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, 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”. Capital Raising Activities 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 March 31, 24 2021, we issued a total of 10,156,561 shares under the August 2020 Equity Distribution Agreement for aggregate gross proceeds of approximately $54.1 million, and net proceeds of approximately $53.2 million, net of commissions and fees. On January 20, 2021, we entered into an underwriting agreement (the “January 2021 Underwriting Agreement”) with J.P. Morgan Securities LLC (“J.P. Morgan”), relating to the offer and sale of 7,600,000 shares of our common stock. J.P. Morgan purchased the shares of our common stock from the Company pursuant to the January 2021 Underwriting Agreement at $5.20 per share. In addition, we granted J.P. Morgan a 30-day option to purchase up to an additional 1,140,000 shares of our common stock on the same terms and conditions, which J.P. Morgan exercised in full on January 21, 2021. The closing of the offering of 8,740,000 shares of our common stock occurred on January 25, 2021, with net proceeds to us of approximately $45.2 million, net of offering expenses. On March 2, 2021 we entered into an underwriting agreement (the “March 2021 Underwriting Agreement”) with J.P. Morgan, relating to the offer and sale of 8,000,000 shares of our common stock. J.P. Morgan purchased the shares of our common stock from the Company pursuant to the March 2021 Underwriting Agreement at $5.45 per share. In addition, we granted J.P. Morgan a 30-day option to purchase up to an additional 1,200,000 shares of our common stock on the same terms and conditions, which J.P. Morgan exercised in full on March 3, 2021. The closing of the offering of 9,200,000 shares of our common stock occurred on March 5, 2021, with net proceeds to us of approximately $50.1 million, net of offering expenses. 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 March 31, 2021, 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. The Company did not repurchase any shares of its common stock during the three months ended March 31, 2021. The remaining authorization under the repurchase program as of March 31, 2021 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: 25 ● 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 Described below are the Company’s results of operations for the three months ended March 31, 2021, as compared to the Company’s results of operations for the three months ended March 31, 2020. Net (Loss) Income Summary Net loss for the three months ended March 31, 2021 was $29.4 million, or $0.34 per share. Net loss for the three months ended March 31, 2020 was $91.2 million, or $1.41 per share. The components of net loss for the three months ended March 31, 2021 and 2020, along with the changes in those components are presented in the table below: (in thousands) 2021 2020 Change Interest income $ 26,856 $ 35,671 $ (8,815) Interest expense (1,941) (16,523) 14,582 Net interest income 24,915 19,148 5,767 Losses on RMBS and derivative contracts (50,791) (108,206) 57,415 Net portfolio deficiency (25,876) (89,058) 63,182 Expenses (3,493) (2,141) (1,352) Net loss $ (29,369) $ (91,199) $ 61,830 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 used for hedging purposes as hedges for accounting purposes, 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. 26 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. 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 March 31, 2021 $ (29,369) $ (50,791) $ 21,422 $ (0.34) $ (0.60) $ 0.26 December 31, 2020 16,479 (4,605) 21,084 0.23 (0.07) 0.30 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 (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 27 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. The Company may invest in TBAs, which are forward contracts for the purchase or sale of Agency RMBS at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date. The specific Agency RMBS to be delivered into the contract are not known until shortly before the settlement date. We may choose, prior to settlement, to move the settlement of these securities out to a later date by entering into a dollar roll transaction. The Agency RMBS purchased or sold for a forward settlement date are typically priced at a discount to equivalent securities settling in the current month. Consequently, forward purchases of Agency RMBS and dollar roll transactions represent a form of off-balance sheet financing. These TBAs are accounted for as derivatives and marked to market through the income statement. Gains or losses on TBAs are included with gains or losses on other derivative contracts and are not included in interest income for purposes of the discussions below. 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 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 2021 to date and 2020. Gains (Losses) on Derivative Instruments (in thousands) Funding Hedges Recognized in Attributed to Attributed to Income U.S. Treasury and TBA Current Future Statement Securities Gain (Loss) Period Periods (GAAP) (Short Positions) (Long Positions) (Non-GAAP) (Non-GAAP) Three Months Ended March 31, 2021 $ 45,472 $ 9,133 $ (8,559) $ (4,044) $ 48,942 December 31, 2020 8,538 (436) 5,480 (5,790) $ 9,284 September 30, 2020 4,079 131 3,336 (6,900) $ 7,512 June 30, 2020 (8,851) 582 1,133 (5,751) $ (4,815) March 31, 2020 (82,858) (7,090) - (4,900) $ (70,868) Economic Interest Expense and Economic Net Interest Income (in thousands) Interest Expense on Borrowings Gains (Losses) on 28 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 March 31, 2021 $ 26,856 $ 1,941 $ (4,044) $ 5,985 $ 24,915 $ 20,871 December 31, 2020 25,893 2,011 (5,790) 7,801 23,882 18,092 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 (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 three months ended March 31, 2021, we generated $24.9 million of net interest income, consisting of $26.9 million of interest income from RMBS assets offset by $1.9 million of interest expense on borrowings. For the comparable period ended March 31, 2020, we generated $19.1 million of net interest income, consisting of $35.7 million of interest income from RMBS assets offset by $16.5 million of interest expense on borrowings. The $8.8 million decrease in interest income was due to a 170 basis point ("bps") decrease in the yield on average RMBS, partially offset by the $762.9 million increase in average RMBS. The $14.6 million decrease in interest expense was due to a 191 bps decrease in the average cost of funds, partially offset by a $759.5 million increase in average outstanding borrowings. We had more average assets and borrowings during the first quarter of 2021 compared to the first quarter of 2020 as we deployed the proceeds of our capital raising activity during the second half of 2020 and the first quarter of 2021. On an economic basis, our interest expense on borrowings for the three months ended March 31, 2021 and 2020 was $6.0 million and $21.4 million, respectively, resulting in $20.9 million and $14.2 million of economic net interest income, respectively. The lower economic interest expense during the three months ended March 31, 2021 was due to the 191 bps decrease in the average cost of funds noted above, partially offset by the $759.5 million increase in average outstanding borrowings and the negative performance of our hedging activities during the period. The tables below provide information on our portfolio average balances, interest income, yield on assets, average borrowings, interest expense, cost of funds, net interest income and net interest spread for each quarter in 2021 to date and 2020 on both a GAAP and economic basis. ($ 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 March 31, 2021 $ 4,032,716 $ 26,856 2.66% $ 3,888,633 $ 1,941 $ 5,985 0.20% 0.62% December 31, 2020 3,633,631 25,893 2.85% 3,438,444 2,011 7,801 0.23% 0.91% 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% ($ in thousands) Net Interest Income Net Interest Spread GAAP Economic GAAP Economic Basis Basis (2) Basis Basis (4) Three Months Ended 29 March 31, 2021 $ 24,915 $ 20,871 2.46% 2.04% December 31, 2020 23,882 18,093 2.62% 1.94% 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% (1) Portfolio yields and costs of borrowings presented in the tables above and the tables on pages 29 and 30 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 30 include 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 three months ended March 31, 2021 and 2020 was $26.9 million and $35.7 million, respectively. We had average RMBS holdings of $4,032.7 million and $3,269.9 million for the three months ended March 31, 2021 and 2020, respectively. The yield on our portfolio was 2.66% and 4.36% for the three months ended March 31, 2021 and 2020, respectively. For the three months ended March 31, 2021 as compared to the three months ended March 31, 2020, there was a $8.8 million decrease in interest income due to a 170 bps decrease in the yield on average RMBS, partially offset by a $762.9 million increase in average RMBS. The table below presents the average portfolio size, income and yields of our respective sub-portfolios, consisting of structured RMBS and PT RMBS for each quarter in 2021 to date and 2020. ($ in thousands) Average RMBS Held Interest Income Realized Yield on Average RMBS PT Structured PT Structured PT Structured Three Months Ended RMBS RMBS Total RMBS RMBS Total RMBS RMBS Total March 31, 2021 $ 3,997,965 $ 34,751 $ 4,032,716 $ 26,869 $ (13) $ 26,856 2.69% (0.15)% 2.66% December 31, 2020 3,603,885 29,746 3,633,631 25,933 (40) 25,893 2.88% (0.53)% 2.85% 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% March 31, 2020 3,207,467 62,392 3,269,859 35,286 385 35,671 4.40% 2.47% 4.36% Interest Expense and the Cost of Funds We had average outstanding borrowings of $3,888.6 million and $3,129.2 million and total interest expense of $1.9 million and $16.5 million for the three months ended March 31, 2021 and 2020, respectively. Our average cost of funds was 0.20% and 2.11% for the three months ended March 31, 2021 and 2020, respectively. Contributing to the decrease in interest expense was a 191 bps decrease in the average cost of funds, partially offset by a $759.5 million increase in average outstanding borrowings during the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. Our economic interest expense was $6.0 million and $21.4 million for the three months ended March 31, 2021 and 2020, respectively. There was a 212 bps decrease in the average economic cost of funds to 0.62% for the three months ended March 31, 2021 from 2.74% for the three months ended March 31, 2020. Since all of our repurchase agreements are short-term, changes in market rates directly affect our interest expense. Our average cost of funds calculated on a GAAP basis was 7 bps above the average one-month LIBOR and 3 bps below the average six-month LIBOR for the quarter ended March 31, 2021. Our average economic cost of funds was 49 bps above the average one-month LIBOR and 39 bps above the average six-month LIBOR for the quarter ended March 31, 2021. The average term to maturity of the outstanding repurchase 30 agreements was 43 days at March 31, 2021 and 31 days at December 31, 2020. The tables below present the average balance of borrowings outstanding, interest expense and average cost of funds, and average one-month and six-month LIBOR rates for each quarter in 2021 to date and 2020 on both a GAAP and economic basis. ($ in thousands) Average Interest Expense Average Cost of Funds Balance of GAAP Economic GAAP Economic Three Months Ended Borrowings Basis Basis Basis Basis March 31, 2021 $ 3,888,633 $ 1,941 $ 5,985 0.20% 0.62% December 31, 2020 3,438,444 2,011 7,801 0.23% 0.91% 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% 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 March 31, 2021 0.13% 0.23% 0.07% (0.03)% 0.49% 0.39% December 31, 2020 0.15% 0.27% 0.08% (0.04)% 0.76% 0.64% 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% Gains or Losses The table below presents our gains or losses for the three months ended March 31, 2021 and 2020. (in thousands) 2021 2020 Change Realized losses on sales of RMBS $ (7,397) $ (28,380) $ 20,983 Unrealized (losses) gains on RMBS (88,866) 3,032 (91,898) Total losses on RMBS (96,263) (25,348) (70,915) Gains (losses) on interest rate futures 2,488 (12,556) 15,044 Gains (losses) on interest rate swaps 27,123 (60,623) 87,746 Losses on payer swaptions (short positions) (26,167) - (26,167) Gains (losses) on payer swaptions (long positions) 40,070 (2,589) 42,659 Gains on interest rate floors 1,384 - 1,384 Losses on TBA securities (long positions) (8,559) - (8,559) Gains (losses) on TBA securities (short positions) 9,133 (7,090) 16,223 Total $ (50,791) $ (108,206) $ 57,415 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 three months ended March 31, 2021 and 2020, we received proceeds of $988.5 million and $1,808.9 million, respectively, from the sales of RMBS. Most of these sales in the first quarter of 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. 31 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. As rates increased during the three months ended March 31, 2021, it had a negative impact on our RMBS 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 2021 to date and 2020. 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) March 31, 2021 0.94% 1.75% 2.39% 3.08% 0.19% December 31, 2020 0.36% 0.92% 2.22% 2.68% 0.23% 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% (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 Total operating expenses were approximately $3.5 million and $2.1 million for the three months ended March 31, 2021 and 2020, respectively. The table below presents a breakdown of operating expenses for the three months ended March 31, 2021 and 2020. (in thousands) 2021 2020 Change Management fees $ 1,621 $ 1,377 $ 244 Overhead allocation 404 347 57 Accrued incentive compensation 364 (436) 800 Directors fees and liability insurance 272 260 12 Audit, legal and other professional fees 318 255 63 Other direct REIT operating expenses 421 206 215 Other expenses 93 132 (39) Total expenses $ 3,493 $ 2,141 $ 1,352 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, 2022 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 $500 million. The Company is obligated to reimburse the Manager for any direct expenses incurred on its behalf and to pay the Manager the Company’s pro rata portion of certain overhead costs set forth in the management agreement. Should the Company terminate the management agreement without cause, it will pay the Manager a termination fee equal to three times the average annual management fee, as defined in the management agreement, before or on the last day of the term of the agreement. 32 The following table summarizes the management fee and overhead allocation expenses for each quarter in 2021 to date and 2020. ($ in thousands) Average Average Advisory Services Orchid Orchid Management Overhead Three Months Ended MBS Equity Fee Allocation Total March 31, 2021 $ 4,032,716 $ 453,353 $ 1,621 $ 404 $ 2,025 December 31, 2020 3,633,631 387,503 1,384 442 1,826 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 Financial Condition: Mortgage-Backed Securities As of March 31, 2021, our RMBS portfolio consisted of $4,338.5 million of Agency RMBS at fair value and had a weighted average coupon on assets of 3.02%. During the three months ended March 31, 2021, we received principal repayments of $123.9 million compared to $142.3 million for the three months ended March 31, 2020. The average three month prepayment speeds for the quarters ended March 31, 2021 and 2020 were 12.0% and 11.9%, respectively. The following table presents the 3-month constant prepayment rate (“CPR”) experienced on our structured and PT RMBS sub-portfolios, on an annualized basis, for the quarterly periods presented. CPR is a method of expressing the prepayment rate for a mortgage pool that assumes that a constant fraction of the remaining principal is prepaid each month or year. Specifically, the CPR in the chart below represents the three month prepayment rate of the securities in the respective asset category. Assets that were not owned for the entire quarter have been excluded from the calculation. The exclusion of certain assets during periods of high trading activity can create a very high, and often volatile, reliance on a small sample of underlying loans. Structured PT RMBS RMBS Total Three Months Ended Portfolio (%) Portfolio (%) Portfolio (%) March 31, 2021 9.9 40.3 12.0 December 31, 2020 16.7 44.3 20.1 September 30, 2020 14.3 40.4 17.0 June 30, 2020 13.9 35.3 16.3 March 31, 2020 9.8 22.9 11.9 The following tables summarize certain characteristics of the Company’s PT RMBS and structured RMBS as of March 31, 2021 and December 31, 2020: ($ in thousands) Weighted Percentage Average of Weighted Maturity Fair Entire Average in Longest Asset Category Value Portfolio Coupon Months Maturity March 31, 2021 Fixed Rate RMBS $ 4,297,731 99.1% 2.95% 335 1-Mar-51 Total Mortgage-backed Pass-through 4,297,731 99.1% 2.95% 335 1-Mar-51 33 Interest-Only Securities 35,521 0.8% 3.98% 264 25-May-50 Inverse Interest-Only Securities 5,284 0.1% 3.77% 311 15-Jun-42 Total Structured RMBS 40,805 0.9% 3.93% 275 25-May-50 Total Mortgage Assets $ 4,338,536 100.0% 3.02% 331 1-Mar-51 December 31, 2020 Fixed Rate RMBS $ 3,560,746 95.5% 3.09% 339 1-Jan-51 Fixed Rate CMOs 137,453 3.7% 4.00% 312 15-Dec-42 Total Mortgage-backed Pass-through 3,698,199 99.2% 3.13% 338 1-Jan-51 Interest-Only Securities 28,696 0.8% 3.98% 268 25-May-50 Total Structured RMBS 28,696 0.8% 3.98% 268 25-May-50 Total Mortgage Assets $ 3,726,895 100.0% 3.19% 333 1-Jan-51 ($ in thousands) March 31, 2021 December 31, 2020 Percentage of Percentage of Agency Fair Value Entire Portfolio Fair Value Entire Portfolio Fannie Mae $ 3,439,588 79.3% $ 2,733,960 73.4% Freddie Mac 898,948 20.7% 992,935 26.6% Total Portfolio $ 4,338,536 100.0% $ 3,726,895 100.0% March 31, 2021 December 31, 2020 Weighted Average Pass-through Purchase Price $ 107.56 $ 107.43 Weighted Average Structured Purchase Price $ 18.69 $ 20.06 Weighted Average Pass-through Current Price $ 106.14 $ 108.94 Weighted Average Structured Current Price $ 13.83 $ 10.87 Effective Duration (1) 4.090 2.360 (1) Effective duration is the approximate percentage change in price for a 100 bps change in rates. An effective duration of 4.090 indicates that an interest rate increase of 1.0% would be expected to cause a 4.090% decrease in the value of the RMBS in the Company’s investment portfolio at March 31, 2021. An effective duration of 2.360 indicates that an interest rate increase of 1.0% would be expected to cause a 2.360% decrease in the value of the RMBS in the Company’s investment portfolio at December 31, 2020. 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 three months ended March 31, 2021 and 2020, including securities purchased during the period that settled after the end of the period, if any. ($ in thousands) 2021 2020 Total Cost Average Price Weighted Average Yield Total Cost Average Price Weighted Average Yield Pass-through RMBS $ 1,971,296 $ 107.09 1.38% $ 1,334,350 $ 107.18 2.28% Structured RMBS 4,807 6.93 0.14 - - 0.00% Borrowings As of March 31, 2021, 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 21 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. 34 As of March 31, 2021, we had obligations outstanding under the repurchase agreements of approximately $4,181.7 million with a net weighted average borrowing cost of 0.18%. The remaining maturity of our outstanding repurchase agreement obligations ranged from 1 to 166 days, with a weighted average remaining maturity of 43 days. Securing the repurchase agreement obligations as of March 31, 2021 are RMBS with an estimated fair value, including accrued interest, of approximately $4,285.9 million and a weighted average maturity of 339 months, and cash pledged to counterparties of approximately $102.6 million. Through April 30, 2021, we have been able to maintain our repurchase facilities with comparable terms to those that existed at March 31, 2021 with maturities through October 8, 2021. The table below presents information about our period end, maximum and average balances of borrowings for each quarter in 2021 to date and 2020. ($ 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 March 31, 2021 $ 4,181,680 $ 4,204,935 $ 3,888,633 $ 293,047 7.54% December 31, 2020 3,595,586 3,597,313 3,438,444 157,142 4.57% 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) (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. 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 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 35 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 three months ended March 31, 2021, haircuts on our pledged collateral remained stable and as of March 31, 2021, our weighted average haircut was approximately 5.0% of the value of our collateral. TBAs represent a form of off-balance sheet financing and are accounted for as derivative instruments. (See Note 4 to our Financial Statements in this Form 10-Q for additional details on our TBAs). Under certain market conditions, it may be uneconomical for us to roll our TBAs into future months and we may need to take or make physical delivery of the underlying securities. If we were required to take physical delivery to settle a long TBA, we would have to fund our total purchase commitment with cash or other financing sources and our liquidity position could be negatively impacted. Our TBAs are also subject to margin requirements governed by the Mortgage-Backed Securities Division ("MBSD") of the FICC and by our master securities forward transaction agreements, which may establish margin levels in excess of the MBSD. Such provisions require that we establish an initial margin based on the notional value of the TBA, which is subject to increase if the estimated fair value of our TBAs or the estimated fair value of our pledged collateral declines. The MBSD has the sole discretion to determine the value of our TBAs and of the pledged collateral securing such contracts. In the event of a margin call, we must generally provide additional collateral on the same business day. Settlement of our TBA obligations by taking delivery of the underlying securities as well as satisfying margin requirements could negatively impact our liquidity position. However, since we do not use TBA dollar roll transactions as our primary source of financing, we believe that we will have adequate sources of liquidity to meet such obligations. 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 $ 4,181,680 $ - $ - $ - $ 4,181,680 36 Interest expense on repurchase agreements (1) 1,800 - - - 1,800 Totals $ 4,183,480 $ - $ - $ - $ 4,183,480 (1) Interest expense on repurchase agreements is based on current interest rates as of March 31, 2021 and the remaining term of the liabilities existing at that date. 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 March 31, 2021, we had cash and cash equivalents of $211.4 million. We generated cash flows of $149.7 million from principal and interest payments on our RMBS and had average repurchase agreements outstanding of $3,888.6 million during the three months ended March 31, 2021. Stockholders’ Equity On January 23, 2020, we entered into 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 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 March 31, 2021, we issued a total of 10,156,561 shares under the August 2020 Equity Distribution Agreement for aggregate gross proceeds of approximately $54.1 million, and net proceeds of approximately $53.2 million, net of commissions and fees. On January 20, 2021, we entered into the January 2021 Underwriting Agreement with J.P. Morgan Securities LLC (“J.P. Morgan”), relating to the offer and sale of 7,600,000 shares of our common stock. J.P. Morgan purchased the shares of our common stock from the Company pursuant to the January 2021 Underwriting Agreement at $5.20 per share. In addition, we granted J.P. Morgan a 30-day option to purchase up to an additional 1,140,000 shares of our common stock on the same terms and conditions, which J.P. Morgan exercised in full on January 21, 2021. The closing of the offering of 8,740,000 shares of our common stock occurred on January 25, 2021, with net proceeds to us of approximately $45.2 million, net of offering expenses. On March 2, 2021 we entered into the “March 2021 Underwriting Agreement with J.P. Morgan, relating to the offer and sale of 8,000,000 shares of our common stock. J.P. Morgan purchased the shares of our common stock from the Company pursuant to the March 2021 Underwriting Agreement at $5.45 per share. In addition, we granted J.P. Morgan a 30-day option to purchase up to an additional 1,200,000 shares of our common stock on the same terms and conditions, which J.P. Morgan exercised in full on March 3, 2021. The closing of the offering of 9,200,000 shares of our common stock occurred on March 5, 2021, with net proceeds to us of approximately $50.1 million, net of offering expenses payable. Outlook Economic Summary During the first quarter of 2021 the economy made tremendous strides towards recovery from the COVID-19 pandemic. Evidence of the recovery was pervasive. New cases of COVID-19, which peaked around the turn of the year, moderated significantly, as did hospitalizations and deaths. As a result of the U.S. Senate run-off elections in early January, both of which were won by Democrats, one party was now in control of the White House and both houses of Congress. This led the way to a new stimulus package being passed that was at the high end of market expectations - $1.9 trillion. The American Rescue Plan Act of 2021 was signed into law on March 11, 2021. This marked the third legislative act related to the nation’s recovery from 37 the COVID-19 pandemic, after the $2.2 trillion CARES Act (described below), which passed on March 27, 2020 and the $2.3 trillion Consolidated Appropriations Act of 2021, which contained $900 billion of COVID-19 relief and was signed on December 27, 2020. Given the momentum the administration had after passing the American Rescue Plan Act of 2021, President Biden shortly thereafter announced plans for a $2 trillion-plus infrastructure bill. The vaccine roll-out, which initially seemed haphazard, improved to the point where the U.S. became a world leader. The U.S. was well on its way to herd immunity as over 200 million inoculations were administered by April 21, 2021, well ahead of even the most optimistic projections at the beginning of the year. Economic data released over the course of the first quarter has been consistently very strong. Fueled by two rounds of stimulus checks during the first quarter, consumers have been spending. Retail sales, home sales, demand for new cars and other durable goods are all benefitting from the stimulus and considerable pent-up demand. Job growth appears to be accelerating quickly, and the unemployment rate has dropped to 6.0%. All of the developments described above have stoked inflation fears. The most obvious evidence of potential price pressures relate to supply shortages of a variety of consumer goods and commodities caused by the combination of still constrained production and surging demand that have begun to surface across the economy. The factors highlighted above have led to a surging economy, which grew at an annualized rate of 6.4% during the first quarter. They have also impacted the financial markets. The various broad equity indices are making new all-time highs on a frequent basis, and corporate debt issuance levels – both investment grade and high yield – are at or near record levels reflecting the demand for capital and investor appetite for yield. U.S. Treasury rates, at least longer-term rates, have risen significantly. The ten-year U.S. Treasury note yield increased from 0.916% to 1.742% over the course of the first quarter, an increase of 82.6 basis points, and the U.S. Treasury curve has steepened substantially. The market has moved up expectations for a recovery from the pandemic and return to normalcy significantly. The Federal Reserve (the “Fed”) gave a green light to higher rates, referring to them as a sign of economic strength. However, when the market has attempted to price in an acceleration to the timing of the rate increases by the Fed, the Fed has pushed back against such sentiment. These efforts have largely been successful, and current market pricing only reflects one interest rate hike by the end of 2022. Legislative Response and the Federal Reserve Congress passed the CARES Act quickly in response to the pandemic’s emergence last spring and followed with additional legislation over the ensuing months. However, as certain provisions of the CARES Act expired, such as supplemental unemployment insurance last July, there appeared to be a need for additional stimulus for the economy to deal with the surge in the pandemic that occurred as cold weather set in, particularly over the Christmas holiday. As mentioned above, the Federal government eventually passed an additional stimulus package in late December of 2020 and again in March of 2021. In addition, the Fed 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 focused on average inflation rate targeting that allows 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. As mentioned above, this appears to be occurring early in 2021 now that effective vaccines have been found and inoculations are distributed at an accelerating pace. Interest Rates Interest rates steadily increased throughout the first quarter as described above and levels of implied volatility rose as well. Mortgage rates slowly declined at the end of 2020 as originators added capacity and could handle ever increasing levels of production volume. This trend in mortgage rates quickly reversed during the first quarter of 2021 as rates began to increase, especially in late February and March. With the increase in interest rates, prepayment activity slowed. The percent of the Agency RMBS universe with sufficient rate incentive to economically refinance has declined from approximately 80% at the end of 2020 to approximately 46% at the end of the first quarter. However, 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. 38 The spread is still slightly above long-term average levels so further compression is possible, meaning rates available to borrowers could remain at current levels even if U.S. Treasury rates increased further. Since the end of the first quarter, interest rates have declined by approximately 20 basis points in the case of the 10-year U.S. Treasury note. Accordingly, prepayment levels on RMBS securities are likely to remain high unless U.S. Treasury rates increase above current levels. The Agency RMBS Market The market conditions that prevailed throughout the first quarter were not conducive to mortgage performance. In fact, apart from high yield bonds, all fixed income sectors had negative returns for quarter. Interest rates rose rapidly, and volatility was elevated. Agency RMBS had negative absolute and excess returns for the first quarter of -1.2% and -0.3%, respectively (both vs U.S Treasuries and LIBOR/swaps). There is a benefit to higher interest rates, and as interest rates rose prepayment levels declined. The Mortgage Bankers Association refinance index declined from approximately 4700 in early January 2021 to approximately 2900 in early April 2021, before rebounding slightly in mid-April 2021. 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 purchased 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. Importantly, the Fed tends to take the worst performing collateral out of the market. The absence of Fed purchases of higher coupons means the market is left to absorb still very high prepayment speeds on these securities as rates have not risen enough to eliminate the economic incentive to refinance. The market expects prepayments on higher coupons will eventually decline as “burn out” sets in – a phenomenon whereby refinancing activity declines as borrowers are exposed to refinancing incentives for an extended period. Through the March 2021 prepayment report released in early April, this has yet to occur. While market participants continue to favor specified pools that have favorable prepayment characteristics that mute the refinance incentive, the premium over generic TBA securities has declined significantly with the reduced refinance incentive caused by the increase in rates available to borrowers. 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 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. In March of 2020, the Fed announced a $700 billion asset purchase program to provide liquidity to the U.S. Treasury and Agency RMBS markets. 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 earlier in the month. Later that same month the Fed announced a program to acquire U.S. Treasuries and Agency RMBS in the amounts needed to support smooth market functioning. With these purchases, market conditions improved substantially. Currently, the Fed is committed to purchasing $80 billion of U.S. Treasuries and $40 billion of Agency RMBS each month. Chairman Powell and the Fed have reiterated their commitment to this level of asset purchases at every meeting since their meeting on June 30, 2020. Chairman Powell has also maintained that the Fed expects to maintain interest rates at this level until the Fed is confident that the economy has weathered the pandemic and its impact on economic activity and is on track to achieve its maximum employment and price stability goals. 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. The CARES Act was passed by Congress and signed into law by President Trump on March 27, 2020. The CARES Act provided 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 39 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). 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 December 27, 2020, President Trump signed into law an additional $900 billion coronavirus aid package as part of the Consolidated Appropriations Act of 2021, providing for extensions of many of the CARES Act policies and programs as well as additional relief. The package provided for, among other things, direct payments to most Americans with a gross income of less than $75,000 a year, extension of unemployment benefits through March 14, 2021, funding for procurement of vaccines and health providers, loans to qualified businesses, funding for rental assistance and funding for schools. On January 29, 2021, the CDC issued guidance extending eviction moratoriums for covered persons through March 31, 2021, which was further extended to June 30, 2021 on March 29, 2021. In addition, on February 9, 2021, the FHFA announced that the foreclosure moratorium begun under the CARES Act for loans backed by Fannie Mae and Freddie Mac and the eviction moratorium for real estate owned by Fannie Mae and Freddie Mac were extended until March 31, 2021, which was further extended to June 30, 2021 on February 25, 2021. On February 16, 2021, the U.S. Housing and Urban Development Department announced the extension of the FHA eviction and foreclosure moratorium to June 30, 2021. On March 11, 2021, the $1.9 trillion American Rescue Plan Act of 2021 was signed into law. This stimulus program furthered the Federal government’s efforts to stabilize the economy and provide assistance to sectors of the population still suffering from the various physical and economic effects of the pandemic. 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 implement both a risk-based capital framework and minimum leverage capital requirements. The final rule on the new capital framework for the GSEs was published in the federal register in December 2020. On January 14, 2021, the U.S. Treasury and the FHFA executed letter agreements allowing the GSEs to continue to retain capital up to their regulatory minimums, including buffers, as prescribed in the December rule. These letter agreements provide, in part, (i) there will be no exit from conservatorship until all material litigation is settled and the GSE has common equity Tier 1 capital of at least 3% of its assets, (ii) the GSEs will comply with the FHFA’s regulatory capital framework, (iii) higher-risk single-family mortgage acquisitions will be restricted to current levels, and (iv) the U.S. Treasury and the FHFA will establish a timeline and process for future GSE reform. However, no definitive proposals or legislation have been released or enacted with respect to ending the conservatorship, unwinding the GSEs, or materially reducing the roles of the GSEs in the U.S. mortgage market. 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. The ICE Benchmark Administration, in its capacity as administrator of USD LIBOR, has confirmed that it will cease publication of (i) the one-week and two-month USD LIBOR settings immediately following the LIBOR publication on December 31, 2021, and (ii) the overnight and one, three, six and 12- month USD LIBOR settings immediately following the LIBOR publication on June 30, 2023. A joint statement by key regulatory authorities calls on banks to cease entering into new contracts that use USD LIBOR as a reference rate by no later than December 31, 2021. The Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, has proposed replacing USD-LIBOR with a new SOFR, a rate based on U.S. repo trading. Many banks believe that it may take four to five years to complete the transition to SOFR, for certain, despite the 2021 deadline. We will monitor the emergence of this new rate carefully as it will potentially become the new benchmark for hedges and a range of interest rate investments. At this time, however, no consensus exists as to what rate or rates may become accepted alternatives to LIBOR. 40 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 was first reflected when January 2021 factors were 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 following exceptions listed below. • 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; or • 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, President Biden’s new administration and the new Congress 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 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 41 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. In March of 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 at all subsequent Fed meetings, including its most recent meeting in April of 2021. If the Fed modifies, reduces or suspends its purchases of Agency RMBS, our investment portfolio could be negatively impacted. Further, the moratoriums on foreclosures and evictions described above will likely delay potential defaults on loans that would otherwise be bought out of Agency MBS pools as described above. Depending on the ultimate resolution of the foreclosure or evictions, when and if it occurs, these loans may be removed from the pool into which they were securitized. If this were to occur, it would have the effect of delaying a prepayment on the Company’s securities until such time. As the majority of the Company’s Agency RMBS assets were acquired at a premium to par, this will tend to increase the realized yield on the asset in question. 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 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. 42 Summary COVID-19 continues to dominate the performance of the markets and economy. In the case of the first quarter of 2021 this meant the recovery from the pandemic, in stark contrast to the first quarter of 2020 when the pandemic first emerged in the U.S. The recovery has been driven by many factors – the emergence and widespread distribution of a very effective vaccine, substantial government stimulus and accommodative monetary policy. The economy is recovering rapidly as the emergence of an effective vaccine has allowed pent-up demand to lead to a surge in demand for goods and services, fueled further by multiple rounds of stimulus checks and numerous other means of financial support provided by the government. Financial markets are benefiting from extremely lose financial conditions, abundant liquidity, high risk tolerance and an insatiable demand for returns. The surge in economic activity during the first quarter of 2021 and expectations for activity to return to pre-pandemic levels much sooner than anticipated caused interest rates to rise rapidly as well. The yield on the 10-year U.S. Treasury note increased by over 82 basis points and closed the quarter at approximately 1.75%, not far below the yield level that prevailed last January before the pandemic emerged last March. In addition, the U.S. Treasury curve has steepened as the market fears an outbreak in inflation caused by the combination of abundant liquidity via government stimulus, loose financial conditions and very strong demand for all types of goods and services. Constrained supply of needed raw materials, various inputs to consumer goods, such as micro chips, and even labor have exacerbated the upward pressure on prices. It remains to be seen if these price pressures prove to be temporary or lead to more sustained inflation. The Fed believes the effects are transitory. Current market pricing is roughly in line with the Fed’s view as the Eurodollar and Fed Funds futures markets only reflect at most one interest rate hike by the end of 2022. The Agency RMBS market did not perform well during the first quarter as market conditions – rapidly rising rates and increased volatility – led to extension fears in mortgage cash flows, driving convexity related selling and spread widening. Agency RMBS had negative absolute and excess returns for the first quarter of 2021 of -1.2% and -0.3%, respectively (both vs U.S. Treasuries and LIBOR/swaps). A positive impact from higher rates and lowered prepayment expectations is slower premium amortization, which enhances net income all else equal. The Mortgage Bankers Association refinance index declined from approximately 4700 in early January 2021 to approximately 2900 in early April, before rebounding slightly in mid-April. As was the case for much of 2020, 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 purchased by the Fed and benefit from the substantial price pressure and attractive TBA dollar roll drops. Higher coupons in the TBA market do not have the benefit of Fed purchases, so the market is left to absorb still very high prepayment speeds on these securities as rates have not risen enough to eliminate the economic incentive to refinance. The market expects prepayments on higher coupons will eventually decline as “burn out” sets in, although this has yet to occur. One final element to poor MBS performance for the quarter was the impact of higher rates on the premiums paid for specified pools. The premium over generic TBA securities has declined significantly with the reduced refinance incentive caused by the increase in rates available to borrowers. Now that the containment of the COVID-19 pandemic appears to be within sight, at least in the U.S., the economy and life as we were accustomed to should return to pre-pandemic norms. The key questions the market must grapple with going forward relate to whether there have been any permanent changes that will result, including, for example, inflationary pressures resulting from the unprecedented government stimulus and monetary quantitative easing by the Fed, the impact of the many technological advancements that were born out of the pandemic, such as employees’ ability to effectively work remotely, the desire to live in congested cities and the implications for commercial real estate values for the cities that many may not want to return to, and the willingness to gather in large numbers or travel by air. These factors will matter to the Company to the extent they impact the levels of interest rates and the efficacy of refinancing specifically, and economic activity and inflation generally. Critical Accounting Estimates 43 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, 2020. Capital Expenditures At March 31, 2021, we had no material commitments for capital expenditures. Off-Balance Sheet Arrangements At March 31, 2021, 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 0.790 53,570 2021 - YTD (1) 0.260 23,374 Totals $ 11.915 $ 365,337 (1) On April 14, 2021, the Company declared a dividend of $0.065 per share to be paid on May 26, 2021. The effect of this dividend is included in the table above, but is not reflected in the Company’s financial statements as of March 31, 2021. 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. 44