credit losses d uring the year ended December 31, 2021 because the security fully repaid in June 2021. Refer to Note 2 – “Summary of Significant Accounting Policies” of our consolidated financial statements included in Part IV, Item 15 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, 2021, we recorded equity in earnings of unconsolidated ventures of $870,000 (2020: $1.2 million; 2019: $2.2 million). We recorded equity in earnings for the years ended December 31, 2021, 2020 and 2019 primarily due to earnings on the underlying 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, 2021, 2020 and 2019: $ in thousands Year ended December 31, 2021 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 185,232 (15,803) (5,869) 163,560 Interest Rate Swaptions (553) — — (553) Currency Forward Contracts 209 — 970 1,179 TBAs (28,731) — (12,844) (41,575) Total 156,157 (15,803) (17,743) 122,611 $ 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) During the year ended December 31, 2021, we terminated existing interest rate swaps with a notional amount of $2.5 billion and entered into new swaps with a notional amount of $4.3 billion, excluding terminations and additions related to the transition of our interest rate swaps to swap that are indexed to SOFR in the fourth quarter of 2021 and terminations and additions of forward starting swaps. We realized a net gain of $185.2 million on interest rate swaps during the year ended December 31, 2021 due to rising interest rates. As of December 31, 2021, we had $7.0 billion of repurchase agreement borrowings with a weighted average remaining maturity of 29 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. In March 2020, we terminated all of our outstanding interest rate swaps 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. 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. 55 Table of Contents As of December 31, 2021 and 2020, we held interest rate swaps whereby we receive interest at a variable rate as shown in the table below. As of December 31, 2021, our interest rate swaps received variable interest based upon SOFR. As of December 31, 2020, our interest rate swaps received variable interest based upon one-month LIBOR. $ in thousands December 31, 2021 December 31, 2020 Derivative instrument Notional Amounts Weighted Average Fixed Pay Rate Weighted Average Floating Receive Rate Weighted Average Years to Maturity Notional Amounts Weighted Average Fixed Pay Rate Weighted Average Floating Receive Rate Weighted Average Years to Maturity Interest Rate Swaps (1) 6,300,000 0.30 % 0.05 % 5.7 6,300,000 0.41 % 0.15 % 6.7 (1) Notional amount as of December 31, 2021 excludes $1.3 billion of interest rate swaps with forward start dates. As of December 31, 2021, we held interest rate swaps whereby we pay variable interest based upon SOFR as shown in the table below. We did not hold any interest rate swaps that paid floating interest as of December 31, 2020. $ in thousands December 31, 2021 Derivative instrument Notional Amounts Weighted Average Floating Pay Rate Weighted Average Fixed Receive Rate Weighted Average Years to Maturity Interest Rate Swaps 1,750,000 0.05 % 0.98 % 4.9 We have also used futures contracts to manage our exposure to interest rate risk. We were not party to any futures contracts as of December 31, 2021, 2020 or 2019. During the year ended December 31, 2019, we realized net losses of $157.9 million 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, 2021, we had $13.6 million (December 31, 2020: $33.1 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, 2021, we had $1.6 billion notional amount of TBAs and recorded $41.6 million of realized and unrealized losses during the year ended December 31, 2021 primarily due to the sharp increase in mortgage rates during the first quarter of 2021. 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 party to any TBAs accounted for as derivatives during 2019. 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 and 2019. Years Ended December 31, $ in thousands 2020 2019 GSE CRT embedded derivative coupon interest 6,323 20,833 Gain (loss) on settlement of GSE CRT embedded derivatives (31,354) — Change in fair value of GSE CRT embedded derivatives (10,281) (12,490) Total realized and unrealized credit derivative income (loss), net (35,312) 8,343 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. 56 Table of Contents Net Gain (Loss) on Extinguishment of Debt As discussed in Note 6 - “Borrowings” of our consolidated financial statements in Part IV, Item 15 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. Other Investment Income (Loss), net Other investment income (loss), net in 2020 and 2019 primarily consists of quarterly dividends from FHLBI stock. 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. FHLBI redeemed our stock at cost during 2020. We terminated our FHLBI membership in the third quarter of 2020. The table below summarizes the components of other investment income (loss), net for the years ended December 31, 2021, 2020 and 2019. Years Ended December 31, $ in thousands 2021 2020 2019 Dividend income — 2,072 3,944 Gain (loss) on foreign currency transactions, net 1 65 6 Total 1 2,137 3,950 Other investment income (loss), net decreased during the year ended December 31, 2021 compared to 2020 and during the year ended December 31, 2020 compared to 2019 due to the redemption of our FHLBI stock. Expenses For the year ended December 31, 2021, we incurred management fees of $21.1 million (2020: $29.4 million) that are payable to our Manager under our management agreement. Management fees decreased for the year ended December 31, 2021 compared to 2020 due to a lower stockholders' equity management fee base in 2021. Our management fees are calculated quarterly in arrears. Refer to Note 11 – “Related Party Transactions” of our consolidated financial statements in Part IV, Item 15 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, 2020 we incurred management fees of $29.4 million (2019: $38.2 million) that 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. For the year ended December 31, 2021, our general and administrative expenses not covered under our management agreement amounted to $8.2 million (2020: $10.9 million; 2019: $8.0 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 lower for the year ended December 31, 2021 compared to 2020 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 in 2020. General and administrative costs were higher for the year ended December 31, 2020 compared to 2019 primarily due to these fees. Issuance and Redemption Costs of Redeemed Preferred Stock On June 16, 2021, we redeemed all issued and outstanding shares of our Series A Preferred Stock. The excess of the consideration transferred over carrying value was accounted for as a deemed dividend and resulted in a reduction of $4.7 million in net income (loss) attributable to common stockholders during the year ended December 31, 2021. Net Income (Loss) attributable to Common Stockholders For the year ended December 31, 2021, our net loss attributable to common stockholders was $132.5 million (2020: $1.7 billion net loss attributable to common stockholders; 2019: $319.7 million net income attributable to common stockholders) or $0.48 basic and diluted net loss per average share available to common stockholders (2020: $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). 57 Table of Contents For the year ended December 31, 2021, the change in net loss attributable to common stockholders compared to 2020 was primarily due to: (i) net losses on investments of $366.5 million versus $961.9 million in the 2020 period; (ii) net gains on derivative instruments of $122.6 million versus net losses on derivatives of $851.1 million in the 2020 period; (iii) net losses on credit derivatives of $35.3 million in the 2020 period; (iv) lower net interest income of $180.5 million versus $197.9 million in the 2020 period and (v) net gains on debt extinguishment of $14.7 million in the 2020 period. 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 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 2021, 2020 and 2019 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 The table below shows the non-GAAP financial measures we use to analyze our operating results and the most directly comparable U.S. GAAP measures. We believe these non-GAAP measures are useful to investors in assessing our performance as discussed further below. Non-GAAP Financial Measure Most Directly Comparable U.S. GAAP Measure Earnings available for distribution (and by calculation, earnings available for distribution per common share) Net income (loss) attributable to common stockholders (and by calculation, basic earnings (loss) per common share) Effective interest income (and by calculation, effective yield) Total interest income (and by calculation, earning asset yields) Effective interest expense (and by calculation, effective cost of funds) Total interest expense (and by calculation, cost of funds) Effective net interest income (and by calculation, effective interest rate margin) Net interest income (and by calculation, net interest rate margin) Economic debt-to-equity ratio Debt-to-equity ratio Commencing with the quarter ended June 30, 2021, we changed the title of our non-GAAP measure of core earnings (and by calculation, core earnings per common share) to earnings available for distribution (and by calculation, earnings available for distribution per common share) to clarify what the measure presents. The adjustments made to reconcile net income (loss) attributable to common stockholders to earnings available for distribution are identical to those adjustments that we previously made to determine core earnings. We adjust our calculations of non-GAAP financial measures for changes in the composition of our investment portfolio where appropriate. We have historically excluded the impact of realized and unrealized gains and losses on GSE CRT embedded derivatives from the calculation of earnings available for distribution. Beginning in 2021, realized and unrealized gains and losses on GSE CRT embedded derivatives no longer impacted the reconciliation of U.S. GAAP net income (loss) attributable to common stockholders to earnings available for distribution because we sold all of our GSE CRTs that were accounted for as hybrid financial instruments during 2020. Additionally, we have historically calculated effective interest income (and by calculation, effective yield) as U.S. GAAP total interest income adjusted for GSE CRT embedded derivative coupon interest that was recorded as realized and unrealized credit derivative income (loss), net. As we no longer earn embedded derivative coupon interest due to the sale of our GSE CRTs during 2020, effective interest income is equal to U.S. GAAP total interest income beginning in 2021. We did not present earnings available for distribution for the year ended December 31, 2020 because earnings available for distribution excluded the material adverse impact of the market disruption caused by the COVID-19 pandemic on our financial condition. In addition, earnings available for the year ended December 31, 2020 was not indicative of the reduced earnings potential of our current investment portfolio. 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. 58 Table of Contents Earnings Available for Distribution (formerly Core Earnings) Our business objective is to provide attractive risk-adjusted returns to our stockholders, primarily through dividends and secondarily through capital appreciation. We use earnings available for distribution as a measure of our investment portfolio’s ability to generate income for distribution to common stockholders and to evaluate our progress toward meeting this objective. We calculate earnings available for distribution 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; realized and unrealized (gain) loss on GSE CRT embedded derivatives, net; TBA dollar roll income; (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. By excluding the gains and losses discussed above, we believe the presentation of earnings available for distribution provides a consistent measure of operating performance that investors can use to evaluate our results over multiple reporting periods and, to a certain extent, compare to our peer companies. However, because not all of our peer companies use identical operating performance measures, our presentation of earnings available for distribution may not be comparable to other similarly titled measures used by our peer companies. We exclude the impact of gains and losses when calculating earnings available for distribution because (i) when analyzed in conjunction with our U.S. GAAP results, earnings available for distribution provides additional detail of our investment portfolio’s earnings capacity and (ii) gains and losses are not accounted for consistently under U.S. GAAP. Under U.S. GAAP, certain gains and losses are reflected in net income whereas other gains and losses are reflected in other comprehensive income. For example, a portion of our mortgage-backed securities are classified as available-for-sale securities, and we record changes in the valuation of these securities in other comprehensive income on our consolidated balance sheets. We elected the fair value option for our mortgage-backed securities purchased on or after September 1, 2016, and changes in the valuation of these securities are recorded in other income (loss) in our consolidated statements of operations. In addition, certain gains and losses represent one-time events. We may add and have added additional reconciling items to our earnings available for distribution calculation as appropriate. 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 have historically distributed at least 100% of our REIT taxable income. Because we view earnings available for distribution as a consistent measure of our investment portfolio's ability to generate income for distribution to common stockholders, earnings available for distribution is one metric, but not the exclusive metric, that our board of directors uses to determine the amount, if any, and the payment date of dividends on our common stock. However, earnings available for distribution should not be considered as an indication of our taxable income, a guaranty of our ability to pay dividends or as a proxy for the amount of dividends we may pay, as earnings available for distribution excludes certain items that impact our cash needs. Earnings available for distribution is an incomplete measure of our financial performance and there are other factors that impact the achievement of our business objective. We caution that earnings available for distribution should not be considered as an alternative to net income (determined in accordance with U.S. GAAP), or as an indication of our cash flow from operating activities (determined in accordance with U.S. GAAP), a measure of our liquidity or as an indication of amounts available to fund our cash needs. 59 Table of Contents The table below provides a reconciliation of U.S. GAAP net income (loss) attributable to common stockholders to earnings available for distribution for the following periods: Years Ended December 31, $ in thousands, except per share data 2021 2019 Net income (loss) attributable to common stockholders (132,477) 319,675 Adjustments: (Gain) loss on investments, net 366,509 (624,466) Realized (gain) loss on derivative instruments, net (1) (156,157) 597,077 Unrealized (gain) loss on derivative instruments, net (1) 17,743 (26,482) Realized and unrealized (gain) loss on GSE CRT embedded derivatives, net (2) — 12,490 TBA dollar roll income (3) 40,058 — (Gain) loss on foreign currency transactions, net (4) (1) (6) Amortization of net deferred (gain) loss on de-designated interest rate swaps (5) (22,000) (23,729) Subtotal 246,152 (65,116) Earnings available for distribution 113,675 254,559 Basic earnings (loss) per common share (0.48) 2.42 Earnings available for distribution per common share (6) 0.41 1.92 (1) U.S. GAAP gain (loss) on derivative instruments, net on the consolidated statements of operations includes the following components: Years Ended December 31, $ in thousands 2021 2019 Realized gain (loss) on derivative instruments, net 156,157 (597,077) Unrealized gain (loss) on derivative instruments, net (17,743) 26,482 Contractual net interest income (expense) on interest rate swaps (15,803) 35,840 Gain (loss) on derivative instruments, net 122,611 (534,755) (2) U.S. GAAP realized and unrealized credit derivative income (loss), net on the consolidated statements of operations includes the following components: Years Ended December 31, $ in thousands 2021 2019 Realized and unrealized gain (loss) on GSE CRT embedded derivatives, net — (12,490) GSE CRT embedded derivative coupon interest — 20,833 Realized and unrealized credit derivative income (loss), net — 8,343 (3) A TBA dollar roll is a series of derivative transactions where TBAs with the same specified issuer, term and coupon but different settlement dates are simultaneously bought and sold. The TBA settling in the later month typically prices at a discount to the TBA settling in the earlier month. TBA dollar roll income represents the price differential between the TBA price for current month settlement versus the TBA price for forward month settlement. We include TBA dollar roll income in earnings available for distribution because it is the economic equivalent of interest income on the underlying Agency securities, less an implied financing cost, over the forward settlement period. TBA dollar roll income is a component of gain (loss) on derivative instruments, net on our consolidated statements of operations. 60 Table of Contents (4) U.S. GAAP other investment income (loss), net on the consolidated statements of operations includes the following components: Years Ended December 31, $ in thousands 2021 2019 Dividend income — 3,944 Gain (loss) on foreign currency transactions, net 1 6 Other investment income (loss), net 1 3,950 (5) U.S. GAAP repurchase agreements interest expense on the consolidated statements of operations includes the following components: Years Ended December 31, $ in thousands 2021 2019 Interest expense on repurchase agreements outstanding 10,710 454,426 Amortization of net deferred (gain) loss on de-designated interest rate swaps (22,000) (23,729) Repurchase agreements interest expense (11,290) 430,697 (6) Earnings available for distribution per common share is equal to earnings available for distribution divided by the basic weighted average number of common shares outstanding. The components of earnings available for distribution for the years ended December 31, 2021 and 2019 are: Years Ended December 31, $ in thousands 2021 2019 Effective net interest income (1) 142,689 338,991 TBA dollar roll income 40,058 — Dividend income — 3,944 Equity in earnings (losses) of unconsolidated ventures 870 2,224 (Increase) decrease in provision for credit losses 1,768 — Total expenses (29,233) (46,174) Subtotal 156,152 298,985 Dividends to preferred stockholders (37,795) (44,426) Issuance and redemption costs of redeemed preferred stock (4,682) — Earnings available for distribution 113,675 254,559 (1) See below for a reconciliation of net interest income to effective net interest income, a non-GAAP measure. Earnings available for distribution for the year ended December 31, 2021 was driven by effective net interest income and TBA dollar roll income. Earnings available for distribution for the year ended December 31, 2019 was driven by effective net interest income. As discussed above, we did not report earnings available for distribution for the year ended December 31, 2020. 61 Table of Contents Effective Interest Income / Effective Yield/ Effective Interest Expense / Effective Cost of Funds / Effective Net Interest Income / Effective Interest Rate Margin Prior to 2021, we calculated effective interest income (and by calculation, effective yield) as U.S. GAAP total interest income adjusted for GSE CRT embedded derivative coupon interest that was recorded as realized and unrealized credit derivative income (loss), net. We included our GSE CRT embedded derivative coupon interest in effective interest income because GSE CRT coupon interest was not accounted for consistently under U.S. GAAP. We accounted for GSE CRTs purchased before August 24, 2015 as hybrid financial instruments, but 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 was recorded as interest income, whereas coupon interest on GSE CRTs accounted for as hybrid financial instruments was recorded as realized and unrealized credit derivative income (loss). We added back GSE CRT embedded derivative coupon interest to our total interest income because we considered GSE CRT embedded derivative coupon interest a current component of our total interest income irrespective of whether we elected the fair value option for the GSE CRT or accounted for the GSE CRT as a hybrid financial instrument. We calculate effective interest expense (and by calculation, effective cost of funds) as U.S. GAAP total interest expense adjusted for contractual net interest income (expense) on our interest rate swaps that is recorded as gain (loss) on derivative instruments, net and the amortization of net deferred gains (losses) on de-designated interest rate swaps that is recorded as repurchase agreements interest expense. We view our interest rate swaps as an economic hedge against increases in future market interest rates on our floating rate borrowings. We add back the net payments 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, 2021 2020 2019 $ in thousands Reconciliation Yield/Effective Yield Reconciliation Yield/Effective Yield Reconciliation Yield/Effective Yield Total interest income 169,202 1.92 % 280,166 3.55 % 778,367 3.78 % 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 % Effective interest income 169,202 1.92 % 286,489 3.63 % 799,200 3.89 % Our effective interest income decreased for the year ended December 31, 2021 versus 2020 due to lower asset yields primarily as a result of our asset sales in the first half of 2020. Changes in effective yield for the year ended December 31, 2021 versus 2020 are primarily due to changes in portfolio composition. Almost all of our investment portfolio (excluding TBAs) was invested in Agency RMBS during the year ended December 31, 2021. Our effective interest income decreased for the year ended December 31, 2020 versus 2019 primarily due to lower average earning 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. 62 Table of Contents 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, 2021 2020 2019 $ 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 (11,290) (0.14) % 82,262 1.19 % 472,320 2.52 % Add: Amortization of net deferred gain (loss) on de-designated interest rate swaps 22,000 0.28 % 23,794 0.34 % 23,729 0.13 % Add (Less): Contractual net interest expense (income) on interest rate swaps recorded as gain (loss) on derivative instruments, net 15,803 0.20 % (8,047) (0.12) % (35,840) (0.19) % Effective interest expense 26,513 0.34 % 98,009 1.41 % 460,209 2.46 % Our effective interest expense and effective cost of funds decreased for the year ended December 31, 2021 versus 2020 primarily due to a lower average cost of funds reflecting decreases in the Federal Funds rate. Lower total interest expense was partially offset by contractual net interest expense on interest rate swaps of $15.8 million during the year ended December 31, 2021 compared to $8.0 million of contractual net interest income for the same period in 2020. Our effective interest expense and effective cost of funds decreased for the year ended December 31, 2020 versus 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 rate. 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, 2021 2020 2019 $ 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 180,492 2.06 % 197,904 2.36 % 306,047 1.26 % Less: Amortization of net deferred (gain) loss on de-designated interest rate swaps (22,000) (0.28) % (23,794) (0.34) % (23,729) (0.13) % 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 % Add (Less): Contractual net interest income (expense) on interest rate swaps recorded as gain (loss) on derivative instruments, net (15,803) (0.20) % 8,047 0.12 % 35,840 0.19 % Effective net interest income 142,689 1.58 % 188,480 2.22 % 338,991 1.43 % Effective net interest income for the year ended December 31, 2021 decreased versus 2020 primarily due to lower asset yields as a result of our asset sales in the first half of 2020 that were partially offset by a lower average cost of funds reflecting decreases in the Federal Funds rate. Effective interest rate margin for the year ended December 31, 2021 decreased versus 2020 due to changes in portfolio composition. Effective net interest income for the year ended December 31, 2020 decreased versus 2019 primarily due to lower average earning asset balances that were partially offset by lower average borrowings and a lower effective cost of funds driven 63 Table of Contents by cuts in the Federal Funds rate. Effective interest rate margin for the year ended December 31, 2020 increased versus 2019 due to changes in portfolio composition, including related repurchase agreement borrowings, and a lower Federal Funds rate. 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, 2021 and December 31, 2020. 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, 2021, approximately 93% 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, 2021 $ in thousands Agency RMBS Credit Portfolio (1) Total Mortgage-backed securities 7,732,281 71,978 7,804,259 Cash and cash equivalents (2) 357,134 — 357,134 Restricted cash (3) 219,918 — 219,918 Derivative assets, at fair value (3) — 270 270 Other assets 25,728 36,532 62,260 Total assets 8,335,061 108,780 8,443,841 Repurchase agreements 6,987,834 — 6,987,834 Derivative liabilities, at fair value (3) 14,356 — 14,356 Other liabilities 35,596 3,920 39,516 Total liabilities 7,037,786 3,920 7,041,706 Total stockholders' equity (allocated) 1,297,275 104,860 1,402,135 Debt-to-equity ratio (4) 5.4 — 5.0 Economic debt-to-equity ratio (5) 6.6 — 6.2 (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 is allocated based on our financing strategy for each asset class. (3) Restricted cash and derivative assets and liabilities are allocated based on our 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 ($1.6 billion as of December 31, 2021 ) to total stockholders' equity. 64 Table of Contents December 31, 2020 $ in thousands Agency RMBS Credit Portfolio (1) Total Mortgage-backed 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, a commercial loan and unconsolidated joint ventures are included in credit portfolio. (2) Cash and cash equivalents is allocated based on our financing strategy for each asset class. (3) Restricted cash and derivative assets and liabilities are allocated based on our 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. 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 this Report for more information on how the COVID-19 pandemic has impacted and may continue to impact our liquidity and capital resources. 65 Table of Contents We held cash, cash equivalents and restricted cash of $577.1 million at December 31, 2021 (2020: $392.6 million). Our cash, cash equivalents and restricted cash increased due to normal fluctuations in cash timing of principal and interest payments, repayments of debt, and asset purchases and sales. Our operating activities provided net cash of approximately $152.3 million for the year ended December 31, 2021 (2020: $170.5 million; 2019: $343.4 million). Our investing activities provided net cash of $120.7 million for the year ended December 31, 2021 (2020: provided net cash of $11.6 billion; 2019: used net cash of $4.3 billion). Our primary source of cash from investing activities during the year ended December 31, 2021 was $16.3 billion from the sale of MBS. We also generated $825.2 million from principal payments of MBS and received cash of $156.2 million to settle derivative contracts during the year ended December 31, 2021. We used cash of $17.1 billion to purchase MBS during the year ended December 31, 2021. During the year ended December 31, 2020, we sold MBS and GSE CRT for proceeds 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 during the year ended December 31, 2020. 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. Our financing activities used net cash of $88.6 million for the year ended December 31, 2021 (2020: used net cash of $11.6 billion; 2019: provided net cash of $4.1 billion). Our financing activities for the year ended December 31, 2021 primarily consisted of net principal repayments on our repurchase agreements of $240.9 million. We paid dividends of $133.1 million and used cash of $140.0 million to redeem our Series A Preferred Stock during the year ended December 31, 2021. Proceeds from the issuance of common stock provided $430.5 million during the year ended December 31, 2021. 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. As of December 31, 2021, the average margin requirement (weighted by borrowing amount), or the haircut, under our repurchase agreements was 4.8% for Agency RMBS. The haircuts ranged from a low of 3% to a high of 5%. 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 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. 66 Table of Contents 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, 2021, we held $7.3 billion of Agency securities that are financed by repurchase agreements. We also had approximately $514.1 million of unencumbered investments and unrestricted cash of $357.1 million as of December 31, 2021. As of December 31, 2021, our known contractual obligations primarily consist of $7.0 billion of repurchase agreement borrowings with a weighted average remaining maturity of 29 days. We generally intend to refinance the majority of our repurchase agreement borrowings at market rates upon maturity. Repurchase agreement borrowings that are not refinanced upon maturity are typically repaid through the use of cash on hand or proceeds from sales of securities. We are also committed to fund $6.5 million in additional capital to our unconsolidated joint ventures to cover future expenses should they occur. 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. 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, Item 15 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. 67 Table of Contents 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, 2021, no counterparty held collateral that exceeded the amounts borrowed under the related repurchase agreements by more than $70.1 million, or 5% of our stockholders’ equity. The following table summarizes our exposure under repurchase agreements to counterparties by geographic concentration as of December 31, 2021. 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 11 4,265,161 219,940 Europe (excluding United Kingdom) 2 614,623 28,202 Asia 4 1,917,804 99,182 United Kingdom 1 190,246 8,018 Total 18 6,987,834 355,342 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 2021. 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, 2021. Consequently, we believe we met the REIT income and asset test as of December 31, 2021. We also met all REIT requirements regarding the stock ownership and distribution of dividends of our taxable income as of December 31, 2021. Therefore, as of December 31, 2021, 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, 2021, we conducted our business so as not to be regulated as an investment company under the 1940 Act.