Invesco Mortgage Capital Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. In this quarterly report on Form 10-Q, or this "Quarterly Report," we refer to Invesco Mortgage Capital Inc. and its consolidated subsidiaries as "we," "us," "our Company," or "our," unless we specifically state otherwise or the context indicates otherwise. We refer to our external manager, Invesco Advisers, Inc., as our "Manager," and we refer to the indirect parent company of our Manager, Invesco Ltd. together with its consolidated subsidiaries (which does not include us), as "Invesco." The following discussion should be read in conjunction with our condensed consolidated financial statements and the accompanying notes to our condensed consolidated financial statements, which are included in Item 1 of this Quarterly Report, as well as the information contained in our most recent Form 10-K filed with the Securities and Exchange Commission (the “SEC”). Forward-Looking Statements We make forward-looking statements in this Quarterly Report and other filings we make with the SEC within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and such statements are intended to be covered by the safe harbor provided by the same. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, investment strategies, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “intend,” “project,” “forecast” or similar expressions and future or conditional verbs such as “will,” “may,” “could,” “should,” and “would,” and any other statement that necessarily depends on future events, we intend to identify forward-looking statements, although not all forward-looking statements may contain such words. Factors that could cause actual results to differ from those expressed in our forward-looking statements include, but are not limited to: • the effects of health endemics, including the COVID-19 pandemic; • unfavorable or changing economic, market or political conditions; • general volatility of financial markets and the effects of governmental responses, including actions and initiatives of the U.S. governmental agencies and changes to U.S. government policies, actions and initiatives of foreign governmental agencies and central banks, and monetary policy actions of the Federal Reserve, including actions relating to its agency mortgage-backed securities portfolio, and our ability to respond to and comply with such actions, initiatives and changes; • our business and investment strategy; • our investment portfolio and expected investments; • the availability of investment opportunities in mortgage-related, real estate-related and other securities; • the availability of U.S. Government Agency guarantees with regard to payments of principal and interest on securities; • the impact of changes in the credit rating of the U.S. government; • financing and advance rates for our target assets; • the impact of changes in interest rates and interest rate spreads and the market value of our target assets; • the potential interest rate mismatches between our target assets and our borrowings used to fund such investments; • changes to our expected leverage; • the availability of financing sources, including our ability to obtain additional financing arrangements and the terms of such arrangements; • the adequacy of our cash flow from operations and borrowings, and our ability to maintain sufficient liquidity to meet our short-term liquidity needs; • changes in prepayment rates on our target assets; • the impact of any deficiencies in loss mitigation of third parties and related uncertainty in the timing of collateral disposition; • our reliance on third parties in connection with services related to our target assets; 24 Table of Contents • the effects of hedging instruments, including, but not limited to, the degree to which our hedging strategies may or may not protect us from interest rate and foreign currency exchange rate volatility; • the degree to which derivative contracts expose us to contingent liabilities; • rates of default or decreased recovery rates on our target assets; • counterparty defaults; • modifications to whole loans or loans underlying securities; • our ability to comply with financial covenants in our financing arrangements; • disruption of our information technology systems; • the impact of potential data security breaches or other cyber-attacks or other disruptions; • changes in governmental regulations, and changes in zoning, insurance, eminent domain and tax law and rates, and similar matters and our ability to respond to such changes; • our ability to maintain our qualification as a real estate investment trust for U.S. federal income tax purposes; • our ability to maintain our exception from the definition of “investment company” under the 1940 Act; • the market price and trading volume of our capital stock; • our ability to continue to generate taxable income and our ability to continue to make distributions to our stockholders in the future; • our intention and ability to pay dividends; • our dependence upon, and the relationship with, our Manager; • the availability of qualified personnel from our Manager, and our Manager’s continued ability to find and retain such personnel; • the accuracy of our estimates relating to fair value of our target assets and interest income recognition; • our understanding of our competition; • the impact of changes to U.S. GAAP; • the adequacy of our disclosure controls and procedures and internal controls over financial reporting; and • market trends in our industry, interest rates, real estate values, the debt securities markets or the general economy. The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. You should not place undue reliance on these forward-looking statements. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. Some of these factors are described under the headings "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in this Report. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. New risks and uncertainties arise over time, and it is not possible for us to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. 25 Table of Contents Executive Summary 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. As of March 31, 2023, we were invested in: • 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; and • other real estate-related financing arrangements. During the periods presented in this Quarterly Report, we also invested in: • a commercial mortgage loan; and • U.S. Treasury securities. 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. (the “Operating Partnership”). We are externally managed and advised by our Manager, an indirect wholly-owned subsidiary of 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 “Investment Company” under the 1940 Act. Market Conditions Macroeconomic factors that affect our business include interest rates, 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. Of these macroeconomic factors, government policy initiatives, inflation, interest rates and interest rate volatility had the most direct impacts on our performance and financial condition during the first quarter of 2023. Contributing factors included: • Financial conditions improved during the first two months of the quarter, as credit spreads tightened, equity markets rallied and volatility eased. However, these positive trends reversed in March as the health of the regional banking system came into question amid multiple bank failures. In response, swift action by regulators, including the Federal Reserve, quickly calmed markets and allowed financial conditions to stabilize and end the quarter only slightly tighter. • Given the uncertainty around the health of the banking system, interest rates rallied during the quarter, as the yield on the 2 year Treasury fell by 40 basis points, to 4.03%, while the yield on the 10 year Treasury decreased by 41 basis points, to 3.47%. The Federal Reserve’s Open Market Committee (“FOMC”) continued its fight against inflation by increasing the Federal Funds target rate twice, taking the target to a range of 4.75% to 5.0%. • After a strong start to the new year in January, Agency MBS lagged similar duration Treasuries in February and March, resulting in underperformance for the quarter. Lower coupon Agency MBS sharply underperformed those higher in the coupon stack, as lower coupons were negatively impacted by two distinct events during the quarter. First in February by the sharp increase in interest rates as the disinflationary trend in economic data slowed, and second in March by concerns regarding the timing of sales from Silicon Valley Bank and Signature Bank portfolios, which were highly concentrated in lower coupon Agency MBS. The following market conditions were also notable for the company in the first quarter of 2023: • Risk assets, with the exception of structured securities, performed well during the quarter. The S&P 500 gained 7.0%, while the NASDAQ was up 16.8%. Likewise, credit spreads across investment grade credit, high yield and emerging 26 Table of Contents market debt all finished the quarter tighter. Debt backed by commercial real estate was negatively impacted by concerns that regional banks could be forced to sell assets. • The employment picture remained strong as gains in non-farm payrolls averaged 345,000 per month, for a total of just over one million jobs added during the quarter. The unemployment rate held steady, ending the quarter at 3.5%. • Year-over-year price growth, as measured by the consumer price index (“CPI”), continued to moderate during the first quarter, declining from 6.5% at year-end to 5.0% at the end of the first quarter. Commodity prices also moderated during the first quarter, with the Commodity Research Bureau commodity index falling 3.6%. Breakeven rates on U.S Treasury inflation-protected securities (“TIPs”), which reflect investors' expectations of future inflation, continue to indicate confidence that the FOMC will be successful at bringing inflation levels significantly lower, as the inflation rate implied by 2 year and 5 year TIPs was 2.68% and 2.48%, respectively, at the end of the quarter. • CMBS risk premiums increased due to declining real estate values, increased borrowing costs and tighter mortgage lending standards. The pace of property rent growth is slowing and vacancy rates are increasing across many property types. Meanwhile, reevaluation of tenant needs and a corresponding increase in the amount of available sublease space has created unique headwinds for the office sector. CMBS loan delinquencies increased slightly over the quarter. Industrial, multifamily and retail property loan delinquencies declined while the rate of office loan delinquencies increased notably. • Credit spreads for non-Agency RMBS ended the quarter largely unchanged, as strong performance early in the period was undone by broader risk aversion into quarter end. Although security valuations were driven primarily by market technicals, investors also focused on deterioration in housing fundamentals, particularly with respect to more credit sensitive profiles. Home price declines resulting from historically low affordability have moderated in recent months as borrowing costs stabilized. Meanwhile, low inventory, positive demographic trends, and shifts in housing preferences in favor of single-family properties have provided crucial support to the market. Despite the potential for a slowing economy, borrower defaults are likely to remain contained given strong loan underwriting and high levels of borrower equity. Outlook Moving into the second quarter of 2023, pricing in the Federal Funds futures market indicates that the market expects one or two additional target rate increases during the second quarter. While the timing of the end of the FOMC’s tightening cycle remains uncertain, we believe the conclusion of tightening monetary policy and a potential reduction in interest rate volatility combined with compelling valuations and favorable funding conditions will support an attractive investment environment for Agency RMBS in 2023. 27 Table of Contents Investment Activities The table below shows the composition of our investment portfolio as of March 31, 2023, December 31, 2022 and March 31, 2022: As of $ in thousands March 31, 2023 December 31, 2022 March 31, 2022 Agency RMBS: 30 year fixed-rate, at fair value 5,320,942 4,661,737 5,861,979 Agency CMO, at fair value 81,258 84,956 60,818 Non-Agency CMBS, at fair value 36,624 36,787 61,295 Non-Agency RMBS, at fair value 8,319 8,413 8,402 U.S. Treasury securities, at fair value — — 482,445 Commercial loan, at fair value — — 23,391 Investments in unconsolidated ventures 504 552 4,854 Subtotal 5,447,647 4,792,445 6,503,184 TBAs, at implied cost basis (1) 929 1,437 1,549,395 Total investment portfolio, including TBAs 5,448,576 4,793,882 8,052,579 (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 condensed 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 condensed 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 I. Item 1 of this report on Form 10-Q. 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 $783.9 million and purchased $1.4 billion of Agency RMBS during the three months ended March 31, 2023. As of March 31, 2023, our holdings of 30 year fixed-rate Agency RMBS represented approximately 98% of our total investment portfolio, including TBAs, versus 97% as of December 31, 2022 and 73% as of March 31, 2022. Our 30 year fixed-rate Agency RMBS holdings as of March 31, 2023, December 31, 2022 and March 31, 2022 consisted of specified pools with coupon distributions as shown in the table below. As of March 31, 2023 December 31, 2022 March 31, 2022 $ in thousands Fair Value Percentage Fair Value Percentage Fair Value Percentage 2.0% — — % — — % 1,911,141 32.6 % 2.5% — — % — — % 1,938,205 33.1 % 3.0% — — % — — % 2,012,633 34.3 % 4.0% 770,111 14.5 % — — % — — % 4.5% 1,445,923 27.2 % 1,392,304 29.9 % — — % 5.0% 1,539,794 28.9 % 1,694,939 36.4 % — — % 5.5% 1,565,114 29.4 % 1,574,494 33.7 % — — % Total 30 year fixed-rate Agency RMBS 5,320,942 100.0 % 4,661,737 100.0 % 5,861,979 100.0 % Our purchases of Agency RMBS have been primarily focused on specified pools with attractive prepayment profiles. We seek to capitalize on the impact of prepayments on our investment portfolio by purchasing specified pools with characteristics that optimize borrower incentive to prepay for both our premium and discount priced investments. The table below shows the specified pool characteristics of our 30 year fixed-rate Agency RMBS holdings as of March 31, 2023, December 31, 2022 and March 31, 2022. 28 Table of Contents As of March 31, 2023 December 31, 2022 March 31, 2022 $ in thousands Fair Value Percentage Fair Value Percentage Fair Value Percentage Specified pool characteristic: Geographic location 1,566,529 29.5 % 1,302,391 27.9 % 2,116,743 36.1 % Loan balance 1,338,150 25.1 % 1,033,014 22.2 % 2,180,304 37.2 % Generic — — % 158,230 3.4 % 372,955 6.4 % High loan-to-value (“LTV”) ratio 956,556 18.0 % 750,724 16.1 % 807,451 13.8 % Low credit score 1,459,707 27.4 % 1,417,378 30.4 % 384,526 6.5 % Total 30 year fixed-rate Agency RMBS 5,320,942 100.0 % 4,661,737 100.0 % 5,861,979 100.0 % We invest in TBAs as an alternative means of investing in and financing Agency RMBS. As of March 31, 2023 and December 31, 2022 the implied cost basis of TBAs did not represent a material amount of our total investment portfolio, versus 19% as of March 31, 2022. We decreased the allocation to TBAs as implied financing rates in the Agency RMBS TBA dollar roll market increased more than those available in the repurchase market for most coupons. As of March 31, 2023; December 31, 2022 and March 31, 2022 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 were rated single-A (or equivalent) or higher by a nationally recognized statistical rating organization as of March 31, 2023. Approximately 72% of non-Agency CMBS were rated double-A (or equivalent) or higher by a nationally recognized statistical rating organization as of March 31, 2023. As of March 31, 2023; December 31, 2022 and March 31, 2022, our holdings of non-Agency RMBS represented less than 1% of our total investment portfolio, including TBAs. As of December 31, 2022 and March 31, 2022, we held investments in two unconsolidated ventures that were managed by an affiliate of our Manager. Our joint venture whose net assets were denominated in euros was dissolved during the first quarter of 2023. Our remaining unconsolidated venture is in liquidation and plans to sell or settle its remaining investments as expeditiously as possible. Until the venture completes its liquidation, we are committed to fund $2.9 million in additional capital to cover future expenses should they occur. Financing and Other Liabilities We finance the majority of investment portfolio through repurchase agreements. 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 the secured overnight financing rate (“SOFR”). The following table presents the amount of collateralized borrowings outstanding under repurchase agreements 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 Quarter Ended Quarter-end balance Average quarterly balance (1) Maximum balance (2) March 31, 2022 5,837,420 6,218,445 6,636,913 June 30, 2022 3,262,530 4,059,917 4,902,191 September 30, 2022 3,887,291 3,907,505 4,165,996 December 31, 2022 4,234,823 3,825,218 4,234,823 March 31, 2023 4,814,700 4,734,819 4,814,700 (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. 29 Table of Contents Hedging Instruments We enter into interest rate swap agreements that are designed to mitigate the effects of changes 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. We actively manage our interest rate swap portfolio as the size and composition of our investment portfolio changes. During the three months ended March 31, 2023, we terminated existing interest rate swaps with a notional amount of $525.0 million. In addition, one of our forward starting swaps held as of December 31, 2022 with a notional amount of $500.0 million began to bear interest during the three months ended March 31, 2023. The remainder of our forward starting swaps begin to bear interest in July 2023. 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 condensed consolidated statement of operati ons. We recorded net losses of $44.5 million on interest rate swaps for the three months ended March 31, 2023 primarily due to changes in forward interest rate expectations. We have historically entered into currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on investments denominated in foreign currencies. We did not have any currency forward contracts outstanding as of March 31, 2023 or December 31, 2022. Capital Activities As of March 31, 2023, we may sell up to 13,069,931 shares of our common stock from time to time in at-the-market or privately negotiated transactions under our equity distribution agreement with placement agents. During the three months ended March 31, 2023, we sold 2,930,069 shares of common stock under our equity distribution agreement for proceeds of $35.8 million, net of approximately $482,000 in commissions and fees. During the three months ended March 31, 2022 we did not sell any shares of common stock under equity distribution agreements. For information on dividends declared during the three months ended March 31, 2023 and 2022, see Note 12 - "Stockholders' Equity" of our condensed consolidated financial statements in Part I. Item 1 of this report on Form 10-Q. During the three months ended March 31, 2023, we did not repurchase any shares of our common stock. In May 2022, our board of directors approved a share repurchase program for our Series B and Series C Preferred Stock. We did not repurchase any preferred stock in the three months ended March 31, 2023. As of March 31, 2023, we had authority to purchase 1,337,634 additional shares of our Series B Preferred Stock and 1,316,470 additional shares of our Series C Preferred Stock under the current share repurchase program. In May 2022, our board of directors approved a one-for-ten reverse split of outstanding shares of our common stock. The reverse stock split was effected following the close of business on June 3, 2022. For all periods presented, common shares and per common share amounts have been adjusted on a retroactive basis to reflect our one-for-ten reverse stock split. Book Value per Common Share We calculate book value per common share as follows. As of In thousands except per share amounts March 31, 2023 December 31, 2022 Numerator (adjusted equity): Total equity 834,115 804,075 Less: Liquidation preference of Series B Preferred Stock (113,441) (113,441) Less: Liquidation preference of Series C Preferred Stock (195,412) (195,412) Total adjusted equity 525,262 495,222 Denominator (number of shares): Common stock outstanding 41,647 38,711 Book value per common share 12.61 12.79 Our book value per common share decreased 1.4% as of March 31, 2023 compared to December 31, 2022 due to modest underperformance in higher coupon Agency RMBS as the slowing of the recent disinflationary trend led to an increase in 30 Table of Contents interest rate volatility. Refer to Item 3. “Quantitative and Qualitative Disclosures About Market Risk” for interest rate risk and its impact on fair value. Critical Accounting Policies and Estimates There have been no significant changes to our critical accounting policies and estimates that are disclosed in our most recent Form 10-K for the year ended December 31, 2022. Recent Accounting Standards None. 31 Table of Contents Results of Operations The table below presents information from our condensed consolidated statements of operations for the three months ended March 31, 2023 and 2022. Three Months Ended March 31, $ in thousands, except share data 2023 2022 Interest income Mortgage-backed and other securities 69,287 41,637 Commercial loan — 537 Total interest income 69,287 42,174 Interest expense Repurchase agreements (1) 49,726 (2,104) Total interest expense 49,726 (2,104) Net interest income 19,561 44,278 Other income (loss) Gain (loss) on investments, net 51,956 (504,388) Equity in earnings (losses) of unconsolidated ventures 2 71 Gain (loss) on derivative instruments, net (44,895) 238,860 Other investment income (loss), net (93) 55 Total other income (loss) 6,970 (265,402) Expenses Management fee – related party 2,979 5,274 General and administrative 2,089 2,024 Total expenses 5,068 7,298 Net income (loss) 21,463 (228,422) Dividends to preferred stockholders (5,862) (8,394) Net income (loss) attributable to common stockholders 15,601 (236,816) Earnings (loss) per share: Net income (loss) attributable to common stockholders Basic 0.39 (7.18) Diluted 0.39 (7.18) Weighted average number of shares of common stock: Basic 39,607,354 32,985,009 Diluted 39,608,545 32,985,009 (1) Negative interest expense on repurchase agreements in 2022 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 I. Item 1. of this report on Form 10-Q. 32 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 three months ended March 31, 2023 and 2022. Three Months Ended March 31, $ in thousands 2023 2022 Average earning assets (1) 5,245,291 7,005,218 Average earning asset yields (2) 5.28 % 2.41 % (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 $5.2 billion for the three months ended March 31, 2023 (March 31, 2022: $7.0 billion). The decrease in average earning assets for the three months ended March 31, 2023 compared to 2022 is primarily due to a reduction in the size of our investment portfolio and related repurchase agreement borrowings during 2022 given expectations that elevated market volatility could result in lower valuations on our assets, while maintaining appropriate levels of leverage following declines in stockholders' equity. Average earning asset yields increased for the three months ended March 31, 2023 compared to 2022 primarily due to our rotation into higher yielding Agency RMBS during 2022. We earned total interest income of $69.3 million for the three months ended March 31, 2023 (March 31, 2022: $42.2 million). Our interest income includes coupon interest and net (premium amortization) discount accretion on mortgage-backed and other securities as well as interest income on our commercial loan as shown in the table below. Three Months Ended March 31, $ in thousands 2023 2022 Interest Income Mortgage-backed and other securities - coupon interest 69,116 48,229 Mortgage-backed and other securities - net (premium amortization) discount accretion 171 (6,592) Mortgage-backed and other securities - interest income 69,287 41,637 Commercial loan — 537 Total interest income 69,287 42,174 Mortgage-backed and other securities interest income increased $27.7 million for the three months ended March 31, 2023 compared to 2022 despite lower average earning assets due to a 287 basis point increase in average earning asset yields. Our commercial loan investment was fully repaid in October 2022. Prepayment Speeds Our RMBS 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. In an environment of rising interest rates, prepayment speeds will generally decrease as homeowners are not as incentivized to refinance. 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. 33 Table of Contents The following table presents net (premium amortization) discount accretion recognized on our mortgage-backed and other securities portfolio for the three months ended March 31, 2023 and 2022. Three Months Ended March 31, $ in thousands 2023 2022 Agency RMBS 14 (6,928) Non-Agency CMBS 291 503 Non-Agency RMBS (134) (151) U.S. Treasury Securities — (16) Net (premium amortization) discount accretion 171 (6,592) Net discount accretion was $171,000 for the three months ended March 31, 2023 compared to net premium amortization of $6.6 million for the same period in 2022. The change in net (premium amortization) discount accretion for the three months ended March 31, 2023 compared to 2022 was primarily the result of repositioning our Agency RMBS portfolio into securities with lower book prices. Our interest income is subject to interest rate risk. Refer to Item 3. "Quantitative and Qualitative Disclosures about Market Risk" for more information relating to interest rate risk and its impact on our operating results. Interest Expense and Cost of Funds The table below presents information related to our borrowings and cost of funds for the three months ended March 31, 2023 and 2022. Three Months Ended March 31, $ in thousands 2023 2022 Total average borrowings (1) 4,737,476 6,219,694 Maximum borrowings during the period (2) 4,814,700 6,636,913 Cost of funds (3) 4.20 % (0.14) % (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 decreased $1.5 billion in the three months ended March 31, 2023 compared to 2022 primarily due to a reduction in the size of our investment portfolio and related repurchase agreement borrowings during 2022 given expectations that elevated market volatility could result in lower valuations on our assets, while maintaining appropriate levels of leverage following declines in stockholders' equity. Our average cost of funds increased 434 basis points for the three months ended March 31, 2023 compared to 2022 as the FOMC has consistently raised the Federal Funds target rate from a range of 0.0% to 0.25% as of January 1, 2022 to a range of 4.75% to 5.0% as of March 31, 2023. The table below presents the components of interest expense for the three months ended March 31, 2023 and 2022. Three Months Ended March 31, $ in thousands 2023 2022 Interest Expense Interest expense on repurchase agreement borrowings 54,220 3,092 Amortization of net deferred (gain) loss on de-designated interest rate swaps (4,494) (5,196) Repurchase agreements interest expense 49,726 (2,104) Total interest expense 49,726 (2,104) Our repurchase agreements interest expense, which equals our total interest expense, increased $51.8 million for the three months ended March 31, 2023 compared to 2022 despite lower average borrowings due to a higher cost of funds. Our repurchase agreements interest expense as reported in our condensed consolidated statement of operations includes amortization of net deferred gains and losses on de-designated interest rate swaps as summarized in the table above. Amortization of net deferred gains on de-designated interest rate swaps decreased our total interest expense by $4.5 million during the three months ended March 31, 2023 and $5.2 million during the three months ended March 31, 2022. Amounts 34 Table of Contents recorded in accumulated other comprehensive income before we discontinued cash flow hedge accounting for our interest rate swaps are reclassified to interest expense on repurchase agreements on the condensed consolidated statements of operations as interest is accrued and paid on the related repurchase agreements over the remaining life of the interest rate swap agreements. We expect that the remaining $5.9 million of net deferred gains on de-designated interest rate swaps will be reclassified from accumulated other comprehensive income and recorded as a decrease to interest expense over a period of time through December 15, 2023. Net Interest Income The table below presents the components of net interest income for the three months ended March 31, 2023 and 2022: Three Months Ended March 31, $ in thousands 2023 2022 Interest Income Mortgage-backed and other securities 69,287 41,637 Commercial loan — 537 Total interest income 69,287 42,174 Interest Expense Interest expense on repurchase agreement borrowings 54,220 3,092 Amortization of net deferred (gain) loss on de-designated interest rate swaps (4,494) (5,196) Repurchase agreements interest expense 49,726 (2,104) Total interest expense 49,726 (2,104) Net interest income 19,561 44,278 Net interest rate margin 1.08 % 2.55 % Our net interest income, which equals interest income less interest expense, totaled $19.6 million for the three months ended March 31, 2023 (March 31, 2022: $44.3 million). 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 1.08% for the three months ended March 31, 2023 (March 31, 2022: 2.55%). The decrease in net interest income for the three months ended March 31, 2023 compared to 2022 was primarily due to a higher cost of funds related to increases in the Federal Funds target rate. The decrease in net interest rate margin for the three months ended March 31, 2023 compared to 2022 was primarily due to a higher cost of funds, which was partially offset by our rotation into higher yielding Agency RMBS. Our short-term borrowings are generally more sensitive to changes in interest rates than our investment portfolio, which is largely comprised of 30 year fixed-rate Agency RMBS. Gain (Loss) on Investments, net The table below summarizes the components of gain (loss) on investments, net for the three months ended March 31, 2023 and 2022: Three Months Ended March 31, $ in thousands 2023 2022 Net realized gains (losses) on sale of MBS (13,765) (318,970) Net unrealized gains (losses) on MBS accounted for under the fair value option 65,721 (165,467) Net unrealized gains (losses) on commercial loan — (124) Net unrealized gains (losses) on U.S. Treasury securities — (19,827) Total gain (loss) on investments, net 51,956 (504,388) During the three months ended March 31, 2023, we sold MBS and realized net losses of $13.8 million (March 31, 2022: net losses of $319.0 million). Net realized losses during the three months ended March 31, 2023 primarily reflect sales of 4.5% and 5.0% coupon Agency RMBS to purchase 4.0% coupon Agency RMBS with similar yields. Net realized losses during the three months ended March 31, 2022 primarily reflect sales of lower yielding Agency RMBS to purchase higher yielding Agency RMBS. We have elected the fair value option for all of our MBS purchased on or after September 1, 2016. Before September 1, 2016, we had also elected the fair value option for our non-Agency RMBS interest-only securities. Under the fair value option, changes in fair value are recognized in income in the condensed consolidated statements of operations and are reported as a 35 Table of Contents component of gain (loss) on investments, net. As of March 31, 2023, $5.4 billion (December 31, 2022: $4.7 billion) or 99% (December 31, 2022: 99%) of our MBS are accounted for under the fair value option. We recorded net unrealized gains on our MBS portfolio accounted for under the fair value option of $65.7 million in the three months ended March 31, 2023 compared to net unrealized losses of $165.5 million in the three months ended March 31, 2022. Net unrealized gains in the three months ended March 31, 2023 were primarily due to improved Agency RMBS valuations as yields on Treasuries decreased. Net unrealized losses in the three months ended March 31, 2022 primarily reflect wider interest rate spreads on our Agency RMBS. We recorded unrealized losses of $124,000 on our commercial loan investment in the three months ended March 31, 2022. We valued our commercial loan based upon a valuation from an independent pricing service. We did not hold any U.S. Treasury securities during the three months ended March 31, 2023 . We recorded unrealized losses of $19.8 million on U.S. Treasury securities during the three months ended March 31, 2022 due to rising interest rates. Equity in Earnings (Losses) of Unconsolidated Ventures For the three months ended March 31, 2023, we recorded equity in earnings of unconsolidated ventures of $2,000 (March 31, 2022: $71,000). Earnings and losses of unconsolidated ventures are driven primarily by the underlying portfolio investments. Gain (Loss) on Derivative Instruments, net We record all derivatives on our condensed 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 condensed 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 condensed consolidated statements of operations. The tables below summarize our realized and unrealized gain (loss) on derivative instruments, net for the following periods. $ in thousands Three months ended March 31, 2023 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 (90,949) 54,464 (7,968) (44,453) TBAs (951) — 509 (442) Total (91,900) 54,464 (7,459) (44,895) $ in thousands Three months ended March 31, 2022 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 343,309 1,284 (11,399) 333,194 Currency Forward Contracts 193 — (41) 152 TBAs (60,073) — (34,413) (94,486) Total 283,429 1,284 (45,853) 238,860 During the three months ended March 31, 2023, we terminated existing interest rate swaps with a notional amount of $525.0 million. In addition, one of our forward starting swaps held as of December 31, 2022 with a notional amount of $500.0 million began to bear interest during the three months ended March 31, 2023. The remainder of our forward starting swaps begin to bear interest in July 2023. We recorded net losses of $44.5 million and net gains of $333.2 million on interest rate swaps for the three months ended March 31, 2023 and 2022, respectively, primarily due to changes in forward interest rate expectations. As of March 31, 2023, we had $4.8 billion of repurchase agreement borrowings with a weighted average remaining maturity of 52 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. 36 Table of Contents As of March 31, 2023 and December 31, 2022, we held the following interest rate swaps whereby we pay fixed rate interest and receive floating rate interest based upon SOFR. $ in thousands As of March 31, 2023 As of December 31, 2022 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 0.45 % 4.82 % 5.8 5,800,000 0.45 % 4.30 % 6.3 (1) Excludes $475.0 million notional amount of interest rate swaps with forward start dates as of March 31, 2023 that will receive floating interest based upon SOFR (December 31, 2022: $975.0 million). As of March 31, 2023, these interest rate swaps had a weighted average maturity of 30.3 years (December 31, 2022: 16.5 years) and a weighted average fixed pay rate of 1.33% (December 31, 2022: 0.89%). As of March 31, 2023 and December 31, 2022, we held the following interest rate swaps whereby we pay floating rate interest based upon SOFR and receive fixed rate interest. $ in thousands As of March 31, 2023 As of December 31, 2022 Derivative instrument Notional Amounts Weighted Average Floating Pay Rate Weighted Average Fixed Receive Rate Weighted Average Years to Maturity Notional Amounts Weighted Average Floating Pay Rate Weighted Average Fixed Receive Rate Weighted Average Years to Maturity Interest Rate Swaps (1) 1,825,000 4.82 % 2.70 % 9.3 2,350,000 4.30 % 2.78 % 9.3 (1) Excludes $275.0 million notional amount of interest rate swaps with forward start dates as of March 31, 2023 that will pay floating interest based upon SOFR (December 31, 2022: $275.0 million). As of March 31, 2023, these interest rate swaps had a weighted average maturity of 15.8 years (December 31, 2022: 16.0 years) and a weighted average fixed receive rate of 2.63% (December 31, 2022: 2.63%). We historically used currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates. As of March 31, 2023 and December 31, 2022, we did not have any currency forward contracts outstanding. During the three months ended March 31, 2022 we settled currency forward contracts of €17.6 million or $20.4 million in notional amount related to our investment in an unconsolidated venture and realized a net gain of $193,000 . 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 March 31, 2023 and December 31, 2022, we did not have a net notional amount of TBAs. We recorded $442,000 and $94.5 million of net realized and unrealized losses on TBAs during the three months ended March 31, 2023 and 2022, respectively. Net realized and unrealized losses on TBAs for the three months ended March 31, 2022 primarily reflect rising interest rates, in addition to wider interest rate spreads on Agency RMBS. Other Investment Income (Loss), net Our other investment income (loss), net during the three months ended March 31, 2023 and 2022 consisted of foreign currency transaction gains and losses. Other investment income (loss) for the three months ended March 31, 2023 also includes the reclassification of our foreign currency translation adjustment that was previously recorded in accumulated other comprehensive income related to an unconsolidated venture that was liquidated during the first quarter of 2023. Expenses We incurred management fees of $3.0 million for the three months ended March 31, 2023 (March 31, 2022: $5.3 million). Management fees decreased for the three months ended March 31, 2023 compared to the same periods in 2022 due to a lower stockholders' equity management fee base. Refer to Note 11 – "Related Party Transactions" of our condensed consolidated financial statements for a discussion of our relationship with our Manager and a description of how our fees are calculated. Our general and administrative expenses not covered under our management agreement amounted to $2.1 million for the three months ended March 31, 2023 (March 31, 2022: $2.0 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. 37 Table of Contents Net Income (Loss) attributable to Common Stockholders For the three months ended March 31, 2023, our net income attributable to common stockholders was $15.6 million (March 31, 2022: $236.8 million net loss attributable to common stockholders) or $0.39 basic and diluted net income per average share available to common stockholders (March 31, 2022: $7.18 basic and diluted net loss per average share available to common stockholders). The change in net income (loss) attributable to common stockholders was primarily due to (i) net gains on investments of $52.0 million in the 2023 period compared to net losses on investments of $504.4 million in the 2022 period; (ii) net losses on derivative instruments of $44.9 million in the 2023 period compared to net gains on derivative instruments of $238.9 million in the 2022 period; and (iii) a $24.7 million decrease in net interest income. For further information on the changes in net gain (loss) on investments, net gain (loss) on derivative instruments, and changes in net interest income, see preceding discussion under “Gain (Loss) on Investments, net”, “Gain (Loss) on Derivative Instruments, net” and “Net Interest Income”. 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 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 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. Earnings Available for Distribution 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; TBA dollar roll income; foreign currency gains (losses), net and amortization of net deferred (gain) loss on de-designated interest rate swaps. 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 condensed 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 condensed 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 38 Table of Contents 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. 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. Three Months Ended March 31, $ in thousands, except per share data 2023 2022 Net income (loss) attributable to common stockholders 15,601 (236,816) Adjustments: (Gain) loss on investments, net (51,956) 504,388 Realized (gain) loss on derivative instruments, net (1) 91,900 (283,429) Unrealized (gain) loss on derivative instruments, net (1) 7,459 45,853 TBA dollar roll income (2) 697 13,401 Foreign currency (gains) losses, net (3) 93 (55) Amortization of net deferred (gain) loss on de-designated interest rate swaps (4) (4,494) (5,196) Subtotal 43,699 274,962 Earnings available for distribution 59,300 38,146 Basic income (loss) per common share 0.39 (7.18) Earnings available for distribution per common share (5) 1.50 1.16 (1) U.S. GAAP gain (loss) on derivative instruments, net on the condensed consolidated statements of operations includes the following components. Three Months Ended March 31, $ in thousands 2023 2022 Realized gain (loss) on derivative instruments, net (91,900) 283,429 Unrealized gain (loss) on derivative instruments, net (7,459) (45,853) Contractual net interest income (expense) on interest rate swaps 54,464 1,284 Gain (loss) on derivative instruments, net (44,895) 238,860 (2) 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 RMBS, 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 condensed consolidated statements of operations. (3) Foreign currency gains (losses), net includes foreign currency transaction gains and losses and the reclassification of currency translation adjustments that were previously recorded in accumulated other comprehensive income and is included in other investment income (loss), net on the condensed consolidated statements of operations. 39 Table of Contents (4) U.S. GAAP repurchase agreements interest expense on the condensed consolidated statements of operations includes the following components. Three Months Ended March 31, $ in thousands 2023 2022 Interest expense on repurchase agreement borrowings 54,220 3,092 Amortization of net deferred (gain) loss on de-designated interest rate swaps (4,494) (5,196) Repurchase agreements interest expense 49,726 (2,104) (5) 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. Earnings available for distribution per common share for the three months ended March 31, 2023 has been retroactively adjusted to reflect our one-for-ten reverse stock split that was effected following the close of business on June 3, 2022. The table below shows the components of earnings available for distribution for the following periods. Three Months Ended March 31, $ in thousands 2023 2022 Effective net interest income (1) 69,531 40,366 TBA dollar roll income 697 13,401 Equity in earnings (losses) of unconsolidated ventures 2 71 Total expenses (5,068) (7,298) Subtotal 65,162 46,540 Dividends to preferred stockholders (5,862) (8,394) Earnings available for distribution 59,300 38,146 (1) See below for a reconciliation of net interest income to effective net interest income, a non-GAAP measure. Earnings available for distribution increased during the three months ended March 31, 2023 compared to the same period in 2022 primarily due to an increase in effective net interest income, which was partially offset by a reduction in our TBA notional amount and related TBA dollar roll activity. Effective Interest Expense / Effective Cost of Funds / Effective Net Interest Income / Effective Interest Rate Margin 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 borrowings. We add back the net payments or receipts 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 and amortization of net deferred gains (losses) on de-designated interest rate swaps that is recorded as repurchase agreements interest expense. We believe the presentation of 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, provides information that is useful to investors in understanding our borrowing costs and operating performance. 40 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. Three Months Ended March 31, 2023 2022 $ in thousands Reconciliation Cost of Funds / Effective Cost of Funds Reconciliation Cost of Funds / Effective Cost of Funds Total interest expense 49,726 4.20 % (2,104) (0.14) % Add: Amortization of net deferred gain (loss) on de-designated interest rate swaps 4,494 0.38 % 5,196 0.33 % Less: Contractual net interest expense (income) on interest rate swaps recorded as gain (loss) on derivative instruments, net (54,464) (4.60) % (1,284) (0.08) % Effective interest expense (244) (0.02) % 1,808 0.11 % Our effective interest expense and effective cost of funds decreased in the three months ended March 31, 2023 compared to the same period in 2022 despite a $51.8 million increase in total interest expense, which primarily reflects increases in the Federal Funds target rate, due to $54.5 million of contractual net interest income on interest rate swaps compared to $1.3 million for the same period in 2022. 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. Three Months Ended March 31, 2023 2022 $ in thousands Reconciliation Net Interest Rate Margin / Effective Interest Rate Margin Reconciliation Net Interest Rate Margin / Effective Interest Rate Margin Net interest income 19,561 1.08 % 44,278 2.55 % Less: Amortization of net deferred (gain) loss on de-designated interest rate swaps (4,494) (0.38) % (5,196) (0.33) % Add: Contractual net interest income (expense) on interest rate swaps recorded as gain (loss) on derivative instruments, net 54,464 4.60 % 1,284 0.08 % Effective net interest income 69,531 5.30 % 40,366 2.30 % Our effective net interest income and effective interest rate margin increased in the three months ended March 31, 2023 compared to the same period in 2022 primarily due to higher interest income resulting from our rotation into higher yielding Agency RMBS during 2022. Effective interest expense and effective cost of funds had a minimal impact on effective net interest income and effective interest rate margin as higher U.S. GAAP interest expense was offset by an increase in contractual net interest income on our interest rate swaps. 41 Table of Contents Economic Debt-to-Equity Ratio The tables below show the allocation of our stockholders' equity to our target assets, our debt-to-equity ratio, and our economic debt-to-equity ratio as of March 31, 2023 and December 31, 2022. 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 March 31, 2023, approximately 95% 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 of other mortgage REITs who also invest in TBAs and present a similar non-GAAP measure of leverage. March 31, 2023 $ in thousands Agency RMBS Credit Portfolio (1) Total Mortgage-backed securities 5,402,200 44,943 5,447,143 Cash and cash equivalents (2) 101,834 — 101,834 Restricted cash (3) 127,038 — 127,038 Derivative assets, at fair value (3) 3,416 — 3,416 Other assets 27,183 758 27,941 Total assets 5,661,671 45,701 5,707,372 Repurchase agreements 4,814,700 — 4,814,700 Derivative liabilities, at fair value (3) 12,291 — 12,291 Other liabilities 44,792 1,474 46,266 Total liabilities 4,871,783 1,474 4,873,257 Total stockholders' equity (allocated) 789,888 44,227 834,115 Debt-to-equity ratio (4) 6.1 — 5.8 Economic debt-to-equity ratio (5) 6.1 — 5.8 (1) Investments in non-Agency CMBS, non-Agency RMBS and an unconsolidated joint venture 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 ($929,000 as of March 31, 2023) to total stockholders' equity. 42 Table of Contents December 31, 2022 $ in thousands Agency RMBS Credit Portfolio (1) Total Mortgage-backed securities 4,746,693 45,200 4,791,893 Cash and cash equivalents (2) 175,535 — 175,535 Restricted cash (3) 103,246 — 103,246 Derivative assets, at fair value (3) 662 — 662 Other assets 25,252 807 26,059 Total assets 5,051,388 46,007 5,097,395 Repurchase agreements 4,234,823 — 4,234,823 Derivative liabilities, at fair value (3) 2,079 — 2,079 Other liabilities 53,980 2,438 56,418 Total liabilities 4,290,882 2,438 4,293,320 Total stockholders' equity (allocated) 760,506 43,569 804,075 Debt-to-equity ratio (4) 5.6 — 5.3 Economic debt-to-equity ratio (5) 5.6 — 5.3 (1) Investments in non-Agency CMBS, non-Agency RMBS 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 ($1.4 million as of December 31, 2022) to total stockholders' equity. Liquidity and Capital Resources Liquidity is a measure 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. We held cash, cash equivalents and restricted cash of $228.9 million at March 31, 2023 (March 31, 2022: $497.5 million). Our cash, cash equivalents and restricted cash change due to normal fluctuations in cash balances related to the timing of principal and interest payments, repayments of debt, and asset purchases and sales. Our operating activities provided net cash of $67.2 million for the three months ended March 31, 2023 (March 31, 2022: $40.1 million). Our investing activities used net cash of $696.9 million in the three months ended March 31, 2023 compared to net cash provided by investing activities of $1.1 billion in the three months ended March 31, 2022. We used cash of $1.4 billion to purchase MBS during the three months ended March 31, 2023 (March 31, 2022: $7.6 billion to purchase MBS and $502.3 million to purchase U.S. Treasury securities). We used cash of $91.9 million to settle derivative contracts in the three months ended March 31, 2023 (March 31, 2022: received cash of $283.4 million). Our primary source of cash from investing activities for the three months ended March 31, 2023 was proceeds from sales of MBS of $783.9 million (March 31, 2022: $8.8 billion from the sales of MBS). We also generated $61.1 million from principal payments of MBS during the three months ended March 31, 2023 (March 31, 2022: $168.3 million). Our financing activities provided net cash of $579.8 million for the three months ended March 31, 2023 (March 31, 2022: net cash used by financing activities of $1.2 billion). During the three months ended March 31, 2023, we received cash for net proceeds on our repurchase agreements of $579.9 million (March 31, 2022: net cash used of $1.2 billion). We also used cash of 43 Table of Contents $31.0 million for the three months ended March 31, 2023 to pay dividends (March 31, 2022: $38.1 million). Proceeds from issuance of common stock provided $35.8 million for the three months ended March 31, 2023. As of March 31, 2023, the average margin requirement (weighted by borrowing amount), or the haircut, under our repurchase agreements was 4.6% for Agency RMBS. The haircuts ranged from a low of 3% to a high of 5% for Agency RMBS. Declines in the value of our securities portfolio can trigger margin calls by our lenders under our repurchase agreements. An event of default or termination event may give our counterparties the option to terminate all repurchase transactions outstanding with us and require any amount due from us to the counterparties to be payable immediately. Effects of Margin Requirements, Leverage and Credit Spreads Our securities have values that fluctuate according to market conditions and the market value of our securities will decrease as prevailing interest rates or credit spreads increase. When the value of the securities pledged to secure a repurchase loan decreases to the point where the positive difference between the collateral value and the loan amount is less than the haircut, our lenders may issue a “margin call”, which means that the lender will require us to pay cash or pledge additional collateral. Under our repurchase facilities, our lenders have full discretion to determine the value of the securities we pledge to them. Most of our lenders will value securities based on recent trades in the market. Lenders also issue margin calls as the published current principal balance factors change on the pool of mortgages underlying the securities pledged as collateral when scheduled and unscheduled paydowns are announced monthly. We experience margin calls and increased collateral requirements in the ordinary course of our business. In seeking to effectively manage the margin requirements established by our lenders, we maintain a position of cash and unpledged securities. We refer to this position as our liquidity. The level of liquidity we have available to meet margin calls is directly affected by our leverage levels, our haircuts and the price changes on our securities. If interest rates increase as a result of a yield curve shift or for another reason or if credit spreads widen, then the prices of our collateral (and our unpledged assets that constitute our liquidity) will decline, we will experience margin calls, and we will seek to use our liquidity to meet the margin calls. There can be no assurance that we will maintain sufficient levels of liquidity to meet any margin calls or increased collateral requirements. If our haircuts increase, our liquidity will proportionately decrease. In addition, if we increase our borrowings, our liquidity will decrease by the amount of additional haircut on the increased level of indebtedness. We intend to maintain a level of liquidity in relation to our assets that enables us to meet reasonably anticipated margin calls and increased collateral requirements but that also allows us to be substantially invested in securities. We may misjudge the appropriate amount of our liquidity by maintaining excessive liquidity, which would lower our investment returns, or by maintaining insufficient liquidity, which would force us to liquidate assets into unfavorable market conditions and harm our results of operations and financial condition. We are subject to financial covenants in connection with our lending, derivatives and other agreements we enter into in the normal course of our business. We intend to operate in a manner which complies with all of our financial covenants. Our lending and derivative agreements provide that we may be declared in default of our obligations if our leverage ratio exceeds certain thresholds and we fail to maintain stockholders’ equity or market value above certain thresholds over specified time periods. Forward-Looking Statements Regarding Liquidity As of March 31, 2023, we held $5.1 billion of Agency securities that are financed by repurchase agreements. We also had approximately $362.1 million of unencumbered investments and unrestricted cash of $101.8 million as of March 31, 2023. As of March 31, 2023, our known contractual obligations primarily consisted of $4.8 billion of repurchase agreement borrowings with a weighted average remaining maturity of 52 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 $2.9 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. 44 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 March 31, 2023, no counterparties held collateral that exceeded the amounts borrowed under the related repurchase agreements by more than $41.7 million, or 5% of our stockholders' equity. The following table summarizes our exposure to counterparties by geographic concentration as of March 31, 2023. 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 12 2,527,438 134,410 Europe (excluding United Kingdom) 2 402,511 18,296 Asia 3 1,291,186 72,187 United Kingdom 1 593,565 26,404 Total 18 4,814,700 251,297 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 annual report on Form 10-K for the year ended December 31, 2022. Unrelated Business Taxable Income We have not engaged in transactions that would result in a portion of our income being treated as unrelated business taxable income. Other Matters We believe that we satisfied each of the asset tests in Section 856(c)(4) of the Internal Revenue Code of 1986, as amended (the "Code") for the period ended March 31, 2023, and that our proposed method of operation will permit us to satisfy the asset tests, gross income tests, and distribution and stock ownership requirements for our taxable year that will end on December 31, 2023. 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 45 Table of Contents own, may not have a combined value in excess of 40% of the value of the Operating Partnership’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis, which we refer to as the 40% test. This requirement limits the types of businesses in which we are permitted to engage in through our subsidiaries. In addition, we believe neither we nor the Operating Partnership are considered an investment company under Section 3(a)(1)(A) of the 1940 Act because they do not engage primarily or hold themselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through the Operating Partnership’s wholly-owned or majority-owned subsidiaries, we and the Operating Partnership are primarily engaged in the non-investment company businesses of these subsidiaries. IAS Asset I LLC and certain of the Operating Partnership’s other subsidiaries that we may form in the future rely upon the exclusion from the definition of "investment company" under the 1940 Act provided by Section 3(c)(5)(C) of the 1940 Act, which is available for entities "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." This exclusion generally requires that at least 55% of each subsidiary’s portfolio be comprised of qualifying assets and at least 80% be comprised of qualifying assets and real estate-related assets (and no more than 20% comprised of miscellaneous assets). We calculate that as of March 31, 2023, we conducted our business so as not to be regulated as an investment company under the 1940 Act.