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 August 4, 2020, we entered into an equity distribution agreement (the “August 2020 Equity Distribution Agreement”) with four sales agents pursuant to which we could 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 were deemed to be “at the market” offerings and privately negotiated transactions. We issued a total of 27,493,650 shares under the August 2020 Equity Distribution Agreement for aggregate gross proceeds of approximately $150.0 million, and net proceeds of approximately $147.4 million, after commissions and fees, prior to its termination in June 2021. 26 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 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 proceeds to us of approximately $50.0 million, net of offering expenses. On June 22, 2021, we entered into an equity distribution agreement (the “June 2021 Equity Distribution Agreement”) with four sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $250,000,000 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 49,407,336 shares under the June 2021 Equity Distribution Agreement for aggregate gross proceeds of approximately $250.0 million, and net proceeds of approximately $246.2 million, after commissions and fees, prior to its termination in October 2021. On October 29, 2021, we entered into an equity distribution agreement (the “October 2021 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 $250,000,000 of shares of our common stock in transactions that are deemed to be “at the market” offerings and privately negotiated transactions. Through March 31, 2022, we issued a total of 15,835,700 shares under the October 2021 Equity Distribution Agreement for aggregate gross proceeds of approximately $78.3 million, and net proceeds of approximately $77.0 million, after 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. On December 9, 2021, the Board of Directors approved an increase in the number of shares of the Company’s common stock available in the stock repurchase program for up to an additional 16,861,994 shares, bringing the remaining authorization under the stock repurchase program to 17,699,305 shares, representing approximately 10% of the Company’s then outstanding shares of common stock. This stock repurchase program has no termination date. From the inception of the stock repurchase program through March 31, 2022, 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, 2022 or the year ended December 31, 2021. 27 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 Federal Reserve (the “Fed”), the Federal Housing Financing Agency (the “FHFA”), Federal Housing Administration (the “FHA”), 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 ● increases in our cost of funds resulting from increases in the Fed Funds rate that are controlled by the Fed and are likely to continue to occur in 2022; 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, 2022, as compared to the Company’s results of operations for the three months ended March 31, 2021. Net (Loss) Income Summary Net loss for the three months ended March 31, 2022 was $148.7 million, or $0.84 per share. Net loss for the three months ended March 31, 2021 was $29.4 million, or $0.34 per share. The components of net loss for the three months ended March 31, 2022 and 2021, along with the changes in those components are presented in the table below: (in thousands) 2022 2021 Change Interest income $ 41,857 $ 26,856 $ 15,001 Interest expense (2,655) (1,941) (714) Net interest income 39,202 24,915 14,287 Losses on RMBS and derivative contracts (183,232) (50,791) (132,441) Net portfolio deficiency (144,030) (25,876) (118,154) Expenses (4,697) (3,493) (1,204) Net loss $ (148,727) $ (29,369) $ (119,358) 28 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. 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. Described below are the Company’s results of operations for the three months ended March 31, 2022, as compared to the Company’s results of operations for each of the three months ended December 31, 2021, September 30, 2021, June 30, 2021 and March 31, 2021. 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, 2022 $ (148,727) $ (183,232) $ 34,505 $ (0.84) $ (1.04) $ 0.20 December 31, 2021 (44,564) (82,597) 38,033 (0.27) (0.49) 0.22 September 30, 2021 26,038 (2,887) 28,925 0.20 (0.02) 0.22 June 30, 2021 (16,865) (40,844) 23,979 (0.17) (0.41) 0.24 March 31, 2021 (29,369) (50,791) 21,422 (0.34) (0.60) 0.26 (1) Includes realized and unrealized gains (losses) on RMBS and derivative financial instruments, including net interest income or expense on interest rate swaps. 29 Economic Interest Expense and Economic Net Interest Income We use derivative and other hedging instruments, specifically Eurodollar, Fed Funds and 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. 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. 30 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 2022 to date and 2021. 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, 2022 $ 177,816 $ 2,539 $ 27 $ (1,287) $ 176,537 December 31, 2021 10,945 2,568 - (7,949) $ 16,326 September 30, 2021 5,375 (2,306) - (1,248) $ 8,929 June 30, 2021 (34,915) (5,963) - (5,104) $ (23,848) March 31, 2021 45,472 9,133 (8,559) (4,044) $ 48,942 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 March 31, 2022 $ 41,857 $ 2,655 $ (1,287) $ 3,942 $ 39,202 $ 37,915 December 31, 2021 44,421 2,023 (7,949) 9,972 42,398 34,449 September 30, 2021 34,169 1,570 (1,248) 2,818 32,599 31,351 June 30, 2021 29,254 1,556 (5,104) 6,660 27,698 22,594 March 31, 2021 26,856 1,941 (4,044) 5,985 24,915 20,871 (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, 2022, we generated $39.2 million of net interest income, consisting of $41.9 million of interest income from RMBS assets offset by $2.7 million of interest expense on borrowings. For the comparable period 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. The $15.0 million increase in interest income was due to a 36 basis point ("bps") increase in the yield on average RMBS, partially offset by the $1,513.1 million increase in average RMBS. The $0.7 million increase in interest expense was due to a $1,465.5 million increase in average outstanding borrowings. We had more average assets and borrowings during the first quarter of 2022 compared to the first quarter of 2021 as we deployed the proceeds of our capital raising activity during the year ended December 31, 2021. 31 On an economic basis, our interest expense on borrowings for the three months ended March 31, 2022 and 2021 was $3.9 million and $6.0 million, respectively, resulting in $37.9 million and $20.9 million of economic net interest income, respectively. The lower economic interest expense during the three months ended March 31, 2022 was due to the positive performance of our hedging activities during the period. The tables below provide information on our portfolio average balances, interest income, yield on assets, average borrowings, interest expense, cost of funds, net interest income and net interest spread for each quarter in 2022 to date and 2021 on both a GAAP and economic basis. ($ 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, 2022 $ 5,545,844 $ 41,857 3.02% $ 5,354,107 $ 2,655 $ 3,942 0.20% 0.29% December 31, 2021 6,056,259 44,421 2.93% 5,728,988 2,023 9,972 0.14% 0.70% September 30, 2021 5,136,331 34,169 2.66% 4,864,287 1,570 2,818 0.13% 0.23% June 30, 2021 4,504,887 29,254 2.60% 4,348,192 1,556 6,660 0.14% 0.61% March 31, 2021 4,032,716 26,856 2.66% 3,888,633 1,941 5,985 0.20% 0.62% ($ in thousands) Net Interest Income Net Interest Spread GAAP Economic GAAP Economic Basis Basis (2) Basis Basis (4) Three Months Ended March 31, 2022 $ 39,202 $ 37,913 2.82% 2.73% December 31, 2021 42,398 34,449 2.79% 2.23% September 30, 2021 32,599 31,351 2.53% 2.43% June 30, 2021 27,698 22,594 2.46% 1.99% March 31, 2021 24,915 20,871 2.46% 2.04% (1) Portfolio yields and costs of borrowings presented in the tables above and the tables on pages 32 and 33 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 32 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, 2022 and 2021 was $41.9 million and $26.9 million, respectively. We had average RMBS holdings of $5,545.8 million and $4,032.7 million for the three months ended March 31, 2022 and 2021, respectively. The yield on our portfolio was 3.02% and 2.66% for the three months ended March 31, 2022 and 2021, respectively. For the three months ended March 31, 2022 as compared to the three months ended March 31, 2021, there was a $15.0 million increase in interest income due to a 36 bps increase in the yield on average RMBS, combined with a $1,513.1 million increase in average RMBS. 32 The table below presents the average portfolio size, income and yields of our respective sub-portfolios, consisting of structured RMBS and PT RMBS for each quarter in 2022 to date and 2021. ($ 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, 2022 $ 5,335,353 $ 210,491 $ 5,545,844 $ 40,066 $ 1,791 $ 41,857 3.00% 3.40% 3.02% December 31, 2021 5,878,376 177,883 6,056,259 42,673 1,748 44,421 2.90% 3.93% 2.93% September 30, 2021 5,016,550 119,781 5,136,331 33,111 1,058 34,169 2.64% 3.53% 2.66% June 30, 2021 4,436,135 68,752 4,504,887 29,286 (32) 29,254 2.64% (0.18)% 2.60% March 31, 2021 3,997,965 34,751 4,032,716 26,869 (13) 26,856 2.69% (0.15)% 2.66% Interest Expense and the Cost of Funds We had average outstanding borrowings of $5,354.1 million and $3,888.6 million and total interest expense of $2.7 million and $1.9 million for the three months ended March 31, 2022 and 2021, respectively. Our average cost of funds was 0.20% for both the three months ended March 31, 2022 and 2021. Contributing to the increase in interest expense was a $1,465.5 million increase in average outstanding borrowings during the three months ended March 31, 2022 as compared to the three months ended March 31, 2021. Our economic interest expense was $3.9 million and $6.0 million for the three months ended March 31, 2022 and 2021, respectively. There was a 33 bps decrease in the average economic cost of funds to 0.29% for the three months ended March 31, 2022 from 0.62% for the three months ended March 31, 2021. Since all of our repurchase agreements are short-term, changes in market rates directly affect our interest expense. Our average cost of funds calculated on a GAAP basis was 5 bps below the average one-month LIBOR and 56 bps below the average six-month LIBOR for the quarter ended March 31, 2022. Our average economic cost of funds was 4 bps above the average one-month LIBOR and 47 bps below the average six-month LIBOR for the quarter ended March 31, 2022. The average term to maturity of the outstanding repurchase agreements was 22 days at March 31, 2022 and 27 days at December 31, 2021. The tables below present the average balance of borrowings outstanding, interest expense and average cost of funds, and average one-month and six-month LIBOR rates for each quarter in 2022 to date and 2021 on both a GAAP and economic basis. ($ 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, 2022 $ 5,354,107 $ 2,655 $ 3,942 0.20% 0.29% December 31, 2021 5,728,988 2,023 9,972 0.14% 0.70% September 30, 2021 4,864,287 1,570 2,818 0.13% 0.23% June 30, 2021 4,348,192 1,556 6,660 0.14% 0.61% March 31, 2021 3,888,633 1,941 5,985 0.20% 0.62% 33 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, 2022 0.25% 0.76% (0.05)% (0.56)% 0.04% (0.47)% December 31, 2021 0.09% 0.23% 0.05% (0.09)% 0.61% 0.47% September 30, 2021 0.09% 0.16% 0.04% (0.03)% 0.14% 0.07% June 30, 2021 0.10% 0.18% 0.04% (0.04)% 0.51% 0.43% March 31, 2021 0.13% 0.23% 0.07% (0.03)% 0.49% 0.39% Gains or Losses The table below presents our gains or losses for the three months ended March 31, 2022 and 2021. (in thousands) 2022 2021 Change Realized losses on sales of RMBS $ (51,086) $ (7,397) $ (43,689) Unrealized losses on RMBS (309,962) (88,866) (221,096) Total losses on RMBS (361,048) (96,263) (264,785) Gains on interest rate futures 79,895 2,488 77,407 Gains on interest rate swaps 66,284 27,123 39,161 Losses on payer swaptions (short positions) (10,908) (26,167) 15,259 Gains on payer swaptions (long positions) 40,975 40,070 905 Losses on interest rate caps (996) - (996) Gains on interest rate floors - 1,384 (1,384) Gains (losses) on TBA securities (long positions) 27 (8,559) 8,586 Gains on TBA securities (short positions) 2,539 9,133 (6,594) Total $ (183,232) $ (50,791) $ (132,441) 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, 2022 and 2021, we received proceeds of $1,413.0 million and $988.5 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. 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 2022 to date and 2021. 34 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, 2022 2.42% 2.33% 3.39% 4.17% 0.84% December 31, 2021 1.26% 1.51% 2.35% 3.10% 0.21% September 30, 2021 1.00% 1.53% 2.18% 2.90% 0.12% June 30, 2021 0.87% 1.44% 2.27% 2.98% 0.13% March 31, 2021 0.94% 1.75% 2.39% 3.08% 0.19% (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 $4.7 million and $3.5 million for the three months ended March 31, 2022 and 2021, respectively. The table below presents a breakdown of operating expenses for the three months ended March 31, 2022 and 2021. (in thousands) 2022 2021 Change Management fees $ 2,634 $ 1,621 $ 1,013 Overhead allocation 441 404 37 Accrued incentive compensation 237 364 (127) Directors fees and liability insurance 311 272 39 Audit, legal and other professional fees 304 318 (14) Other direct REIT operating expenses 643 421 222 Other expenses 127 93 34 Total expenses $ 4,697 $ 3,493 $ 1,204 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, 2023 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. 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. 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. 35 On April 1, 2022, pursuant to the third amendment to the management agreement entered into on November 16, 2021, the Manager began providing certain repurchase agreement trading, clearing and administrative services to the Company that had been previously provided by AVM, L.P. under an agreement terminated on March 31, 2022. In consideration for such services, the Company will pay the following fees to the Manager: ● A daily fee equal to the outstanding principal balance of repurchase agreement funding in place as of the end of such day multiplied by 1.5 basis points for the amount of aggregate outstanding principal balance less than or equal to $5 billion, and multiplied by 1.0 basis points for any amount of aggregate outstanding principal balance in excess of $5 billion, and ● A fee for the clearing and operational services provided by personnel of the Manager equal to $10,000 per month. The following table summarizes the management fee and overhead allocation expenses for each quarter in 2022 to date and 2021. ($ in thousands) Average Average Advisory Services Orchid Orchid Management Overhead Three Months Ended MBS Equity Fee Allocation Total March 31, 2022 $ 5,545,844 $ 853,576 $ 2,634 $ 441 $ 3,075 December 31, 2021 6,056,259 806,382 2,587 443 3,030 September 30, 2021 5,136,331 672,384 2,156 390 2,546 June 30, 2021 4,504,887 542,679 1,792 395 2,187 March 31, 2021 4,032,716 456,687 1,621 404 2,025 Financial Condition: Mortgage-Backed Securities As of March 31, 2022, our RMBS portfolio consisted of $4,580.6 million of Agency RMBS at fair value and had a weighted average coupon on assets of 3.11%. During the three months ended March 31, 2022, we received principal repayments of $157.1 million compared to $123.9 million for the three months ended March 31, 2021. The average three month prepayment speeds for the quarters ended March 31, 2022 and 2021 were 10.7% and 12.0%, respectively. The following table presents the 3-month constant prepayment rate (“CPR”) experienced on our structured and PT RMBS sub- portfolios, on an annualized basis, for the quarterly periods presented. CPR is a method of expressing the prepayment rate for a mortgage pool that assumes that a constant fraction of the remaining principal is prepaid each month or year. Specifically, the CPR in the chart below represents the three month prepayment rate of the securities in the respective asset category. Structured PT RMBS RMBS Total Three Months Ended Portfolio (%) Portfolio (%) Portfolio (%) March 31, 2022 8.1 19.5 10.7 December 31, 2021 9.0 24.6 11.4 September 30, 2021 9.8 25.1 12.4 June 30, 2021 10.9 29.9 12.9 March 31, 2021 9.9 40.3 12.0 36 The following tables summarize certain characteristics of the Company’s PT RMBS and structured RMBS as of March 31, 2022 and December 31, 2021: ($ in thousands) Weighted Percentage Average of Weighted Maturity Fair Entire Average in Longest Asset Category Value Portfolio Coupon Months Maturity March 31, 2022 Fixed Rate RMBS $ 4,372,517 95.5% 3.01% 336 1-Dec-51 Interest-Only Securities 206,617 4.5% 3.42% 257 25-Jan-52 Inverse Interest-Only Securities 1,460 0.0% 3.75% 297 15-Jun-42 Total Mortgage Assets $ 4,580,594 100.0% 3.11% 318 25-Jan-52 December 31, 2021 Fixed Rate RMBS $ 6,298,189 96.7% 2.93% 342 1-Dec-51 Interest-Only Securities 210,382 3.2% 3.40% 263 25-Jan-52 Inverse Interest-Only Securities 2,524 0.1% 3.75% 300 15-Jun-42 Total Mortgage Assets $ 6,511,095 100.0% 3.03% 325 25-Jan-52 ($ in thousands) March 31, 2022 December 31, 2021 Percentage of Percentage of Agency Fair Value Entire Portfolio Fair Value Entire Portfolio Fannie Mae $ 3,016,954 65.9% $ 4,719,349 72.5% Freddie Mac 1,563,640 34.1% 1,791,746 27.5% Total Portfolio $ 4,580,594 100.0% $ 6,511,095 100.0% March 31, 2022 December 31, 2021 Weighted Average Pass-through Purchase Price $ 107.82 $ 107.19 Weighted Average Structured Purchase Price $ 15.25 $ 15.21 Weighted Average Pass-through Current Price $ 98.85 $ 105.31 Weighted Average Structured Current Price $ 15.61 $ 14.08 Effective Duration (1) 4.890 3.390 (1) Effective duration is the approximate percentage change in price for a 100 bps change in rates. An effective duration of 4.890 indicates that an interest rate increase of 1.0% would be expected to cause a 4.890% decrease in the value of the RMBS in the Company’s investment portfolio at March 31, 2022. An effective duration of 3.390 indicates that an interest rate increase of 1.0% would be expected to cause a 3.390% decrease in the value of the RMBS in the Company’s investment portfolio at December 31, 2021. 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, 2022 and 2021, including securities purchased during the period that settled after the end of the period, if any. 37 ($ in thousands) 2022 2021 Total Cost Average Price Weighted Average Yield Total Cost Average Price Weighted Average Yield Pass-through RMBS $ - $ - - $ 1,971,296 $ 107.09 1.38% Structured RMBS - - - 4,807 6.93 14.21% Borrowings As of March 31, 2022, 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 22 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 March 31, 2022, we had obligations outstanding under the repurchase agreements of approximately $4,464.1 million with a net weighted average borrowing cost of 0.37%. The remaining maturity of our outstanding repurchase agreement obligations ranged from 6 to 167 days, with a weighted average remaining maturity of 22 days. Securing the repurchase agreement obligations as of March 31, 2022 are RMBS with an estimated fair value, including accrued interest, of approximately $4,591.7 million and a weighted average maturity of 340 months, and cash pledged to counterparties of approximately $113.6 million. Through April 28, 2022, we have been able to maintain our repurchase facilities with comparable terms to those that existed at March 31, 2022 with maturities through September 14, 2022. The table below presents information about our period end, maximum and average balances of borrowings for each quarter in 2022 to date and 2021. ($ 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, 2022 $ 4,464,109 $ 6,244,106 $ 5,354,107 $ (889,998) (16.62)% (1) December 31, 2021 6,244,106 6,419,689 5,728,988 515,118 8.99% September 30, 2021 5,213,869 5,214,254 4,864,287 349,582 7.19% June 30, 2021 4,514,704 4,517,953 4,348,192 166,512 3.83% March 31, 2021 4,181,680 4,204,935 3,888,633 293,047 7.54% (1) The lower ending balance relative to the average balance during the quarter ended March 31, 2022 reflects the disposal of RMBS pledged as collateral. During the quarter ended March 31, 2022, the Company’s investment in RMBS decreased $510.4 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. We have both internal and external sources of liquidity. However, our material unused sources of liquidity include cash balances, unencumbered assets and our ability to sell encumbered assets to raise cash. 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. 38 Internal Sources of Liquidity Our internal sources of liquidity include our cash balances, unencumbered assets and our ability to liquidate our encumbered security holdings. Our balance sheet also generates liquidity on an on-going basis through payments of principal and interest we receive on our RMBS portfolio. 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 funds or risk operating the portfolio with less liquidity. External Sources of Liquidity Our primary external sources of liquidity are our ability to (i) borrow under master repurchase agreements, (ii) use the TBA security market and (iii) sell our equity or debt securities in public offerings or private placements. Our borrowing capacity will vary over time as the market value of our interest earning assets varies. 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. 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, 2022, haircuts on our pledged collateral remained stable and as of March 31, 2022, 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. 39 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 (“MSFTAs”), 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. 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, 2022, we had cash and cash equivalents of $297.2 million. We generated cash flows of $202.9 million from principal and interest payments on our RMBS and had average repurchase agreements outstanding of $5,354.1 million during the three months ended March 31, 2022. As described more fully below, we may also access liquidity by selling our equity or debt securities in public offerings or private placements. Stockholders’ Equity On August 4, 2020, we entered into the August 2020 Equity Distribution Agreement with four sales agents pursuant to which we could 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 were deemed to be “at the market” offerings and privately negotiated transactions. We issued a total of 27,493,650 shares under the August 2020 Equity Distribution Agreement for aggregate gross proceeds of approximately $150.0 million, and net proceeds of approximately $147.4 million, after commissions and fees, prior to its termination in June 2021. 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 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 proceeds to us of approximately $50.0 million, net of offering expenses payable. 40 On June 22, 2021, we entered into the June 2021 Equity Distribution Agreement with four sales agents pursuant to which we may could offer and sell, from time to time, up to an aggregate amount of $250,000,000 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 49,407,336 shares under the June 2021 Equity Distribution Agreement for aggregate gross proceeds of approximately $250.0 million, and net proceeds of approximately $246.2 million, after commissions and fees, prior to its termination in October 2021. On October 29, 2021, we entered into the October 2021 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 $250,000,000 of shares of our common stock in transactions that are deemed to be “at the market” offerings and privately negotiated transactions. Through March 31, 2022, we issued a total of 15,835,700 shares under the October 2021 Equity Distribution Agreement for aggregate gross proceeds of approximately $78.3 million, and net proceeds of approximately $77.0 million, after commissions and fees. Outlook Economic Summary The first quarter of 2022 was a transition period whereby the Fed migrated from reluctantly acknowledging they needed to start removing the emergency monetary policy regime in place since the COVID-19 pandemic emerged in the U.S. during the first quarter of 2020 towards a more aggressive tightening cycle. The Fed announced the first rate hike at their March 2022 meeting and simultaneously announced quantitative tightening would begin soon, likely in May 2022. The acceleration in the rate of inflation that first emerged during the second quarter of 2021, and was deemed “transitory” by the Fed at the time, accelerated even further into 2022 and has continued to do so in the second quarter of 2022 to date. All measures of inflation – personal consumption expenditures, the consumer price index and the producer price index – are the highest levels seen since the early 1980s. Inflation has been exacerbated, both in the U.S. and globally, by the war in Ukraine and COVID related lock-downs in China. The war in Ukraine in particular has caused global inflationary pressures that may have yet to peak. As the war in Ukraine began in late February 2022, western nations began to impose progressively more severe sanctions on Russia. These sanctions, and related boycotts of Russian goods, have created shortages of many commodities. Ukraine is also a major global supplier of many commodities as well, particularly food. As cases of COVID-19 increased in many population centers in China, authorities imposed lock-downs aggressively which led to the closure of many manufacturing operations, further exacerbating the many supply chain constraints across the world. In the U.S., the economy continues to grow and, in particular, the labor market continues to tighten. The unemployment rate appears poised to drop below the pre-pandemic lows, unemployment claims are at the lowest levels since the 1950s and wages are growing rapidly, although still less than the rate of inflation. All of these factors have led the Fed, and most market participants, to anticipate that inflation, particularly food and energy inflation, will not recede in the near term and may even accelerate further. Inflation for goods other than food and energy may moderate, as the necessities of life cannot be ignored and other goods can, potentially lessening price pressures for these goods. The cost of housing and rents are expected to remain elevated as affordability continues to deteriorate due to higher mortgage rates and inflated home prices. In sum, inflation is very far above the Fed’s target level of 2% and not likely to recede in the near-term. Given the outlook for inflation and the Fed’s anticipated response, interest rate volatility has become very elevated and is not far below the extreme peak seen in March of 2020 when the COVID-19 pandemic first emerged in the U.S. Given the magnitude of the forces driving the market and the uncertainty that exists with respect to the war in Ukraine, COVID related lockdowns in China and the uncertain capacity of the U.S. economy to weather these forces, it is likely that volatility will remain very elevated until these forces subside. The outlook for the remainder of 2022 hinges on how these developments unfold, the extent to which the Fed has to raise rates and possibly sell assets from their portfolio, and the impact these factors have on the growth rate of the U.S. economy and the unemployment rate. 41 Interest Rates As the outlook for inflation changed materially to the upside and the resulting change in monetary policy by the Fed unfolded over the course of the first quarter of 2022, interest rates moved much higher and the curve flattened. During the first quarter of 2022, the yield on the 2-year U.S. Treasury Note increased by over 160 basis points, the yield on the 5-year U.S. Treasury Note increased by almost 120 basis points and the yield on the 10-year U.S. Treasury Note increased by 82.8 basis points. The spread between the 2-year and 10-year points thus declined, or flattened, by almost 80 basis points. In early April of 2022 the yield curve actually inverted by approximately 7.5 basis points, albeit for only a brief period. Since then, the yield curve has re-steepened and was just above 20 basis points on April 28, 2022. The impetus for the re-steepening was the release of the FOMC minutes from the Fed’s January 2022 meeting which strongly implied the Fed may actually sell assets from their portfolio. The market expects this may occur as early as the third quarter of 2022. The minutes also revealed that the Fed viewed such asset sales were akin to 100 to 150 basis points of tightening to the Fed Funds rate, thus the market reduced the number of hikes priced in over the course of the next year and the curve steepened. As of April 28th, 2022 market pricing, as reflected in the Fed Funds futures market, anticipates between 225 and 250 basis points of additional hikes by the end of the year. The Agency RMBS Market The sharp increase in interest rates, the end of net Agency RMBS purchases by the Fed and the pending run-off of the Fed’s Agency RMBS portfolio, with the potential for outright sales in addition to the prepayment related run-off, resulted in poor returns for the sector. The poor performance has continued into the second quarter as all of these factors remain. The Agency RMBS market is transitioning away from a prolonged period of support. The market benefited from not only daily purchases by the Fed - $40 billion per month in addition to the reinvestment of all paydowns on their existing holdings – but also by the bank community. Demand from the bank community is a byproduct of their deposit base growth resulting from asset purchases. Going forward the RMBS market faces meaningful headwinds as the Fed is only purchasing enough RMBS to replace a decreasing portion of their monthly pay-downs and eventually may consider outright sales, and the banking community will likely buy fewer RMBS assets as their deposit base shrinks as the Fed removes reserves from the system. The total return for Agency RMBS for the first quarter of 2022 was -5.0% and the excess return versus U.S. Treasuries was -1.2%. Longer duration/lower coupon mortgages underperformed higher coupon/lower duration as 30-year underperformed 15-year maturities and lower coupons of each tenor underperformed higher coupons. The same pattern held for excess returns versus comparable duration U.S. Treasuries. The trend has also continued into the second quarter as interest rates continue to rise and volatility remains at or near multi-year highs. Recent Legislative and Regulatory Developments The Fed has taken a number of actions to stabilize markets as a result of the impacts of the COVID-19 pandemic. On March 15, 2020, the Fed announced a $700 billion asset purchase program to provide liquidity to the U.S. Treasury and Agency RMBS markets. Specifically, the Fed announced that it would purchase at least $500 billion of U.S. Treasuries and at least $200 billion of Agency RMBS. 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. The FOMC continued to reaffirm this commitment at all subsequent meetings through December of 2021, 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. On January 26, 2022, the FOMC reiterated its goals of maximum employment and a 2% long-run inflation rate and stated that, with a strong labor market and inflation well above 2%, it expected it would soon be appropriate to raise the target Fed Funds rate. 42 In response to the deterioration in the markets for U.S. Treasuries, Agency RMBS 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 RMBS in the amounts needed to support smooth market functioning. With these purchases, market conditions improved substantially. Through November of 2021, the Fed was committed to purchasing $80 billion of U.S. Treasuries and $40 billion of Agency RMBS each month. In November of 2021, it began tapering its net asset purchases each month and ended net asset purchases entirely by early March of 2022. The minutes to the March 16, 2022 FOMC meeting implied that the Fed would begin reducing its balance sheet by a maximum of $60 billion of U.S. Treasuries and $35 billion of Agency RMBS each month, phased in over three months and likely beginning in May 2022. 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. The $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). 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, 2021, providing for extensions of many of the CARES Act policies and programs as well as additional relief. On January 29, 2021, the CDC issued guidance extending eviction moratoriums for covered persons through March 31, 2021. The FHFA subsequently extended 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 until July 31, 2021 and September 30, 2021, respectively. The U.S. Housing and Urban Development Department subsequently extended the FHA foreclosure and eviction moratoria to July 31, 2021 and September 30, 2021, respectively. Despite the expirations of these foreclosure moratoria, a final rule adopted by the CFPB on June 28, 2021 effectively prohibited servicers from initiating a foreclosure before January 1, 2022 in most instances. Following the end of this limitation, foreclosure starts for January and February of 2022 were up 29% and 40% month-over-month and 126% and 176% year-over-year, respectively, although they remain below pre-pandemic levels. 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. On September 14, 2021, the U.S. Treasury and the FHFA suspended certain policy provisions in the January agreement, including limits on loans acquired for cash consideration, multifamily loans, loans with higher risk characteristics and second homes and investment properties. On February 25, 2022, the FHFA published a final rule, effective as of 43 April 26, 2022, amending the GSE capital framework established in December 2020 by, among other things, replacing the fixed leverage buffer equal to 1.5% of a GSE’s adjusted total assets with a dynamic leverage buffer equal to 50% of a GSE’s stability capital buffer, reducing the risk weight floor from 10% to 5%, and removing the requirement that the GSEs must apply an overall effectiveness adjustment to their credit risk transfer exposures. 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. However, the ICE Benchmark Administration, in its capacity as administrator of USD LIBOR, has announced that it intends to extend publication of USD LIBOR (other than one-week and two-month tenors) by 18 months to June 2023. Notwithstanding this possible extension, 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 ARRC, 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. We will monitor the emergence of SOFR carefully as it appears likely to 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. On December 7, 2021, the CFPB released a final rule that amends Regulation Z, which implemented the Truth in Lending Act, aimed at addressing cessation of LIBOR for both closed-end (e.g., home mortgage) and open-end (e.g., home equity line of credit) products. The rule, which mostly becomes effective in April of 2022, establishes requirements for the selection of replacement indices for existing LIBOR- linked consumer loans. Although the rule does not mandate the use of SOFR as the alternative rate, it identifies SOFR as a comparable rate for closed-end products and states that for open-end products, the CFPB has determined that ARRC’s recommended spread-adjusted indices based on SOFR for consumer products to replace the one-month, three-month, or six-month USD LIBOR index “have historical fluctuations that are substantially similar to those of the LIBOR indices that they are intended to replace.” The CFPB reserved judgment, however, on a SOFR-based spread-adjusted replacement index to replace the one-year USD LIBOR until it obtained additional information. On December 8, 2021, the House of Representatives passed the Adjustable Interest Rate (LIBOR) Act of 2021 (H.R. 4616) (the “LIBOR Act”), which provides for a statutory replacement benchmark rate for contracts that use LIBOR as a benchmark and do not contain any fallback mechanism independent of LIBOR. Pursuant to the LIBOR Act, SOFR becomes the new benchmark rate by operation of law for any such contract. The LIBOR Act establishes a safe harbor from litigation for claims arising out of or related to the use of SOFR as the recommended benchmark replacement. The LIBOR Act makes clear that it should not be construed to disfavor the use of any benchmark on a prospective basis. The LIBOR Act also attempts to forestall challenges that it is impairing contracts. It provides that the discontinuance of LIBOR and the automatic statutory transition to a replacement rate neither impairs or affects the rights of a party to receive payment under such contracts, nor allows a party to discharge their performance obligations or to declare a breach of contract. It amends the Trust Indenture Act of 1939 to state that the “the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security shall not be deemed to be impaired or affected” by application of the LIBOR Act to any indenture security. On December 9, 2021, the United States Senate referred the LIBOR Act to the Committee on Banking, Housing and Urban Affairs. One-week and two-month U.S. dollar LIBOR rates phased out on December 31, 2021, but other U.S. dollar tenors may continue until June 30, 2023. We will monitor the emergence of SOFR carefully as it appears likely to 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. 44 Effective January 1, 2021, Fannie Mae, in alignment with Freddie Mac, extended 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 applied 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 anticipated, 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 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 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. 45 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, but ended these purchases in March 2022 and announced plans to reduce its balance sheet. The Fed’s planned reduction of its balance sheet could negatively impact our investment portfolio. Further, the moratoriums on foreclosures and evictions described above will likely delay potential defaults on loans that would otherwise be bought out of Agency RMBS 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. Increases in the Fed Funds rate or LIBOR typically 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. 46 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 The first quarter of 2022 was extremely volatile as the Fed pivoted quickly from unprecedented monetary policy accommodation to the rapid removal of the accommodation. Current market pricing in the futures markets implies the Fed will raise the target for the Fed Funds rate to approximately 3.25% by the third quarter of 2023 and to over 2.5% by the end of 2022. The U.S. economy has recovered quickly from the COVID-19 induced downturn with the help of the Fed’s monetary policy and equally unprecedented fiscal stimulus from the government. As the economy recovered rapidly, inflationary pressures emerged and were exacerbated by numerous supply constraints, including the supply of labor, resulting in a sub-4% unemployment rate which continues to fall and wage growth above 5%. The war in Ukraine has further stimulated inflationary pressures as Russia and Ukraine are leading suppliers of food, energy and many other commodities. COVID-19 induced shutdowns in China have also increased supply constraints, another source of inflationary pressure. As the second quarter of 2022 unfolds, these trends have intensified and the Fed appears even more intent on removing their accommodation as quickly as possible. The Fed may even begin outright sales of U.S. Treasury and Agency RMBS assets later this year. For the Company, this means our funding costs are likely to rise materially over the course of 2022 and possibly into 2023. As interest rates have risen the prices of the Company’s assets have fallen. Investors fear possible outright sales of Agency RMBS by the Fed, in addition to the Fed and most banks buying far fewer Agency RMBS as well. During the first quarter of 2022, these securities have underperformed the hedge instruments the Company has employed and they may continue to do so. This puts downward pressure on the Company’s shareholders equity and book value per share. As interest rates have risen, refinancing and purchase activity in the residential housing market has slowed. However, as the Company’s Agency RMBS assets are trading at discounts, this lowers the yield the Company realizes. In sum, the current market environment is challenging for the Company’s portfolio and all Agency RMBS and/or mortgage focused and levered investors. To counter these challenging market conditions, the Company continues to take steps to minimize their impact through asset selection and the lower use of leverage. The Company’s share prices have traded below our book value per share since late in 2021. The Company increased the size of the share buy-back program in late 2021 and has the option to repurchase up to 10% of our outstanding shares, which could result in accretive purchases to book value per share owing to the common stock price trading at a discount to the Company’s book value. 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, 2021. Capital Expenditures At March 31, 2022, we had no material commitments for capital expenditures. Off-Balance Sheet Arrangements At March 31, 2022, we did not have any off-balance sheet arrangements. 47 Dividends In addition to other requirements that must be satisfied to continue 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 0.780 97,601 2022 - YTD (1) 0.200 35,484 Totals $ 12.635 $ 475,048 (1) On April 13, 2022, the Company declared a dividend of $0.045 per share to be paid on May 27, 2022. 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, 2022.