Orchid Island Capital, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and notes to those statements included in Item 1 of this Form 10-Q. The discussion may contain certain forward-looking statements that involve risks and uncertainties. Forward-looking statements are those that are not historical in nature. As a result of many factors, such as those set forth under “Risk Factors” in our most recent Annual Report on Form 10-K and our quarterly reports on Form 10-Q, our actual results may differ materially from those anticipated in such forward-looking statements. Overview We are a specialty finance company that invests in residential mortgage-backed securities (“RMBS”) which are issued and guaranteed by a federally chartered corporation or agency (“Agency RMBS”). Our investment strategy focuses on, and our portfolio consists of, two categories of Agency RMBS: (i) traditional pass-through Agency RMBS, such as mortgage pass-through certificates issued by Fannie Mae, Freddie Mac or Ginnie Mae (the “GSEs”) and collateralized mortgage obligations (“CMOs”) issued by the GSEs (“PT RMBS”) and (ii) structured Agency RMBS, such as interest-only securities (“IOs”), inverse interest-only securities (“IIOs”) and principal only securities (“POs”), among other types of structured Agency RMBS. We were formed by Bimini in August 2010, commenced operations on November 24, 2010 and completed our initial public offering (“IPO”) on February 20, 2013. We are externally managed by Bimini Advisors, an investment adviser registered with the Securities and Exchange Commission (the “SEC”). Our business objective is to provide attractive risk-adjusted total returns over the long term through a combination of capital appreciation and the payment of regular monthly distributions. We intend to achieve this objective by investing in and strategically allocating capital between the two categories of Agency RMBS described above. We seek to generate income from (i) the net interest margin on our leveraged PT RMBS portfolio and the leveraged portion of our structured Agency RMBS portfolio, and (ii) the interest income we generate from the unleveraged portion of our structured Agency RMBS portfolio. We intend to fund our PT RMBS and certain of our structured Agency RMBS through short-term borrowings structured as repurchase agreements. PT RMBS and structured Agency RMBS typically exhibit materially different sensitivities to movements in interest rates. Declines in the value of one portfolio may be offset by appreciation in the other. The percentage of capital that we allocate to our two Agency RMBS asset categories will vary and will be actively managed in an effort to maintain the level of income generated by the combined portfolios, the stability of that income stream and the stability of the value of the combined portfolios. We believe that this strategy will enhance our liquidity, earnings, book value stability and asset selection opportunities in various interest rate environments. We operate so as to qualify to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). We generally will not be subject to U.S. federal income tax to the extent that we currently distribute all of our REIT taxable income (as defined in the Code) to our stockholders and maintain our REIT qualification. The Company’s common stock trades on the New York Stock Exchange under the symbol “ORC”. Impact of the COVID-19 Pandemic Beginning in March 2020, the global pandemic associated with the novel coronavirus COVID-19 (“COVID-19”) and related economic conditions began to impact our financial position and results of operations. As a result of the economic, health and market turmoil brought about by COVID-19, the Agency RMBS market experienced severe dislocations. This resulted in falling prices of our assets and increased margin calls from our repurchase agreement lenders. Further, as interest rates declined, we faced additional margin calls related to our various hedge positions. In order to maintain sufficient cash and liquidity, reduce risk and satisfy margin calls, we were forced to sell assets at levels significantly below their carrying values and closed several of our hedge positions. The Agency RMBS market largely stabilized after the Federal Reserve (the “Fed”) announced on March 23, 2020 that it would purchase Agency RMBS and U.S. Treasuries in the amounts needed to support smooth market functioning. As of September 30, 2020, we had 26 timely satisfied all margin calls. The following summarizes the impact COVID-19 has had on our financial position and results of operations through September 30, 2020. ● We sold approximately $2.7 billion of RMBS during the nine months ended September 30, 2020, realizing losses of approximately $24.5 million. Approximately $1.1 billion of these sales were executed on March 19th and March 20th and resulted in losses of approximately $31.4 million. The losses sustained on these two days were a direct result of the adverse RMBS market conditions associated with COVID-19. ● We terminated interest rate swap positions with an aggregate notional value of $1.2 billion and incurred approximately $54.5 million in mark to market losses on the positions through the date of the respective terminations. Approximately $45.0 million of these losses occurred during the three months ended March 31, 2020. ● Our RMBS portfolio had a fair market value of approximately $3.5 billion as of September 30, 2020, compared to $3.6 billion as of December 31, 2019. The September 30, 2020 balance represents an increase from the $3.3 billion balance as of June 30, 2020 and the $2.9 billion balance as of March 31, 2020. ● Our outstanding balances under our repurchase agreement borrowings as of September 30, 2020 were approximately $3.3 billion, compared to $3.4 billion as of December 31, 2019, $3.2 billion as of June 30, 2020, and $2.8 billion as of March 31, 2020. ● Our stockholders’ equity was $376.7 million as of September 30, 2020, compared to $395.5 million as of December 31, 2019, $346.0 million as of June 30, 2020 and $308.1 million as of March 31, 2020. Largely as a result of actions taken by the Fed in late March, Agency RMBS valuations have increased and the market for these assets has stabilized. Bimini Advisors, LLC (our “Manager”) has invoked its Disaster Recovery Plan and its employees are working remotely. Prior planning resulted in the successful implementation of this plan and key operational team members maintain daily communication. We do not anticipate incurring additional material costs, nor have we identified any operational or internal control issues related to this remote working plan. Capital Raising Activities On August 2, 2017, we entered into an equity distribution agreement (the “August 2017 Equity Distribution Agreement”) with two sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $125,000,000 of shares of our common stock in transactions that were deemed to be “at the market” offerings and privately negotiated transactions. We issued a total of 15,123,178 shares under the August 2017 Equity Distribution Agreement for aggregate gross proceeds of $125.0 million, and net proceeds of approximately $123.1 million, net of commissions and fees, prior to its termination in July 2019. On July 30, 2019, we entered into an underwriting agreement (the “Underwriting Agreement”) with Morgan Stanley & Co. LLC, Citigroup Global Markets Inc. and J.P. Morgan Securities LLC, as representatives of the underwriters named therein, relating to the offer and sale of 7,000,000 shares of our common stock at a price to the public of $6.55 per share. The underwriters purchased the shares pursuant to the Underwriting Agreement at a price of $6.3535 per share. The closing of the offering of 7,000,000 shares of common stock occurred on August 2, 2019, with net proceeds to us of approximately $44.2 million after deduction of underwriting discounts and commissions and other estimated offering expenses. On January 23, 2020, we entered into an equity distribution agreement (the “January 2020 Equity Distribution Agreement”) with three sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $200,000,000 of shares of our common stock in transactions that were deemed to be “at the market” offerings and privately negotiated transactions. We issued a total of 3,170,727 shares under the January 2020 Equity Distribution Agreement for aggregate gross proceeds of $19.8 million, and net proceeds of approximately $19.4 million, net of commissions and fees, prior to its termination in August 2020. 27 On August 4, 2020, we entered into an equity distribution agreement (the “August 2020 Equity Distribution Agreement”) with four sales agents pursuant to which we may offer and sell, from time to time, up to an aggregate amount of $150,000,000 of shares of our common stock in transactions that are deemed to be “at the market” offerings and privately negotiated transactions. Through September 30, 2020, we issued a total of 3,073,326 shares under the August 2020 Equity Distribution Agreement for aggregate gross proceeds of approximately $15.8 million, and net proceeds of approximately $15.6 million, net of commissions and fees. Stock Repurchase Agreement On July 29, 2015, the Company’s Board of Directors authorized the repurchase of up to 2,000,000 shares of our common stock. The timing, manner, price and amount of any repurchases is determined by the Company in its discretion and is subject to economic and market conditions, stock price, applicable legal requirements and other factors. The authorization does not obligate the Company to acquire any particular amount of common stock and the program may be suspended or discontinued at the Company’s discretion without prior notice. On February 8, 2018, the Board of Directors approved an increase in the stock repurchase program for up to an additional 4,522,822 shares of the Company’s common stock. Coupled with the 783,757 shares remaining from the original 2,000,000 share authorization, the increased authorization brought the total authorization to 5,306,579 shares, representing 10% of the Company’s then outstanding share count. This stock repurchase program has no termination date. From the inception of the stock repurchase program through September 30, 2020, the Company repurchased a total of 5,685,511 shares at an aggregate cost of approximately $40.4 million, including commissions and fees, for a weighted average price of $7.10 per share. During the nine months ended September 30, 2020, the Company repurchased 19,891 shares of its common at an aggregate cost of approximately $0.1 million, including commissions and fees, for a weighted average price of $3.42 per share. The remaining authorization under the repurchase program as of September 30, 2020 was 837,311 shares. Factors that Affect our Results of Operations and Financial Condition A variety of industry and economic factors may impact our results of operations and financial condition. These factors include: ● interest rate trends; ● the difference between Agency RMBS yields and our funding and hedging costs; ● competition for, and supply of, investments in Agency RMBS; ● actions taken by the U.S. government, including the presidential administration, the Fed, the Federal Housing Financing Agency (the “FHFA”), the Federal Open Market Committee (the “FOMC”) and the U.S. Treasury; ● prepayment rates on mortgages underlying our Agency RMBS and credit trends insofar as they affect prepayment rates; and ● other market developments. In addition, a variety of factors relating to our business may also impact our results of operations and financial condition. These factors include: ● our degree of leverage; ● our access to funding and borrowing capacity; ● our borrowing costs; ● our hedging activities; ● the market value of our investments; and ● the requirements to qualify as a REIT and the requirements to qualify for a registration exemption under the Investment Company Act. Results of Operations 28 Described below are the Company’s results of operations for the nine and three months ended September 30, 2020, as compared to the Company’s results of operations for the nine and three months ended September 30, 2019. Net (Loss) Income Summary Net loss for the nine months ended September 30, 2020 was $14.4 million, or $0.22 per share. Net income for the nine months ended September 30, 2019 was $5.7 million, or $0.10 per share. Net income for the three months ended September 30, 2020 was $28.1 million, or $0.42 per share. Net loss for the three months ended September 30, 2019 was $8.5 million, or $0.14 per share. The components of net (loss) income for the nine and three months ended September 30, 2020 and 2019, along with the changes in those components are presented in the table below: (in thousands) Nine Months Ended September 30, Three Months Ended, September 30, 2020 2019 Change 2020 2019 Change Interest income $ 90,152 $ 104,795 $ (14,643) $ 27,223 $ 35,907 $ (8,684) Interest expense (23,045) (63,644) 40,599 (2,043) (22,321) 20,278 Net interest income 67,107 41,151 25,956 25,180 13,586 11,594 (Losses) gains on RMBS and derivative contracts (73,712) (27,848) (45,864) 5,745 (19,431) 25,176 Net portfolio (loss) income (6,605) 13,303 (19,908) 30,925 (5,845) 36,770 Expenses (7,746) (7,650) (96) (2,849) (2,632) (217) Net (loss) income $ (14,351) $ 5,653 $ (20,004) $ 28,076 $ (8,477) $ 36,553 GAAP and Non-GAAP Reconciliations In addition to the results presented in accordance with GAAP, our results of operations discussed below include certain non-GAAP financial information, including “Net Earnings Excluding Realized and Unrealized Gains and Losses”, “Economic Interest Expense” and “Economic Net Interest Income.” Net Earnings Excluding Realized and Unrealized Gains and Losses We have elected to account for our Agency RMBS under the fair value option. Securities held under the fair value option are recorded at estimated fair value, with changes in the fair value recorded as unrealized gains or losses through the statements of operations. In addition, we have not designated our derivative financial instruments in hedge accounting relationships, but rather hold them for economic hedging purposes. Changes in fair value of these instruments are presented in a separate line item in the Company’s statements of operations and are not included in interest expense. As such, for financial reporting purposes, interest expense and cost of funds are not impacted by the fluctuation in value of the derivative instruments. Presenting net earnings excluding realized and unrealized gains and losses allows management to: (i) isolate the net interest income and other expenses of the Company over time, free of all fair value adjustments and (ii) assess the effectiveness of our funding and hedging strategies on our capital allocation decisions and our asset allocation performance. Our funding and hedging strategies, capital allocation and asset selection are integral to our risk management strategy, and therefore critical to the management of our portfolio. We believe that the presentation of our net earnings excluding realized and unrealized gains is useful to investors because it provides a means of comparing our results of operations to those of our peers who have not elected the same accounting treatment. Our presentation of net earnings excluding realized and unrealized gains and losses may not be comparable to similarly-titled measures of other companies, who may use different calculations. As a result, net earnings excluding realized and unrealized gains and losses should not be considered as a substitute for our GAAP net income (loss) as a measure of our financial performance or any measure of our liquidity under GAAP. The table below presents a reconciliation of our net income (loss) determined in accordance with GAAP and net earnings excluding realized and unrealized gains and losses. 29 Net Earnings Excluding Realized and Unrealized Gains and Losses (in thousands, except per share data) Per Share Net Earnings Net Earnings Excluding Excluding Realized and Realized and Realized and Realized and Net Unrealized Unrealized Net Unrealized Unrealized Income Gains and Gains and Income Gains and Gains and (GAAP) Losses (1) Losses (GAAP) Losses Losses Three Months Ended September 30, 2020 $ 28,076 $ 5,745 $ 22,331 $ 0.42 $ 0.09 $ 0.33 June 30, 2020 48,772 28,749 20,023 0.74 0.43 0.31 March 31, 2020 (91,199) (108,206) 17,007 (1.41) (1.68) 0.27 December 31, 2019 18,612 3,840 14,772 0.29 0.06 0.23 September 30, 2019 (8,477) (19,431) 10,954 (0.14) (0.32) 0.18 June 30, 2019 3,533 (7,670) 11,203 0.07 (0.15) 0.22 March 31, 2019 10,597 (747) 11,344 0.22 (0.02) 0.24 Nine Months Ended September 30, 2020 $ (14,351) $ (73,712) $ 59,361 $ (0.22) $ (1.12) $ 0.90 September 30, 2019 5,653 (27,848) 33,501 0.10 (0.52) 0.62 (1) Includes realized and unrealized gains (losses) on RMBS and derivative financial instruments, including net interest income or expense on interest rate swaps . Economic Interest Expense and Economic Net Interest Income We use derivative and other hedging instruments, specifically Eurodollar, Fed Funds and Treasury Note (“T-Note”) futures contracts, short positions in U.S. Treasury securities, interest rate swaps and swaptions, to hedge a portion of the interest rate risk on repurchase agreements in a rising rate environment. We have not elected to designate our derivative holdings for hedge accounting treatment. Changes in fair value of these instruments are presented in a separate line item in our statements of operations and not included in interest expense. As such, for financial reporting purposes, interest expense and cost of funds are not impacted by the fluctuation in value of the derivative instruments. For the purpose of computing economic net interest income and ratios relating to cost of funds measures, GAAP interest expense has been adjusted to reflect the realized and unrealized gains or losses on certain derivative instruments the Company uses, specifically Eurodollar, Fed Funds and U.S. Treasury futures, and interest rate swaps and swaptions, that pertain to each period presented. We believe that adjusting our interest expense for the periods presented by the gains or losses on these derivative instruments would not accurately reflect our economic interest expense for these periods. The reason is that these derivative instruments may cover periods that extend into the future, not just the current period. Any realized or unrealized gains or losses on the instruments reflect the change in market value of the instrument caused by changes in underlying interest rates applicable to the term covered by the instrument, not just the current period. For each period presented, we have combined the effects of the derivative financial instruments in place for the respective period with the actual interest expense incurred on borrowings to reflect total economic interest expense for the applicable period. Interest expense, including the effect of derivative instruments for the period, is referred to as economic interest expense. Net interest income, when calculated to include the effect of derivative instruments for the period, is referred to as economic net interest income. This presentation includes gains or losses on all contracts in effect during the reporting period, covering the current period as well as periods in the future. We believe that economic interest expense and economic net interest income provide meaningful information to consider, in addition to the respective amounts prepared in accordance with GAAP. The non-GAAP measures help 30 management to evaluate its financial position and performance without the effects of certain transactions and GAAP adjustments that are not necessarily indicative of our current investment portfolio or operations. The unrealized gains or losses on derivative instruments presented in our statements of operations are not necessarily representative of the total interest rate expense that we will ultimately realize. This is because as interest rates move up or down in the future, the gains or losses we ultimately realize, and which will affect our total interest rate expense in future periods, may differ from the unrealized gains or losses recognized as of the reporting date. Our presentation of the economic value of our hedging strategy has important limitations. First, other market participants may calculate economic interest expense and economic net interest income differently than the way we calculate them. Second, while we believe that the calculation of the economic value of our hedging strategy described above helps to present our financial position and performance, it may be of limited usefulness as an analytical tool. Therefore, the economic value of our investment strategy should not be viewed in isolation and is not a substitute for interest expense and net interest income computed in accordance with GAAP. The tables below present a reconciliation of the adjustments to interest expense shown for each period relative to our derivative instruments, and the income statement line item, gains (losses) on derivative instruments, calculated in accordance with GAAP for each quarter of 2020 to date and 2019. Gains (Losses) on Derivative Instruments (in thousands) U.S. Treasury Funding Hedges Recognized in and Attributed to Attributed to Income TBA Current Future Statement Securities Period Periods (GAAP) Income (Loss) (Non-GAAP) (Non-GAAP) Three Months Ended September 30, 2020 $ 4,079 $ 3,467 $ (6,900) $ 7,512 June 30, 2020 (8,851) 1,715 (5,751) (4,815) March 31, 2020 (82,858) (7,090) (4,900) (70,868) December 31, 2019 10,792 (512) 3,823 7,481 September 30, 2019 (8,648) 2,479 1,244 (12,371) June 30, 2019 (34,288) (1,684) 1,464 (34,068) March 31, 2019 (19,032) (4,641) 2,427 (16,818) Nine Months Ended September 30, 2020 $ (87,630) $ (1,908) $ (17,551) $ (68,171) September 30, 2019 (61,968) (3,846) 5,135 (63,257) Economic Interest Expense and Economic Net Interest Income (in thousands) Interest Expense on Borrowings Gains (Losses) on Derivative Instruments Net Interest Income GAAP Attributed Economic GAAP Economic Interest Interest to Current Interest Net Interest Net Interest Income Expense Period (1) Expense (2) Income Income (3) Three Months Ended September 30, 2020 $ 27,223 $ 2,043 $ (6,900) $ 8,943 $ 25,180 $ 18,280 June 30, 2020 27,258 4,479 (5,751) 10,230 22,779 17,028 March 31, 2020 35,671 16,523 (4,900) 21,423 19,148 14,248 December 31, 2019 37,529 20,022 3,823 16,199 17,507 21,330 September 30, 2019 35,907 22,321 1,244 21,077 13,586 14,830 31 June 30, 2019 36,455 22,431 1,464 20,967 14,024 15,488 March 31, 2019 32,433 18,892 2,427 16,465 13,541 15,968 Nine Months Ended September 30, 2020 $ 90,152 $ 23,045 $ (17,551) $ 40,596 $ 67,107 $ 49,556 September 30, 2019 104,795 63,644 5,135 58,509 41,151 46,286 (1) Reflects the effect of derivative instrument hedges for only the period presented. (2) Calculated by adding the effect of derivative instrument hedges attributed to the period presented to GAAP interest expense. (3) Calculated by adding the effect of derivative instrument hedges attributed to the period presented to GAAP net interest income. Net Interest Income During the nine months ended September 30, 2020, we generated $67.1 million of net interest income, consisting of $90.2 million of interest income from RMBS assets offset by $23.0 million of interest expense on borrowings. For the comparable period ended September 30, 2019, we generated $41.2 million of net interest income, consisting of $104.8 million of interest income from RMBS assets offset by $63.6 million of interest expense on borrowings. The $14.6 million decrease in interest income was due to a 51 basis point ("bps") decrease in the yield on average RMBS, combined with a $71.4 million decrease in average RMBS. The $40.6 million decrease in interest expense was due to a 166 bps decrease in the average cost of funds, combined with an $88.7 million decrease in average outstanding borrowings. On an economic basis, our interest expense on borrowings for the nine months ended September 30, 2020 and 2019 was $40.6 million and $58.5 million, respectively, resulting in $49.6 million and $46.3 million of economic net interest income, respectively. During the three months ended September 30, 2020, we generated $25.2 million of net interest income, consisting of $27.2 million of interest income from RMBS assets offset by $2.0 million of interest expense on borrowings. For the three months ended September 30, 2019, we generated $13.6 million of net interest income, consisting of $35.9 million of interest income from RMBS assets offset by $22.3 million of interest expense on borrowings. The $8.7 million decrease in interest income was due to a 73 bps decrease in the yield on average RMBS, combined with a $251.5 million decrease in average RMBS. The $20.3 million decrease in interest expense was due to a 225 bps decrease in the average cost of funds, combined with a $343.7 million decrease in average outstanding borrowings. On an economic basis, our interest expense on borrowings for the three months ended September 30, 2020 and 2019 was $8.9 million and $21.1 million, respectively, resulting in $18.3 million and $14.8 million of economic net interest income, respectively. The tables below provide information on our portfolio average balances, interest income, yield on assets, average borrowings, interest expense, cost of funds, net interest income and net interest spread for the nine months ended September 30, 2020 and 2019 and each quarter of 2020 to date and 2019 on both a GAAP and economic basis. ($ in thousands) Average Yield on Interest Expense Average Cost of Funds RMBS Interest Average Average GAAP Economic GAAP Economic Held (1) Income RMBS Borrowings (1) Basis Basis (2) Basis Basis (3) Three Months Ended September 30, 2020 $ 3,422,564 $ 27,223 3.18% $ 3,228,021 $ 2,043 $ 8,943 0.25% 1.11% June 30, 2020 3,126,779 27,258 3.49% 2,992,494 4,479 10,230 0.60% 1.37% March 31, 2020 3,269,859 35,671 4.36% 3,129,178 16,523 21,423 2.11% 2.74% December 31, 2019 3,705,920 37,529 4.05% 3,631,042 20,022 16,199 2.21% 1.78% September 30, 2019 3,674,087 35,907 3.91% 3,571,752 22,321 21,077 2.50% 2.36% June 30, 2019 3,307,885 36,455 4.41% 3,098,133 22,431 20,967 2.90% 2.71% March 31, 2019 3,051,509 32,433 4.25% 2,945,895 18,892 16,465 2.57% 2.24% Nine Months Ended September 30, 2020 $ 3,273,068 $ 90,152 3.67% $ 3,116,564 $ 23,045 $ 40,596 0.99% 1.74% 32 September 30, 2019 3,344,494 104,795 4.18% 3,205,260 63,644 58,509 2.65% 2.43% ($ in thousands) Net Interest Income Net Interest Spread GAAP Economic GAAP Economic Basis Basis (2) Basis Basis (4) Three Months Ended September 30, 2020 $ 25,180 $ 18,280 2.93% 2.07% June 30, 2020 22,779 $ 17,028 2.89% 2.12% March 31, 2020 19,148 14,248 2.25% 1.62% December 31, 2019 17,507 21,330 1.84% 2.27% September 30, 2019 13,586 14,830 1.41% 1.55% June 30, 2019 14,024 15,488 1.51% 1.70% March 31, 2019 13,541 15,968 1.68% 2.01% Nine Months Ended September 30, 2020 $ 67,107 $ 49,556 2.68% 1.93% September 30, 2019 41,151 46,286 1.53% 1.75% (1) Portfolio yields and costs of borrowings presented in the tables above and the tables on pages 34 and 35 are calculated based on the average balances of the underlying investment portfolio/borrowings balances and are annualized for the periods presented. Average balances for quarterly periods are calculated using two data points, the beginning and ending balances. (2) Economic interest expense and economic net interest income presented in the table above and the tables on page 31 includes the effect of our derivative instrument hedges for only the periods presented. (3) Represents interest cost of our borrowings and the effect of derivative instrument hedges attributed to the period divided by average RMBS. (4) Economic net interest spread is calculated by subtracting average economic cost of funds from realized yield on average RMBS. Interest Income and Average Asset Yield Our interest income for the nine months ended September 30, 2020 and 2019 was $90.2 million and $104.8 million, respectively. We had average RMBS holdings of $3,273.1 million and $3,344.5 million for the nine months ended September 30, 2020 and 2019, respectively. The yield on our portfolio was 3.67% and 4.18% for the nine months ended September 30, 2020 and 2019, respectively. For the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019, there was a $14.6 million decrease in interest income due to the 51 bps decrease in the yield on average RMBS, combined with the $71.4 million decrease in average RMBS. Our interest income for the three months ended September 30, 2020 and 2019 was $27.2 million and $35.9 million, respectively. We had average RMBS holdings of $3,422.6 million and $3,674.1 million for the three months ended September 30, 2020 and 2019, respectively. The yield on our portfolio was 3.18% and 3.91% for the three months ended September 30, 2020 and 2019, respectively. For the three months ended September 30, 2020 as compared to the three months ended September 30, 2019, there was an $8.7 million decrease in interest income due to the 73 bps decrease in the yield on average RMBS, combined with the $251.5 million decrease in average RMBS. The table below presents the average portfolio size, income and yields of our respective sub-portfolios, consisting of structured RMBS and PT RMBS, for the nine months ended September 30, 2020 and 2019, and for each quarter of 2020 to date and 2019. ($ in thousands) Average RMBS Held Interest Income Realized Yield on Average RMBS PT Structured PT Structured PT Structured RMBS RMBS Total RMBS RMBS Total RMBS RMBS Total Three Months Ended September 30, 2020 $ 3,389,037 $ 33,527 $ 3,422,564 $ 27,021 $ 202 $ 27,223 3.19% 2.41% 3.18% June 30, 2020 3,088,603 38,176 3,126,779 $ 27,004 254 27,258 3.50% 2.67% 3.49% 33 March 31, 2020 3,207,467 62,392 3,269,859 35,286 385 35,671 4.40% 2.47% 4.36% December 31, 2019 3,611,461 94,459 3,705,920 36,600 929 37,529 4.05% 3.93% 4.05% September 30, 2019 3,558,075 116,012 3,674,087 36,332 (425) 35,907 4.08% (1.47)% 3.91% June 30, 2019 3,181,976 125,909 3,307,885 34,992 1,463 36,455 4.40% 4.65% 4.41% March 31, 2019 2,919,415 132,094 3,051,509 30,328 2,105 32,433 4.16% 6.37% 4.25% Nine Months Ended September 30, 2020 $ 3,228,369 $ 44,699 $ 3,273,068 $ 89,311 $ 841 $ 90,152 3.69% 2.51% 3.67% September 30, 2019 3,219,822 124,672 3,344,494 101,652 3,143 104,795 4.21% 3.36% 4.18% Interest Expense and the Cost of Funds We had average outstanding borrowings of $3,116.6 million and $3,205.3 million and total interest expense of $23.0 million and $63.6 million for the nine months ended September 30, 2020 and 2019, respectively. Our average cost of funds was 0.99% for the nine months ended September 30, 2020, compared to 2.65% for the comparable period in 2019. The $40.6 million decrease in interest expense was due to the 166 bps decrease in the average cost of funds, combined with an $88.7 million decrease in average outstanding borrowings during the nine months ended September 30, 2020 as compared to the nine months ended September 30, 2019. Our economic interest expense was $40.6 million and $58.5 million for the nine months ended September 30, 2020 and 2019, respectively. There was a 69 bps decrease in the average economic cost of funds to 1.74% for the nine months ended September 30, 2020 from 2.43% for the nine months ended September 30, 2019. We had average outstanding borrowings of $3,228.0 million and $3,571.8 million and total interest expense of $2.0 million and $22.3 million for the three months ended September 30, 2020 and 2019, respectively. Our average cost of funds was 0.25% and 2.50% for three months ended September 30, 2020 and 2019, respectively. There was a 225 bps decrease in the average cost of funds and a $343.7 million decrease in average outstanding borrowings during the three months ended September 30, 2020, compared to the three months ended September 30, 2019. Our economic interest expense was $8.9 million and $21.1 million for the three months ended September 30, 2020 and 2019, respectively. There was a 125 bps decrease in the average economic cost of funds to 1.11% for the three months ended September 30, 2020 from 2.36% for the three months ended September 30, 2019. Since all of our repurchase agreements are short-term, changes in market rates directly affect our interest expense. Our average cost of funds calculated on a GAAP basis was 8 bps above the average one-month LIBOR and 10 bps below the average six-month LIBOR for the quarter ended September 30, 2020. Our average economic cost of funds was 94 bps above the average one-month LIBOR and 76 bps above the average six-month LIBOR for the quarter ended September 30, 2020. The average term to maturity of the outstanding repurchase agreements increased to 60 days at September 30, 2020 from 25 days at December 31, 2019. The tables below present the average balance of borrowings outstanding, interest expense and average cost of funds, and average one-month and six-month LIBOR rates for the nine months ended September 30, 2020 and 2019, and for each quarter in 2020 to date and 2019 on both a GAAP and economic basis. ($ in thousands) Average Interest Expense Average Cost of Funds Balance of GAAP Economic GAAP Economic Borrowings Basis Basis Basis Basis Three Months Ended September 30, 2020 $ 3,228,021 $ 2,043 $ 8,943 0.25% 1.11% June 30, 2020 2,992,494 4,479 10,230 0.60% 1.37% March 31, 2020 3,129,178 16,523 21,423 2.11% 2.74% December 31, 2019 3,631,042 20,022 16,199 2.21% 1.78% 34 September 30, 2019 3,571,752 22,321 21,077 2.50% 2.36% June 30, 2019 3,098,133 22,431 20,967 2.90% 2.71% March 31, 2019 2,945,895 18,892 16,465 2.57% 2.24% Nine Months Ended September 30, 2020 $ 3,116,564 $ 23,045 $ 40,596 0.99% 1.74% September 30, 2019 3,205,260 63,644 58,509 2.65% 2.43% Average GAAP Cost of Funds Average Economic Cost of Funds Relative to Average Relative to Average Average LIBOR One-Month Six-Month One-Month Six-Month One-Month Six-Month LIBOR LIBOR LIBOR LIBOR Three Months Ended September 30, 2020 0.17% 0.35% 0.08% (0.10)% 0.94% 0.76% June 30, 2020 0.55% 0.70% 0.05% (0.10)% 0.82% 0.67% March 31, 2020 1.34% 1.43% 0.77% 0.68% 1.40% 1.31% December 31, 2019 1.90% 1.98% 0.31% 0.23% (0.12)% (0.20)% September 30, 2019 2.22% 2.18% 0.28% 0.32% 0.14% 0.18% June 30, 2019 2.45% 2.49% 0.45% 0.41% 0.26% 0.22% March 31, 2019 2.51% 2.77% 0.06% (0.20)% (0.27)% (0.53)% Nine Months Ended September 30, 2020 0.68% 0.83% 0.31% 0.16% 1.06% 0.91% September 30, 2019 2.39% 2.48% 0.26% 0.17% 0.04% (0.05)% Gains or Losses The table below presents our gains or losses for the nine and three months ended September 30, 2020 and 2019. (in thousands) Nine Months Ended September 30, Three Months Ended September 30, 2020 2019 Change 2020 2019 Change Realized (losses) gains on sales of RMBS $ (24,522) $ (5,135) $ (19,387) $ 498 $ (5,491) $ 5,989 Unrealized gains (losses) on RMBS 38,440 39,255 (815) 1,168 (5,292) 6,460 Total gains (losses) on RMBS 13,918 34,120 (20,202) 1,666 (10,783) 12,449 Losses on interest rate futures (13,161) (20,421) 7,260 (119) (893) 774 (Losses) gains on interest rate swaps (67,713) (36,322) (31,391) 489 (9,918) 10,407 (Losses) gains on payer swaptions (4,848) (1,379) (3,469) 242 (316) 558 (Losses) gains on TBA securities (1,813) (3,846) 2,033 3,431 2,479 952 (Losses) gains on U.S. Treasury securities - short (95) - (95) 36 - 36 Total (losses) gains from derivative instruments (87,630) (61,968) (25,662) 4,079 (8,648) 12,727 We invest in RMBS with the intent to earn net income from the realized yield on those assets over their related funding and hedging costs, and not for the purpose of making short term gains from sales. However, we have sold, and may continue to sell, existing assets to acquire new assets, which our management believes might have higher risk-adjusted returns in light of current or anticipated interest rates, federal government programs or general economic conditions or to manage our balance sheet as part of our asset/liability management strategy. During the nine months ended September 30, 2020 and 2019, we received proceeds of $2,692.2 million and $1,948.1 million, respectively, from the sales of RMBS. Most of these sales during the nine months ended September 30, 2020 occurred during the second half of March 2020 as we sold assets in order to maintain sufficient cash and liquidity and reduce risk associated with the market turmoil brought about by COVID-19. During the three months ended September 30, 2020 and 2019, we received proceeds of $668.9 million and $258.3 million, respectively, from the sales of RMBS. Realized and unrealized gains and losses on RMBS are driven in part by changes in yields and interest rates, which affect the pricing of the securities in our portfolio. Gains and losses on interest rate futures contracts are affected by changes in implied forward rates during the reporting period. The table below presents historical interest rate data for each quarter end during 2020 to date and 2019. 35 5 Year 10 Year 15 Year 30 Year Three U.S. Treasury U.S. Treasury Fixed-Rate Fixed-Rate Month Rate (1) Rate (1) Mortgage Rate (2) Mortgage Rate (2) LIBOR (3) September 30, 2020 0.27% 0.68% 2.39% 2.89% 0.24% June 30, 2020 0.29% 0.65% 2.60% 3.16% 0.31% March 31, 2020 0.38% 0.70% 2.89% 3.45% 1.10% December 31, 2019 1.69% 1.92% 3.18% 3.72% 1.91% September 30, 2019 1.55% 1.68% 3.12% 3.61% 2.13% June 30, 2019 1.76% 2.00% 3.24% 3.80% 2.40% March 31, 2019 2.24% 2.41% 3.72% 4.27% 2.61% (1) Historical 5 and 10 Year U.S. Treasury Rates are obtained from quoted end of day prices on the Chicago Board Options Exchange. (2) Historical 30 Year and 15 Year Fixed Rate Mortgage Rates are obtained from Freddie Mac’s Primary Mortgage Market Survey. (3) Historical LIBOR is obtained from the Intercontinental Exchange Benchmark Administration Ltd. Expenses For the nine and three months ended September 30, 2020, the Company’s total operating expenses were approximately $7.7 million and $2.8 million, respectively, compared to approximately $7.7 million and $2.6 million, respectively, for the nine and three months ended September 30, 2019. The table below presents a breakdown of operating expenses for the nine and three months ended September 30, 2020 and 2019. (in thousands) Nine Months Ended September 30, Three Months Ended September 30, 2020 2019 Change 2020 2019 Change Management fees $ 3,897 $ 4,051 $ (154) $ 1,252 $ 1,440 $ (188) Overhead allocation 1,072 1,001 71 377 351 26 Accrued incentive compensation (117) (53) (64) 158 173 (15) Directors fees and liability insurance 750 750 - 242 260 (18) Audit, legal and other professional fees 841 886 (45) 240 221 19 Direct REIT operating expenses 852 790 62 406 130 276 Other administrative 451 225 226 174 57 117 Total expenses $ 7,746 $ 7,650 $ 96 $ 2,849 $ 2,632 $ 217 We are externally managed and advised by Bimini Advisors, LLC (the “Manager”) pursuant to the terms of a management agreement. The management agreement has been renewed through February 20, 2021 and provides for automatic one-year extension options thereafter and is subject to certain termination rights. Under the terms of the management agreement, the Manager is responsible for administering the business activities and day-to-day operations of the Company. The Manager receives a monthly management fee in the amount of: ● One-twelfth of 1.5% of the first $250 million of the Company’s month end equity, as defined in the management agreement, ● One-twelfth of 1.25% of the Company’s month end equity that is greater than $250 million and less than or equal to $500 million, and ● One-twelfth of 1.00% of the Company’s month end equity that is greater than $500 million. The Company is obligated to reimburse the Manager for any direct expenses incurred on its behalf and to pay the Manager the Company’s pro rata portion of certain overhead costs set forth in the management agreement. Should the Company terminate the management agreement without cause, it will pay the Manager a termination fee equal to three times the average annual management fee, as defined in the management agreement, before or on the last day of the term of the agreement. 36 The following table summarizes the management fee and overhead allocation expenses for each quarter in 2020 to date and 2019. ($ in thousands) Average Average Advisory Services Orchid Orchid Management Overhead Three Months Ended MBS Equity Fee Allocation Total September 30, 2020 $ 3,422,564 $ 368,588 $ 1,252 $ 377 $ 1,629 June 30, 2020 3,126,779 361,093 1,268 348 1,616 March 31, 2020 3,269,859 376,673 1,377 347 1,724 December 31, 2019 3,705,920 414,018 1,477 379 1,856 September 30, 2019 3,674,087 394,788 1,440 351 1,791 June 30, 2019 3,307,885 363,961 1,326 327 1,653 March 31, 2019 3,051,509 363,204 1,285 323 1,608 Nine Months Ended September 30, 2020 $ 3,273,068 $ 368,785 $ 3,897 $ 1,072 $ 4,969 September 30, 2019 3,344,494 373,984 4,051 1,001 5,052 Financial Condition: Mortgage-Backed Securities As of September 30, 2020, our RMBS portfolio consisted of $3,540.4 million of Agency RMBS at fair value and had a weighted average coupon on assets of 3.62%. During the nine months ended September 30, 2020, we received principal repayments of $384.3 million compared to $389.5 million for the nine months ended September 30, 2019. The average prepayment speeds for the quarters ended September 30, 2020 and 2019 were 17.0% and 16.4%, respectively. The following table presents the 3-month constant prepayment rate (“CPR”) experienced on our structured and PT RMBS sub-portfolios, on an annualized basis, for the quarterly periods presented. CPR is a method of expressing the prepayment rate for a mortgage pool that assumes that a constant fraction of the remaining principal is prepaid each month or year. Specifically, the CPR in the chart below represents the three month prepayment rate of the securities in the respective asset category. Assets that were not owned for the entire quarter have been excluded from the calculation. The exclusion of certain assets during periods of high trading activity can create a very high, and often volatile, reliance on a small sample of underlying loans. Structured PT RMBS RMBS Total Three Months Ended Portfolio (%) Portfolio (%) Portfolio (%) September 30, 2020 14.3 40.4 17.0 June 30, 2020 13.9 35.3 16.3 March 31, 2020 9.8 22.9 11.9 December 31, 2019 14.3 23.4 16.0 September 30, 2019 15.5 19.3 16.4 June 30, 2019 10.9 12.7 11.4 March 31, 2019 9.5 8.4 9.2 The following tables summarize certain characteristics of the Company’s PT RMBS and structured RMBS as of September 30, 2020 and December 31, 2019: ($ in thousands) Weighted Percentage Average 37 of Weighted Maturity Fair Entire Average in Longest Asset Category Value Portfolio Coupon Months Maturity September 30, 2020 Adjustable Rate RMBS $ 960 0.0% 3.64% 167 1-Sep-35 Fixed Rate RMBS 3,357,501 94.8% 3.57% 339 1-Sep-50 Fixed Rate CMOs 151,110 4.3% 4.00% 316 15-Dec-42 Total Mortgage-backed Pass-through 3,509,571 99.1% 3.59% 338 1-Sep-50 Interest-Only Securities 30,796 0.9% 4.00% 270 25-Jul-48 Total Structured RMBS 30,796 0.9% 4.00% 270 25-Jul-48 Total Mortgage Assets $ 3,540,367 100.0% 3.62% 332 1-Sep-50 December 31, 2019 Adjustable Rate RMBS $ 1,014 0.0% 4.51% 176 1-Sep-35 Fixed Rate RMBS 3,206,013 89.3% 3.90% 342 1-Dec-49 Fixed Rate CMOs 299,205 8.3% 4.20% 331 15-Oct-44 Total Mortgage-backed Pass-through 3,506,232 97.6% 3.92% 341 1-Dec-49 Interest-Only Securities 60,986 1.7% 3.99% 280 25-Jul-48 Inverse Interest-Only Securities 23,703 0.7% 3.34% 285 15-Jul-47 Total Structured RMBS 84,689 2.4% 3.79% 281 25-Jul-48 Total Mortgage Assets $ 3,590,921 100.0% 3.90% 331 1-Dec-49 ($ in thousands) September 30, 2020 December 31, 2019 Percentage of Percentage of Agency Fair Value Entire Portfolio Fair Value Entire Portfolio Fannie Mae $ 2,151,928 60.8% $ 2,170,668 60.4% Freddie Mac 1,388,439 39.2% 1,420,253 39.6% Total Portfolio $ 3,540,367 100.0% $ 3,590,921 100.0% September 30, 2020 December 31, 2019 Weighted Average Pass-through Purchase Price $ 107.30 $ 105.16 Weighted Average Structured Purchase Price $ 20.14 $ 18.15 Weighted Average Pass-through Current Price $ 110.14 $ 106.26 Weighted Average Structured Current Price $ 10.26 $ 13.85 Effective Duration (1) 1.790 2.780 (1) Effective duration is the approximate percentage change in price for a 100 bps change in rates. An effective duration of 1.790 indicates that an interest rate increase of 1.0% would be expected to cause a 1.790% decrease in the value of the RMBS in the Company’s investment portfolio at September 30, 2020. An effective duration of 2.780 indicates that an interest rate increase of 1.0% would be expected to cause a 2.780% decrease in the value of the RMBS in the Company’s investment portfolio at December 31, 2019. These figures include the structured securities in the portfolio, but do not include the effect of the Company’s funding cost hedges. Effective duration quotes for individual investments are obtained from The Yield Book, Inc. The following table presents a summary of portfolio assets acquired during the nine months ended September 30, 2020 and 2019, including securities purchased during the period that settled after the end of the period, if any. ($ in thousands) 2020 2019 Total Cost Average Price Weighted Average Yield Total Cost Average Price Weighted Average Yield Pass-through RMBS $ 3,012,072 $ 107.22 1.67% $ 3,083,929 $ 104.77 3.06% Structured RMBS - - - 12,265 18.06 7.82% 38 Borrowings As of September 30, 2020, we had established borrowing facilities in the repurchase agreement market with a number of commercial banks and other financial institutions and had borrowings in place with 19 of these counterparties. None of these lenders are affiliated with the Company. These borrowings are secured by the Company’s RMBS and cash, and bear interest at prevailing market rates. We believe our established repurchase agreement borrowing facilities provide borrowing capacity in excess of our needs. As of September 30, 2020, we had obligations outstanding under the repurchase agreements of approximately $3,281.3 million with a net weighted average borrowing cost of 0.24%. The remaining maturity of our outstanding repurchase agreement obligations ranged from 1 to 225 days, with a weighted average remaining maturity of 60 days. Securing the repurchase agreement obligations as of September 30, 2020 are RMBS with an estimated fair value, including accrued interest, of approximately $3,426.3 million and a weighted average maturity of 341 months, and cash pledged to counterparties of approximately $24.8 million. Through October 30, 2020, we have been able to maintain our repurchase facilities with comparable terms to those that existed at September 30, 2020 with maturities through May 13, 2021. The table below presents information about our period end, maximum and average balances of borrowings for each quarter in 2020 to date and 2019. ($ in thousands) Difference Between Ending Ending Maximum Average Borrowings and Balance of Balance of Balance of Average Borrowings Three Months Ended Borrowings Borrowings Borrowings Amount Percent September 30, 2020 $ 3,281,303 $ 3,286,454 $ 3,228,021 $ 53,282 1.65% June 30, 2020 3,174,739 3,235,370 2,992,494 182,245 6.09% March 31, 2020 2,810,250 4,297,621 3,129,178 (318,928) (10.19)% (1) December 31, 2019 3,448,106 3,986,919 3,631,042 (182,936) (5.04)% September 30, 2019 3,813,977 3,847,417 3,571,752 242,225 6.78% June 30, 2019 3,329,527 3,730,460 3,098,133 231,394 7.47% March 31, 2019 2,866,738 3,022,771 2,945,895 (79,157) (2.69)% (1) The lower ending balance relative to the average balance during the quarter ended March 31, 2020 reflects the disposal of RMBS pledged as collateral in order to maintain cash and liquidity in response to the dislocations in the financial and mortgage markets resulting from the economic impacts of COVID-19. During the quarter ended March 31, 2020, the Company’s investment in RMBS decreased $642.1 million. Liquidity and Capital Resources Liquidity is our ability to turn non-cash assets into cash, purchase additional investments, repay principal and interest on borrowings, fund overhead, fulfill margin calls and pay dividends. Our principal immediate sources of liquidity include cash balances, unencumbered assets and borrowings under repurchase agreements. Our borrowing capacity will vary over time as the market value of our interest earning assets varies. Our balance sheet also generates liquidity on an on-going basis through payments of principal and interest we receive on our RMBS portfolio. Despite the dislocations in the financial and mortgage markets and the economic impacts resulting from COVID-19, management believes that we currently have sufficient liquidity and capital resources available for (a) the acquisition of additional investments consistent with the size and nature of our existing RMBS portfolio, (b) the repayments on borrowings and (c) the payment of dividends to the extent required for our continued qualification as a REIT. We may also generate liquidity from time to time by selling our equity or debt securities in public offerings or private placements. Because our PT RMBS portfolio consists entirely of government and agency securities, we do not anticipate having difficulty converting our assets to cash should our liquidity needs ever exceed our immediately available sources of cash. Our structured RMBS 39 portfolio also consists entirely of governmental agency securities, although they typically do not trade with comparable bid / ask spreads as PT RMBS. However, we anticipate that we would be able to liquidate such securities readily, even in distressed markets, although we would likely do so at prices below where such securities could be sold in a more stable market. To enhance our liquidity even further, we may pledge a portion of our structured RMBS as part of a repurchase agreement funding, but retain the cash in lieu of acquiring additional assets. In this way we can, at a modest cost, retain higher levels of cash on hand and decrease the likelihood we will have to sell assets in a distressed market in order to raise cash. Our strategy for hedging our funding costs typically involves taking short positions in interest rate futures, treasury futures, interest rate swaps, interest rate swaptions or other instruments. When the market causes these short positions to decline in value we are required to meet margin calls with cash. This can reduce our liquidity position to the extent other securities in our portfolio move in price in such a way that we do not receive enough cash via margin calls to offset the derivative related margin calls. If this were to occur in sufficient magnitude, the loss of liquidity might force us to reduce the size of the levered portfolio, pledge additional structured securities to raise funds or risk operating the portfolio with less liquidity. Our master repurchase agreements have no stated expiration, but can be terminated at any time at our option or at the option of the counterparty. However, once a definitive repurchase agreement under a master repurchase agreement has been entered into, it generally may not be terminated by either party. A negotiated termination can occur, but may involve a fee to be paid by the party seeking to terminate the repurchase agreement transaction, as it did during the three months ended March 31, 2020. Under our repurchase agreement funding arrangements, we are required to post margin at the initiation of the borrowing. The margin posted represents the haircut, which is a percentage of the market value of the collateral pledged. To the extent the market value of the asset collateralizing the financing transaction declines, the market value of our posted margin will be insufficient and we will be required to post additional collateral. Conversely, if the market value of the asset pledged increases in value, we would be over collateralized and we would be entitled to have excess margin returned to us by the counterparty. Our lenders typically value our pledged securities daily to ensure the adequacy of our margin and make margin calls as needed, as do we. Typically, but not always, the parties agree to a minimum threshold amount for margin calls so as to avoid the need for nuisance margin calls on a daily basis. Our master repurchase agreements do not specify the haircut; rather haircuts are determined on an individual repurchase transaction basis. Throughout the nine months ended September 30, 2020, haircuts on our pledged collateral remained stable and as of September 30, 2020, our weighted average haircut was approximately 4.9% of the value of our collateral. As discussed earlier, we invest a portion of our capital in structured Agency RMBS. We generally do not apply leverage to this portion of our portfolio. The leverage inherent in structured securities replaces the leverage obtained by acquiring PT securities and funding them in the repurchase market. This structured RMBS strategy has been a core element of the Company’s overall investment strategy since inception. However, we have and may continue to pledge a portion of our structured RMBS in order to raise our cash levels, but generally will not pledge these securities in order to acquire additional assets. The following table summarizes the effect on our liquidity and cash flows from contractual obligations for repurchase agreements and interest expense on repurchase agreements. (in thousands) Obligations Maturing Within One Year One to Three Years Three to Five Years More than Five Years Total Repurchase agreements $ 3,281,303 $ - $ - $ - $ 3,281,303 Interest expense on repurchase agreements (1) 2,062 - - - 2,062 Totals $ 3,283,365 $ - $ - $ - $ 3,283,365 (1) Interest expense on repurchase agreements is based on current interest rates as of September 30, 2020 and the remaining term of the liabilities existing at that date. 40 In future periods, we expect to continue to finance our activities in a manner that is consistent with our current operations through repurchase agreements. As of September 30, 2020, we had cash and cash equivalents of $199.8 million. We generated cash flows of $475.8 million from principal and interest payments on our RMBS and had average repurchase agreements outstanding of $3,116.6 million during the nine months ended September 30, 2020. Stockholders’ Equity On August 2, 2017, we entered into an equity distribution agreement (the “August 2017 Equity Distribution Agreement”) with two sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $125,000,000 of shares of our common stock in transactions that were deemed to be “at the market” offerings and privately negotiated transactions. We issued a total of 15,123,178 shares under the August 2017 Equity Distribution Agreement for aggregate gross proceeds of $125.0 million, and net proceeds of approximately $123.1 million, net of commissions and fees, prior to its termination in July 2019. On July 30, 2019, we entered into an underwriting agreement (the “Underwriting Agreement”) with Morgan Stanley & Co. LLC, Citigroup Global Markets Inc. and J.P. Morgan Securities LLC, as representatives of the underwriters named therein, relating to the offer and sale of 7,000,000 shares of our common stock at a price to the public of $6.55 per share. The underwriters purchased the shares pursuant to the Underwriting Agreement at a price of $6.3535 per share. The closing of the offering of 7,000,000 shares of common stock occurred on August 2, 2019, with net proceeds to us of approximately $44.2 million after deduction of underwriting discounts and commissions and other estimated offering expenses. On January 23, 2020, we entered into an equity distribution agreement (the “January 2020 Equity Distribution Agreement”) with three sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $200,000,000 of shares of our common stock in transactions that were deemed to be “at the market” offerings and privately negotiated transactions. We issued a total of 3,170,727 shares under the January 2020 Equity Distribution Agreement for aggregate gross proceeds of $19.8 million, and net proceeds of approximately $19.4 million, net of commissions and fees, prior to its termination in August 2020. On August 4, 2020, we entered into an equity distribution agreement (the “August 2020 Equity Distribution Agreement”) with four sales agents pursuant to which we may offer and sell, from time to time, up to an aggregate amount of $150,000,000 of shares of our common stock in transactions that are deemed to be “at the market” offerings and privately negotiated transactions. Through September 30, 2020, we issued a total of 3,073,326 shares under the August 2020 Equity Distribution Agreement for aggregate gross proceeds of approximately $15.8 million, and net proceeds of approximately $15.6 million, net of commissions and fees. Outlook Economic Summary The COVID-19 coronavirus that emerged in China in late 2019 and spread to the U.S. during the first quarter of 2020 continues to be the driving force behind economic activity both in the U.S. and abroad. As reported in our second quarter earnings release, cases of COVID-19 were starting to surge in the U.S. starting in mid-June. This surge lasted into July and August, particularly in the south and warmer states. By late summer the surge subsided and economic optimism rebounded as evidenced by most measures of economic activity. As the weather turns colder in the fall and people spend more time indoors, cases could start to increase again. This appears to be happening as we enter the fourth quarter, especially in northern states across the U.S. and Europe. To date governments have not responded with such drastic measures such as shelter in place orders like we saw in the spring. In contrast with the spring and summer, hospitalizations and serious cases appear to be occurring less frequently, and the medical community appears more adept at dealing with the more severe cases. The economic recovery from the severe contraction that occurred in the spring continues. However, the “V” shaped days of the recovery are over, at least on a broad basis. Growth is very uneven with certain sectors approaching levels of activity last seen before the onset of the pandemic, while others remain far short of such levels. A few sectors have surpassed pre- 41 pandemic levels – importantly housing among them, as well as retail sales. However, the leisure and hospitality sectors remain far below pre-pandemic activity levels and are not expected to fully recover in the near term. The consequence of the unbalanced recovery is a labor market that still has a long way to go to get back to February 2020 levels, as the unemployment rate was reported at 7.9% in early October. While progress towards finding a vaccine continues, with many efforts showing considerable promise, widespread access to a viable vaccine appears to be months away. Progress has also been made on the treatment and testing side of the pandemic, especially with respect to the latter. The lower death and hospitalization rates may be a result of the former. Legislative Response and the Federal Reserve Congress passed the CARES Act (described below) quickly in response to the pandemic’s emergence this spring and followed with additional legislation over the ensuing months. However, as certain provisions of the CARES Act have expired, such as supplemental unemployment insurance at the end of July, there appears to be a need for additional stimulus for the economy to deal with the uneven recovery and still high level of unemployment. However, the government has been unable to reach an agreement on additional measures. It appears the politicians in Washington and the national media are focused on the presidential election on November 3rd and a compromise on additional stimulus may have to wait until after then. The Fed on the other hand has provided, and continues to provide, as much support to the markets and the economy as it can within the constraints of its mandate. During the third quarter of 2020, the Fed unveiled a new monetary policy framework that will allow the Fed Funds rate to remain quite low, even if inflation is expected to temporarily surpass the 2% target level. Further, the Fed will look past the presence of very tight labor markets, should they be present at the time. This marks a significant shift from their prior policy framework, which was focused on the unemployment rate as a key indicator of impending inflation. Adherence to this policy could steepen the U.S. Treasury curve as short term rates could remain low for a considerable period but longer term rates could rise given the Fed’s intention to let inflation potentially run above 2% in the future as the economy more fully recovers. Interest Rates Interest rates remained in a tight range throughout the third quarter of 2020 and seem likely to do so for the short to medium term, especially given the change to the Fed’s monetary policy framework. With realized levels of volatility low, implied volatility is also very low by historical norms. Mortgage rates continue to slowly decline, however, as originators slowly add capacity and can handle ever increasing levels of production volume. The spread between rates available to borrowers and the implied yield on a current coupon mortgage, known as the Primary/Secondary spread, has continued to compress. The spread is still above long-term average levels so further compression is possible, meaning either rates available to borrowers can remain at current levels should U.S. Treasury rates increase, or they could move lower if U.S. Treasury rates remain stable. In either case, prepayment levels on RMBS securities are likely to remain high for the foreseeable future. The Agency RMBS Market The Agency RMBS market continues to be essentially bifurcated with two separate and distinct sub-markets. Lower coupon fixed rate mortgages, coupons of 1.5% through 2.5%, are, or will be soon in the case of 1.5% coupons, the focus of daily purchases by the Fed. Fed purchase activity maintains substantial price pressure under these coupons, and they benefit from attractive TBA dollar roll drops. Higher coupons in the TBA market do not have the benefit of Fed purchases and trade poorly. Importantly, the Fed tends to take the worst performing collateral out of the market. The absence of Fed purchases means the market is left to absorb very high prepayment speeds on these securities. For these coupons, specified pools are in very high demand and trade at very high premiums. These premiums continue to rise as prepayment activity remains very elevated and is likely to do so for some time. This dynamic has existed since March and is likely to continue. Recent Legislative and Regulatory Developments The Fed conducted large scale overnight repo operations from late 2019 until July 2020 to address disruptions in the U.S. Treasury, Agency debt and Agency MBS financing markets. These operations ceased in July 2020 after the central bank 42 successfully tamed volatile funding costs that had threatened to cause disruption across the financial system. The Fed has taken a number of other actions to stabilize markets as a result of the impacts of the COVID-19 pandemic. On Sunday, March 15, 2020, the Fed announced a $700 billion asset purchase program to provide liquidity to the U.S. Treasury and Agency MBS markets. Specifically, the Fed announced that it would purchase at least $500 billion of U.S. Treasuries and at least $200 billion of Agency MBS. The Fed also lowered the Fed Funds rate to a range of 0.0% – 0.25%, after having already lowered the Fed Funds rate by 50 bps on March 3, 2020. On June 30, 2020, Fed Chairman Powell announced expectations to maintain interest rates at this level until the Fed is confident that the economy has weathered recent events and is on track to achieve maximum employment and price stability goals. On September 16, 2020, the Federal Open Market Committee (“FOMC”) reaffirmed this commitment, as well as an intention to allow inflation to climb modestly above their 2% target and maintain that level for a period sufficient for inflation to average 2% long term. In response to the deterioration in the markets for U.S. Treasuries, Agency MBS and other mortgage and fixed income markets as investors liquidated investments in response to the economic crisis resulting from the actions to contain and minimize the impacts of the COVID-19 pandemic, on the morning of Monday, March 23, 2020, the Fed announced a program to acquire U.S. Treasuries and Agency MBS in the amounts needed to support smooth market functioning. With these purchases, market conditions improved substantially, and in early April, the Fed began to gradually reduce the pace of these purchases. On June 30, 2020, Chairman Powell also announced the Fed’s intention to increase its holdings of U.S. Treasury securities and Agency MBS over the coming months, at least at the current pace, to sustain smooth market functioning and thereby foster the effective transmission of monetary policy to broader financial conditions. On September 16, 2020, the FOMC reaffirmed this commitment. Since March, the Fed has taken various other steps to support certain other fixed income markets, to support mortgage servicers and to implement various portions of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. Congress and President Trump have adopted several pieces of legislation in response to the public health and economic impacts resulting from the COVID-19 pandemic. The first two pieces of legislation provided, among other things, emergency funding to develop a vaccine for COVID-19, medical supplies, grants for public health agencies, small business loans, assistance for health systems in other countries, expanded coronavirus testing, paid leave, enhanced unemployment insurance, expanded food security initiatives and increased federal Medicaid funding. The CARES Act was passed by Congress and signed into law by President Trump on March 27, 2020. The CARES Act provides many forms of direct support to individuals and small businesses in order to stem the steep decline in economic activity. This over $2 trillion COVID-19 relief bill, among other things, provided for direct payments to each American making up to $75,000 a year, increased unemployment benefits for up to four months (on top of state benefits), funding to hospitals and health providers, loans and investments to businesses, states and municipalities and grants to the airline industry. On April 24, 2020, President Trump signed an additional funding bill into law that provides an additional $484 billion of funding to individuals, small businesses, hospitals, health care providers and additional coronavirus testing efforts. Various provisions of the CARES Act began to expire in July 2020, including a moratorium on evictions (July 25, 2020), expanded unemployment benefits (July 31, 2020), and a moratorium on foreclosures (August 31, 2020). Additional legislative relief efforts stalled in Congress, and expectations for a compromise prior to the 2020 election are low. On August 8, 2020, President Trump issued Executive Order 13945, directing the Department of Health and Human Services, the Centers for Disease Control and Prevention (“CDC”), the Department of Housing and Urban Development, and Department of the Treasury to take measures to temporarily halt residential evictions and foreclosures, including through temporary financial assistance. On September 4, 2020, the CDC issued guidance extending eviction moratoriums for covered persons through the end of 2020. In January 2019, the Trump administration made statements of its plans to work with Congress to overhaul Fannie Mae and Freddie Mac and expectations to announce a framework for the development of a policy for comprehensive housing finance reform soon. On September 30, 2019, the FHFA announced that Fannie Mae and Freddie Mac were allowed to increase their capital buffers to $25 billion and $20 billion, respectively, from the prior limit of $3 billion each. This step could ultimately lead to Fannie Mae and Freddie Mac being privatized and represents the first concrete step on the road to GSE reform. On June 30, 2020, the FHFA released a proposed rule on a new regulatory framework for the GSEs which seeks to 43 implement both a risk-based capital framework and minimum leverage capital requirements. On September 25, 2020, the Financial Stability Oversight Council released a statement on the proposed rule cautioning that, in its opinion, the credit risk requirements were too low relative to other credit providers and would maintain a significant concentration of risk in the GSEs. At this time, however, no decisions have been made on any additional steps to be taken as part of the GSE reform plan and the economic impact of COVID-19 may delay GSE reform plans further. Although the Trump administration has made statements of its intentions to reform housing finance and tax policy, many of these potential policy changes will require congressional action. In 2017, policymakers announced that LIBOR will be replaced by December 31, 2021. The directive was spurred by the fact that banks are uncomfortable contributing to the LIBOR panel given the shortage of underlying transactions on which to base levels and the liability associated with submitting an unfounded level. LIBOR will be replaced with a new SOFR, a rate based on U.S. repo trading. The new benchmark rate will be based on overnight Treasury General Collateral repo rates. The rate-setting process will be managed and published by the Fed and the Treasury’s Office of Financial Research. Many banks believe that it may take four to five years to complete the transition to SOFR, despite the 2021 deadline. We will monitor the emergence of this new rate carefully as it will likely become the new benchmark for hedges and a range of interest rate investments. Effective January 1, 2021, Fannie Mae, in alignment with Freddie Mac, will extend the timeframe for its delinquent loan buyout policy for Single-Family Uniform Mortgage-Backed Securities (UMBS) and Mortgage-Backed Securities (MBS) from four consecutively missed monthly payments to twenty-four consecutively missed monthly payments (i.e., 24 months past due). This new timeframe will apply to outstanding single-family pools and newly issued single-family pools and will first be reflected when January 2021 factors are released on the fourth business day in February 2021. For Agency RMBS investors, when a delinquent loan is bought out of a pool of mortgage loans, the removal of the loan from the pool is the same as a total prepayment of the loan. The respective GSEs currently anticipate, however, that delinquent loans will be repurchased in most cases before the 24-month deadline under one of the exceptions listed below. Exceptions include: • a loan that is paid in full, or where the related lien is released and/or the note debt is satisfied or forgiven; • a loan repurchased by a seller/servicer under applicable selling and servicing requirements; • a loan entering a permanent modification, which generally requires it to be removed from the MBS. During any modification trial period, the loan will remain in the MBS until the trial period ends; • a loan subject to a short sale or deed-in-lieu of foreclosure; • a loan referred to foreclosure. Because of these exceptions, the GSEs currently believe based on prevailing assumptions and market conditions this change will have only a marginal impact on prepayment speeds, in aggregate. Cohort level impacts may vary. For example, more than half of loans referred to foreclosure are historically referred within six months of delinquency. The degree to which speeds are affected depends on delinquency levels, borrower response, and referral to foreclosure timelines. The scope and nature of the actions the U.S. government or the Fed will ultimately undertake are unknown and will continue to evolve, especially in light of the COVID-19 pandemic and the upcoming presidential and Congressional elections in the United States. Effect on Us Regulatory developments, movements in interest rates and prepayment rates affect us in many ways, including the following: Effects on our Assets 44 A change in or elimination of the guarantee structure of Agency RMBS may increase our costs (if, for example, guarantee fees increase) or require us to change our investment strategy altogether. For example, the elimination of the guarantee structure of Agency RMBS may cause us to change our investment strategy to focus on non-Agency RMBS, which in turn would require us to significantly increase our monitoring of the credit risks of our investments in addition to interest rate and prepayment risks. Lower long-term interest rates can affect the value of our Agency RMBS in a number of ways. If prepayment rates are relatively low (due, in part, to the refinancing problems described above), lower long-term interest rates can increase the value of higher-coupon Agency RMBS. This is because investors typically place a premium on assets with yields that are higher than market yields. Although lower long-term interest rates may increase asset values in our portfolio, we may not be able to invest new funds in similarly-yielding assets. If prepayment levels increase, the value of our Agency RMBS affected by such prepayments may decline. This is because a principal prepayment accelerates the effective term of an Agency RMBS, which would shorten the period during which an investor would receive above-market returns (assuming the yield on the prepaid asset is higher than market yields). Also, prepayment proceeds may not be able to be reinvested in similar-yielding assets. Agency RMBS backed by mortgages with high interest rates are more susceptible to prepayment risk because holders of those mortgages are most likely to refinance to a lower rate. IOs and IIOs, however, may be the types of Agency RMBS most sensitive to increased prepayment rates. Because the holder of an IO or IIO receives no principal payments, the values of IOs and IIOs are entirely dependent on the existence of a principal balance on the underlying mortgages. If the principal balance is eliminated due to prepayment, IOs and IIOs essentially become worthless. Although increased prepayment rates can negatively affect the value of our IOs and IIOs, they have the opposite effect on POs. Because POs act like zero-coupon bonds, meaning they are purchased at a discount to their par value and have an effective interest rate based on the discount and the term of the underlying loan, an increase in prepayment rates would reduce the effective term of our POs and accelerate the yields earned on those assets, which would increase our net income. Higher long-term rates can also affect the value of our Agency RMBS. As long-term rates rise, rates available to borrowers also rise. This tends to cause prepayment activity to slow and extend the expected average life of mortgage cash flows. As the expected average life of the mortgage cash flows increases, coupled with higher discount rates, the value of Agency RMBS declines. Some of the instruments the Company uses to hedge our Agency RMBS assets, such as interest rate futures, swaps and swaptions, are stable average life instruments. This means that to the extent we use such instruments to hedge our Agency RMBS assets, our hedges may not adequately protect us from price declines, and therefore may negatively impact our book value. It is for this reason we use interest only securities in our portfolio. As interest rates rise, the expected average life of these securities increases, causing generally positive price movements as the number and size of the cash flows increase the longer the underlying mortgages remain outstanding. This makes interest only securities desirable hedge instruments for pass-through Agency RMBS. As described above, the Agency RMBS market began to experience severe dislocations in mid-March 2020 as a result of the economic, health and market turmoil brought about by COVID-19. On March 23, 2020, the Fed announced that it would purchase Agency RMBS and U.S. Treasuries in the amounts needed to support smooth market functioning, which largely stabilized the Agency RMBS market, a commitment it reaffirmed on June 30, 2020 and September 16, 2020. If the Fed modifies, reduces or suspends its purchases of Agency RMBS, our investment portfolio could be negatively impacted. Because we base our investment decisions on risk management principles rather than anticipated movements in interest rates, in a volatile interest rate environment we may allocate more capital to structured Agency RMBS with shorter durations. We believe these securities have a lower sensitivity to changes in long-term interest rates than other asset classes. We may attempt to mitigate our exposure to changes in long-term interest rates by investing in IOs and IIOs, which typically have different sensitivities to changes in long-term interest rates than PT RMBS, particularly PT RMBS backed by fixed-rate mortgages. Effects on our borrowing costs 45 We leverage our PT RMBS portfolio and a portion of our structured Agency RMBS with principal balances through the use of short-term repurchase agreement transactions. The interest rates on our debt are determined by the short term interest rate markets. An increase in the Fed Funds rate or LIBOR would increase our borrowing costs, which could affect our interest rate spread if there is no corresponding increase in the interest we earn on our assets. This would be most prevalent with respect to our Agency RMBS backed by fixed rate mortgage loans because the interest rate on a fixed-rate mortgage loan does not change even though market rates may change. In order to protect our net interest margin against increases in short-term interest rates, we may enter into interest rate swaps, which economically convert our floating-rate repurchase agreement debt to fixed-rate debt, or utilize other hedging instruments such as Eurodollar, Fed Funds and T-Note futures contracts or interest rate swaptions. Summary COVID-19 continues to dominate the performance of the markets and economy. While both have recovered from the depths of March, especially the financial markets, the economy continues to languish. The recovery has proven to be very uneven, with some sectors back to or near pre-pandemic levels of activity while others remain far below with little prospect for getting back to those levels soon. The unemployment rate remains elevated – with the most recent read at 7.9% - as millions of Americans remain out of work. The Fed has taken, and continues to take, steps to support markets and the economy. However, much needed additional stimulus from Washington and the federal government has been absent since the end of the second quarter. The federal government, with a presidential election on the horizon in November, appears hopelessly caught up in partisan politics and unable to agree on another round of stimulus. Interest rates continue to trade in a narrow range and at extremely low levels. The market expects the Fed Funds rate to remain at the effective lower bound near zero for an extended period of time, even more so after the Fed altered its monetary policy framework during the third quarter. Henceforth, the Fed appears to be willing to let inflation run above the 2% target level, even when unemployment is very low, before removing accommodation. The Agency RMBS market continues to be bifurcated between the production coupons – the target of Fed asset purchases – and higher coupons in specified pool form. The TBA market for higher coupons remains weak as the sector lacks support form the Fed and prepayment speeds are extremely high, resulting in poor expected returns for investors. This leads investors to look to the specified pool market – with lower expected prepayment speeds – for attractive returns. Since the economy cannot fully recover absent the containment of the COVID-19 pandemic, which is not expected to occur in the near term, current market conditions are likely to persist. As a result, we expect prepayment speeds will remain elevated, the Fed will be active in the Agency RMBS market with asset purchases, funding levels will remain low and the most attractive returns available will be either in the TBA dollar roll market with lower coupons or with specified pools in higher coupons. Critical Accounting Estimates Our condensed financial statements are prepared in accordance with GAAP. GAAP requires our management to make some complex and subjective decisions and assessments. Our most critical accounting estimates involve decisions and assessments which could significantly affect reported assets, liabilities, revenues and expenses. There have been no changes to our critical accounting estimates as discussed in our annual report on Form 10-K for the year ended December 31, 2019. Capital Expenditures At September 30, 2020, we had no material commitments for capital expenditures. 46 Off-Balance Sheet Arrangements At September 30, 2020, we did not have any off-balance sheet arrangements. Dividends In addition to other requirements that must be satisfied to qualify as a REIT, we must pay annual dividends to our stockholders of at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gains. REIT taxable income (loss) is computed in accordance with the Code, and can be greater than or less than our financial statement net income (loss) computed in accordance with GAAP. These book to tax differences primarily relate to the recognition of interest income on RMBS, unrealized gains and losses on RMBS, and the amortization of losses on derivative instruments that are treated as funding hedges for tax purposes. We intend to pay regular monthly dividends to our stockholders and have declared the following dividends since the completion of our IPO. (in thousands, except per share amounts) Year Per Share Amount Total 2013 $ 1.395 $ 4,662 2014 2.160 22,643 2015 1.920 38,748 2016 1.680 41,388 2017 1.680 70,717 2018 1.070 55,814 2019 0.960 54,421 2020 - YTD (1) 0.660 44,055 Totals $ 11.525 $ 332,448 (1) On October 14, 2020, the Company declared a dividend of $0.065 per share to be paid on November 25, 2020. The effect of this dividend is included in the table above, but is not reflected in the Company’s financial statements as of September 30, 2020. Inflation Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our distributions will be determined by our Board of Directors consistent with our obligation to distribute to our stockholders at least 90% of our REIT taxable income on an annual basis in order to maintain our REIT qualification; in each case, our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation.