Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to         
Commission file number 001-35896
Ellington Residential Mortgage REIT
(Exact Name of Registrant as Specified in Its Charter)

Maryland
 
46-0687599
(State or Other Jurisdiction of Incorporation)
 
(IRS Employer Identification No.)
53 Forest Avenue
Old Greenwich, CT 06870
(Address of principal executive offices, zip code)
(203) 698-1200
(Registrant's Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x No ¨ 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
¨
 
Accelerated Filer
x
Non-Accelerated Filer
¨
 
Smaller Reporting Company
x
 
 
 
Emerging Growth Company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨  No  x
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Trading Symbol(s)
 
Name of Each Exchange on Which Registered
Common Shares of Beneficial Interest, $0.01 par value per share
 
EARN
 
The New York Stock Exchange
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
 
Outstanding at August 2, 2019
Common Shares of Beneficial Interest, $0.01 par value per share
 
12,467,103



ELLINGTON RESIDENTIAL MORTGAGE REIT
INDEX
PART I. Financial Information
 
Item 1. Consolidated Financial Statements (unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
PART II. Other Information
 
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 5. Other Information
Item 6. Exhibits





PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED BALANCE SHEET
(UNAUDITED)

 
June 30, 2019
 
December 31, 2018
(In thousands except for share amounts)
 
 
 
ASSETS
 
 
 
Cash and cash equivalents
$
41,473

 
$
18,585

Mortgage-backed securities, at fair value
1,459,452

 
1,540,296

Due from brokers
41,838

 
24,051

Financial derivatives–assets, at fair value
1,831

 
11,839

Reverse repurchase agreements
40,097

 
379

Receivable for securities sold
106,376

 
74,197

Interest receivable
5,204

 
5,607

Other assets
771

 
612

Total Assets
$
1,697,042

 
$
1,675,566

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
LIABILITIES

 
 
Repurchase agreements
$
1,442,043

 
$
1,481,561

Payable for securities purchased
39,528

 
11,275

Due to brokers
751

 
1,325

Financial derivatives–liabilities, at fair value
15,891

 
16,559

U.S. Treasury securities sold short, at fair value
34,522

 
374

Dividend payable
3,491

 
4,252

Accrued expenses
664

 
838

Management fee payable to affiliate
582

 
579

Interest payable
4,965

 
4,981

Total Liabilities
1,542,437

 
1,521,744

SHAREHOLDERS' EQUITY
 
 
 
Preferred shares, par value $0.01 per share, 100,000,000 shares authorized;
(0 shares issued and outstanding, respectively)

 

Common shares, par value $0.01 per share, 500,000,000 shares authorized;
(12,467,103 and 12,507,213 shares issued and outstanding, respectively)
125

 
125

Additional paid-in-capital
230,580

 
230,888

Accumulated deficit
(76,100
)
 
(77,191
)
Total Shareholders' Equity
154,605

 
153,822

Total Liabilities and Shareholders' Equity
$
1,697,042

 
$
1,675,566



See Notes to Consolidated Financial Statements
3


ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)

 
 
Three-Month Period Ended June 30,
 
Six-Month Period
Ended June 30,
 
 
2019
 
2018
 
2019
 
2018
(In thousands except for per share amounts)
 
 
 
 
 
 
 
 
INTEREST INCOME (EXPENSE)
 
 
 
 
 
 
 
 
Interest income
 
$
12,139

 
$
14,081

 
$
24,752

 
$
27,506

Interest expense
 
(9,662
)
 
(7,668
)
 
(19,217
)
 
(14,915
)
Total net interest income
 
2,477

 
6,413

 
5,535

 
12,591

EXPENSES
 
 
 
 
 
 
 
 
Management fees to affiliate
 
582

 
656

 
1,177

 
1,327

Professional fees
 
207

 
217

 
436

 
452

Compensation expense
 
112

 
187

 
263

 
375

Insurance expense
 
74

 
74

 
148

 
148

Other operating expenses
 
325

 
293

 
644

 
641

Total expenses
 
1,300

 
1,427

 
2,668

 
2,943

OTHER INCOME (LOSS)
 
 
 
 
 
 
 
 
Net realized gains (losses) on securities
 
1,418

 
(7,114
)
 
(256
)
 
(5,188
)
Net realized gains (losses) on financial derivatives
 
(8,771
)
 
(3,702
)
 
(20,862
)
 
12,253

Change in net unrealized gains (losses) on securities
 
14,511

 
(3,218
)
 
36,482

 
(30,279
)
Change in net unrealized gains (losses) on financial derivatives
 
(8,442
)
 
10,834

 
(9,410
)
 
11,399

Total other income (loss)
 
(1,284
)
 
(3,200
)
 
5,954

 
(11,815
)
NET INCOME (LOSS)
 
$
(107
)
 
$
1,786

 
$
8,821

 
$
(2,167
)
NET INCOME (LOSS) PER COMMON SHARE:
 
 
 
 
 
 
 
 
Basic and Diluted
 
$
(0.01
)
 
$
0.14

 
$
0.71

 
$
(0.17
)


See Notes to Consolidated Financial Statements
4


ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(UNAUDITED)

 
Common Shares
 
Common
Shares,
par value
 
Preferred Shares
 
Preferred Shares,
par value
 
Additional Paid-in-Capital
 
Accumulated (Deficit) Earnings
 
Total
(In thousands except for share amounts)
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, December 31, 2017
13,340,217

 
$
134

 

 
$

 
$
240,062

 
$
(47,493
)
 
$
192,703

Share based compensation
 
 
 
 
 
 
 
 
49

 
 
 
49

Repurchase of common shares
(512,367
)
 
(6
)
 

 

 
(5,735
)
 
 
 
(5,741
)
Dividends declared
 
 
 
 
 
 
 
 
 
 
(4,746
)
 
(4,746
)
Net income (loss)
 
 
 
 
 
 
 
 
 
 
(3,953
)
 
(3,953
)
BALANCE, March 31, 2018
12,827,850

 
$
128

 

 
$

 
$
234,376

 
$
(56,192
)
 
$
178,312

Share based compensation
 
 
 
 
 
 
 
 
50

 
 
 
50

Repurchase of common shares
(115,800
)
 
(1
)
 

 

 
(1,274
)
 

 
(1,275
)
Dividends declared(1)
 
 
 
 
 
 
 
 
 
 
(4,704
)
 
(4,704
)
Net income (loss)
 
 
 
 
 
 
 
 
 
 
1,786

 
1,786

BALANCE, June 30, 2018
12,712,050

 
$
127

 

 
$

 
$
233,152

 
$
(59,110
)
 
$
174,169

 
 
 
 
 
 
 
 
 
 
 
 
 
 
BALANCE, December 31, 2018
12,507,213

 
$
125

 

 
$

 
$
230,888

 
$
(77,191
)
 
$
153,822

Share based compensation
 
 
 
 
 
 
 
 
53

 
 
 
53

Repurchase of common shares
(40,110
)
 

 

 

 
(414
)
 
 
 
(414
)
Dividends declared
 
 
 
 
 
 
 
 
 
 
(4,239
)
 
(4,239
)
Net income (loss)
 
 
 
 
 
 
 
 
 
 
8,928

 
8,928

BALANCE, March 31, 2019
12,467,103

 
125

 

 

 
230,527

 
(72,502
)
 
158,150

Share based compensation
 
 
 
 
 
 
 
 
53

 
 
 
53

Dividends declared(1)
 
 
 
 
 
 
 
 
 
 
(3,491
)
 
(3,491
)
Net income (loss)
 
 
 
 
 
 
 
 
 
 
(107
)
 
(107
)
BALANCE, June 30, 2019
12,467,103

 
125

 

 

 
230,580

 
(76,100
)
 
154,605

(1)
For the three-month periods ended June 30, 2019 and 2018, dividends totaling $0.28 and $0.37, respectively, per common share outstanding, were declared. For the six-month periods ended June 30, 2019 and 2018, dividends totaling $0.62 and $0.74, respectively, per common share outstanding, were declared.

See Notes to Consolidated Financial Statements
5


ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)

 
 
Six-Month Period Ended
June 30,
 
 
2019
 
2018(1)
(In thousands)
 
 
 
 
Cash flows provided by (used in) operating activities:
 
 
 
 
Net income (loss)
 
$
8,821

 
$
(2,167
)
Reconciliation of net income (loss) to net cash provided by (used in) operating activities:
 
 
 
 
Net realized (gains) losses on securities
 
256

 
5,188

Change in net unrealized (gains) losses on securities
 
(36,482
)
 
30,279

Net realized (gains) losses on financial derivatives
 
20,862

 
(12,253
)
Change in net unrealized (gains) losses on financial derivatives
 
9,410

 
(11,399
)
Amortization of premiums and accretion of discounts (net)
 
6,106

 
5,153

Share based compensation
 
106

 
99

(Increase) decrease in assets:
 
 
 
 
Interest receivable
 
403

 
(204
)
Other assets
 
(159
)
 
(173
)
Increase (decrease) in liabilities:
 
 
 
 
Accrued expenses
 
(174
)
 
121

Interest payable
 
(16
)
 
809

Management fees payable to affiliate
 
3

 
(69
)
Net cash provided by (used in) operating activities
 
9,136

 
15,384

Cash flows provided by (used in) investing activities:
 
 
 
 
Purchases of securities
 
(861,386
)
 
(611,463
)
Proceeds from sale of securities
 
888,047

 
551,032

Principal repayments of mortgage-backed securities
 
81,160

 
89,401

Proceeds from investments sold short
 
267,205

 
635,002

Repurchase of investments sold short
 
(233,841
)
 
(696,242
)
Proceeds from disposition of financial derivatives
 
8,126

 
22,112

Purchase of financial derivatives
 
(29,017
)
 
(9,856
)
Payments made on reverse repurchase agreements
 
(2,774,397
)
 
(9,536,399
)
Proceeds from reverse repurchase agreements
 
2,734,679

 
9,596,486

Due from brokers, net
 
(11,108
)
 
3,603

Due to brokers, net
 
(182
)
 
6,646

Net cash provided by (used in) investing activities
 
69,286

 
50,322

 
 
 
 
 

See Notes to Consolidated Financial Statements
6


ELLINGTON RESIDENTIAL MORTGAGE REIT
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(UNAUDITED)
 
 
 
 
 
 
 
 
Six-Month Period Ended
June 30,
 
 
2019
 
2018(1)
Cash flows provided by (used in) financing activities:
 
 
 
 
Repurchase of common shares
 
(414
)
 
(7,016
)
Dividends paid
 
(8,491
)
 
(9,682
)
Borrowings under repurchase agreements
 
893,858

 
771,028

Repayments of repurchase agreements
 
(933,376
)
 
(831,018
)
Due from brokers, net
 
(6,643
)
 
(3,733
)
Due to brokers, net
 
(468
)
 

Cash provided by (used in) financing activities
 
(55,534
)
 
(80,421
)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
 
22,888

 
(14,715
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
 
18,585

 
56,117

CASH AND CASH EQUIVALENTS, END OF PERIOD
 
$
41,473

 
$
41,402

Supplemental disclosure of cash flow information:
 
 
 
 
Interest paid
 
$
19,233

 
$
14,106

Dividends payable
 
$
3,491

 
$
4,703

(1)
Conformed to current period presentation.

See Notes to Consolidated Financial Statements
7



ELLINGTON RESIDENTIAL MORTGAGE REIT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2019
(UNAUDITED)
1. Organization and Investment Objective
Ellington Residential Mortgage REIT, or "EARN," was formed as a Maryland real estate investment trust, or "REIT," on August 2, 2012, and commenced operations on September 25, 2012. EARN conducts its business through its wholly owned subsidiaries, EARN OP GP LLC, or the "General Partner," and Ellington Residential Mortgage LP, or the "Operating Partnership," which were formed as a Delaware limited liability company and a Delaware limited partnership, respectively, on July 31, 2012 and commenced operations on September 25, 2012. The Operating Partnership conducts its business of acquiring, investing in, and managing residential mortgage- and real estate-related assets through its wholly owned subsidiaries. EARN, the General Partner, the Operating Partnership, and their consolidated subsidiaries are hereafter defined as the "Company."
Ellington Residential Mortgage Management LLC, or the "Manager," serves as the Manager of the Company pursuant to the terms of the Fifth Amended and Restated Management Agreement, or the "Management Agreement." The Manager is an affiliate of Ellington Management Group, L.L.C., or "EMG," an investment management firm that is an SEC-registered investment adviser with a 24-year history of investing in a broad spectrum of mortgage-backed securities and related derivatives, with an emphasis on the residential mortgage-backed securities, or "RMBS," market. In accordance with the terms of the Management Agreement and the Services Agreement (as described in Note 9), the Manager is responsible for administering the Company's business activities and day-to-day operations, and performs certain services, subject to oversight by the Board of Trustees. See Note 9 for further information on the Management Agreement.
The Company acquires and manages RMBS, for which the principal and interest payments are guaranteed by a U.S. government agency or a U.S. government-sponsored entity, or "Agency RMBS," and RMBS that do not carry such guarantees, or "non-Agency RMBS," such as RMBS backed by prime jumbo, Alternative A-paper, manufactured housing, and subprime residential mortgage loans. Agency RMBS include both Agency pools and Agency collateralized mortgage obligations, or "CMOs," and non-Agency RMBS primarily consist of non-Agency CMOs, both investment grade and non-investment grade. The Company may also acquire and manage mortgage servicing rights, credit risk transfer securities, residential mortgage loans, and other mortgage- and real estate-related assets. The Company may also invest in other instruments including, but not limited to, forward-settling To-Be-Announced Agency pass-through certificates, or "TBAs," interest rate swaps and swaptions, U.S. Treasury securities, Eurodollar and U.S. Treasury futures, other financial derivatives, and cash equivalents. The Company's targeted investments may range from unrated first loss securities to AAA senior securities.
The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, or "the Code," and intends to conduct its operations to be qualified and taxed as a REIT. As a REIT, the Company is required to distribute annually at least 90% of its taxable income. As long as the Company continues to qualify as a REIT, it will not be subject to U.S. federal corporate taxes on its taxable income to the extent that it distributes all of its annual taxable income to its shareholders within the time limits prescribed by the Code. It is the intention of the Company to distribute at least 100% of its taxable income, after application of available tax attributes, within the time limits prescribed by the Code, which may extend into the subsequent taxable year.
2. Significant Accounting Policies
(A) Basis of Presentation: The Company's unaudited interim consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America, or "U.S. GAAP." Entities in which the Company has a controlling financial interest, through ownership of the majority of the entities' voting equity interests, or through other contractual rights that give the Company control, are consolidated by the Company. All inter-company balances and transactions have been eliminated. The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and those differences could be material. In management's opinion, all material adjustments considered necessary for a fair statement of the Company's interim consolidated financial statements have been included and are only of a normal recurring nature. Interim results are not necessarily indicative of the results that may be expected for the entire fiscal year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2018.
(B) Valuation: The Company applies ASC 820-10, Fair Value Measurement ("ASC 820-10"), to its holdings of financial instruments. ASC 820-10 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation

8



hierarchy is based upon the observability of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
Level 1—inputs to the valuation methodology are observable and reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Currently, the types of financial instruments the Company generally includes in this category are exchange-traded derivatives;
Level 2—inputs to the valuation methodology other than quoted prices included in Level 1 are observable for the asset or liability, either directly or indirectly. Currently, the types of financial instruments that the Company generally includes in this category are Agency RMBS, U.S. Treasury securities, certain non-Agency RMBS, and actively traded derivatives such as TBAs, interest rate swaps, and swaptions; and
Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement. Currently, this category includes certain RMBS, such as certain non-Agency RMBS and certain Agency interest only securities, or "IOs," where there is less price transparency.
For certain financial instruments, the various inputs that management uses to measure fair value may fall into different levels of the fair value hierarchy. For each such financial instrument, the determination of which category within the fair value hierarchy is appropriate is based on the lowest level of input that is significant to the fair value measurement. ASC 820 prioritizes the various inputs that management uses to measure fair value, with the highest priority given to inputs that are observable and reflect quoted prices (unadjusted) for identical assets or liabilities in active markets (Level 1), and the lowest priority given to inputs that are unobservable and significant to the fair value measurement (Level 3). The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. The Company may use valuation techniques consistent with the market and income approaches to measure the fair value of its assets and liabilities. The market approach uses third-party valuations and information obtained from market transactions involving identical or similar assets or liabilities. The income approach uses projections of the future economic benefits of an instrument to determine its fair value, such as in the discounted cash flow methodology. The inputs or methodology used for valuing financial instruments are not necessarily an indication of the risk associated with investing in these financial instruments. The leveling of each financial instrument is reassessed at the end of each period. Transfers between levels of the fair value hierarchy are assumed to occur at the end of the reporting period.
Summary Valuation Techniques
For financial instruments that are traded in an "active market," the best measure of fair value is the quoted market price. However, many of the Company's financial instruments are not traded in an active market. Therefore, management generally uses third-party valuations when available. If third-party valuations are not available, management uses other valuation techniques, such as the discounted cash flow methodology. The following are summary descriptions, for the various categories of financial instruments, of the valuation methodologies management uses in determining fair value of the Company's financial instruments in such categories. Management utilizes such methodologies to assign a fair value (the estimated price that, in an orderly transaction at the valuation date, would be received to sell an asset, or paid to transfer a liability, as the case may be) to each such financial instrument.
For the Company's RMBS investments and TBAs, management seeks to obtain at least one third-party valuation, and often obtains multiple valuations when available. Management has been able to obtain third-party valuations on the vast majority of these instruments and expects to continue to solicit third-party valuations in the future. Management generally values each financial instrument at the average of third-party valuations received and not rejected as described below. Third-party valuations are not binding, management may adjust the valuations it receives (e.g., downward adjustments for odd lots), and management may challenge or reject a valuation when, based on its validation criteria, management determines that such valuation is unreasonable or erroneous. Furthermore, based on its validation criteria, management may determine that the average of the third-party valuations received for a given instrument does not result in what management believes to be the fair value of such instrument, and in such circumstances management may override this average with its own good faith valuation. The validation criteria may take into account output from management's own models, recent trading activity in the same or similar instruments, and valuations received from third parties. The use of proprietary models requires the use of a significant amount of judgment and the application of various assumptions including, but not limited to, assumptions concerning future prepayment rates and default rates.
Given their relatively high level of price transparency, Agency RMBS pass-throughs and TBAs are typically designated as Level 2 assets. Non-Agency RMBS and Agency interest only and inverse interest only RMBS are generally classified as either Level 2 or Level 3 based on the analysis of available market data and/or third-party valuations. Furthermore, the methodology used by the third-party valuation providers is reviewed at least annually by management, so as to ascertain whether such providers are utilizing observable market data to determine the valuations that they provide.

9



Interest rate swaps and swaptions are typically valued based on internal models that use observable market data, including applicable interest rates in effect as of the measurement date; the model-generated valuations are then typically compared to counterparty valuations for reasonableness. These financial derivatives are generally designated as Level 2 instruments.
In valuing its derivatives, the Company also considers the creditworthiness of both the Company and its counterparties, along with collateral provisions contained in each derivative agreement.
The Company's repurchase and reverse repurchase agreements are carried at cost, which approximates fair value. Repurchase agreements and reverse repurchase agreements are classified as Level 2 assets and liabilities based on the adequacy of the collateral and their short term nature.
The Company's valuation process, including the application of validation criteria, is overseen by the Manager's Valuation Committee ("Valuation Committee"). The Valuation Committee includes senior level executives from various departments within the Manager, and each quarter the Valuation Committee reviews and approves the valuations of the Company's investments. The valuation process also includes a monthly review by the Company's third party administrator. The goal of this review is to replicate various aspects of the Company's valuation process based on the Company's documented procedures.
Because of the inherent uncertainty of valuation, the estimated fair value of the Company's financial instruments may differ significantly from the values that would have been used had a ready market for the financial instruments existed, and the differences could be material to the consolidated financial statements.
(C) Accounting for Securities: Purchases and sales of securities are recorded on trade date and realized and unrealized gains and losses are calculated based on identified cost.
The Company has chosen to make a fair value election pursuant to ASC 825-10, Financial Instruments, for its securities portfolio. Electing the fair value option allows the Company to record changes in fair value in the Consolidated Statement of Operations, which, in management's view, more appropriately reflects the results of operations for a particular reporting period as all securities activities will be recorded in a similar manner. As such, securities are recorded at fair value on the Consolidated Balance Sheet and the period change in fair value is recorded in current period earnings on the Consolidated Statement of Operations as a component of Change in net unrealized gains (losses) on securities.
The Company evaluates the cost basis of its Agency IOs and non-Agency RMBS for other-than-temporary impairment, or "OTTI," on at least a quarterly basis. When the fair value of a security is less than its amortized cost basis as of the balance sheet date, the security is considered impaired, and the impairment is designated as either temporary or other-than-temporary. When a security's cost basis is impaired, an OTTI is considered to have occurred if (i) the Company intends to sell the security (i.e., a decision has been made as of the reporting date), (ii) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, or (iii) the Company does not expect to recover the security's amortized cost basis, even if the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security. If any of these conditions exist as of the financial reporting date, the entire amount of the impairment loss, if any, is recognized in earnings as a realized loss and the cost basis of the security is adjusted. Any resulting OTTI adjustments made to the amortized cost basis of the security are reflected in Net realized gains (losses) on securities, on the Consolidated Statement of Operations.
(D) Interest Income: Coupon interest income on investment securities is accrued based on the outstanding principal balance or notional amount and the current coupon rate on each security. The Company amortizes purchase premiums and accretes purchase discounts on its fixed-income securities. For RMBS that are deemed to be of high credit quality at the time of purchase, premiums and discounts are generally amortized/accreted into interest income over the life of such securities using the effective interest method. For such RMBS whose cash flows vary depending on prepayments, an effective yield retroactive to the time of purchase is periodically recomputed based on actual prepayments and changes in projected prepayment activity, and a catch-up adjustment, or "Catch-up Premium Amortization Adjustment," is made to amortization to reflect the cumulative impact of the change in effective yield. For RMBS that are deemed not to be of high credit quality at the time of purchase, interest income is recognized based on the effective interest method. For purposes of determining the effective interest rate, management estimates the future expected cash flows of its investment holdings based on assumptions including, but not limited to, assumptions for future prepayment rates, default rates, and loss severities (each of which may in turn incorporate various macro-economic assumptions, such as future housing prices). These assumptions are re-evaluated not less than quarterly. Principal write-offs are generally treated as realized losses. Changes in projected cash flows, as applied to the current amortized cost of the security, may result in a prospective change in the yield/interest income recognized on such securities.
The Company's accretion of discounts and amortization of premiums on securities for U.S. federal and other tax purposes is likely to differ from the accounting treatment under U.S. GAAP of these items as described above.

10



(E) Cash and Cash Equivalents: Cash and cash equivalents include cash and short term investments with original maturities of three months or less at the date of acquisition. Cash and cash equivalents typically include amounts held in an interest bearing overnight account and amounts held in money market funds, and these balances generally exceed insured limits. The Company holds its cash at institutions that it believes to be highly creditworthy.
(F) Due from brokers/Due to brokers: Due from brokers and Due to brokers accounts on the Consolidated Balance Sheet include collateral transferred to or received from counterparties, including clearinghouses, along with receivables and payables for open and/or closed derivative positions.
(G) Financial Derivatives: The Company enters into various types of financial derivatives subject to its investment guidelines, which include restrictions associated with maintaining its qualification as a REIT. The Company's financial derivatives are predominantly subject to bilateral collateral arrangements or clearing in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Company may be required to deliver or may receive cash or securities as collateral upon entering into derivative transactions. In addition, changes in the relative value of financial derivative transactions may require the Company or the counterparty to post or receive additional collateral. In the case of cleared financial derivatives, the clearinghouse becomes the Company's counterparty and a futures commission merchant acts as intermediary between the Company and the clearinghouse with respect to all facets of the related transaction, including the posting and receipt of required collateral. Collateral received by the Company is reflected on the Consolidated Balance Sheet as "Due to Brokers." Conversely, collateral posted by the Company is reflected as "Due from Brokers" on the Consolidated Balance Sheet. The types of financial derivatives that have been utilized by the Company to date are interest rate swaps, TBAs, swaptions, and futures.
Swaps: The Company enters into interest rate swaps. Interest rate swaps are contractual agreements whereby one party pays a floating interest rate on a notional principal amount and receives a fixed-rate payment on the same notional principal, or vice versa, for a fixed period of time. The Company enters into interest rate swap contracts primarily to mitigate interest rate risk. The Company is subject to interest rate risk exposure in the normal course of pursuing its investment objectives.
Swaps change in value with movements in interest rates or total return of the reference securities. During the term of swap contracts, changes in value are recognized as unrealized gains or losses on the Consolidated Statement of Operations. When a contract is terminated, the Company realizes a gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Company's basis in the contract, if any. Periodic payments or receipts required by swap agreements are recorded as unrealized gains or losses when accrued and realized gains or losses when received or paid. Upfront payments paid and/or received by the Company to open swap contracts are recorded as an asset and/or liability on the Consolidated Balance Sheet and are recorded as a realized gain or loss on the termination date.
TBA Securities: The Company transacts in the forward settling TBA market. A TBA position is a forward contract for the purchase ("long position") or sale ("short position") of Agency RMBS at a predetermined price, face amount, issuer, coupon, and maturity on an agreed-upon future delivery date. For each TBA contract and delivery month, a uniform settlement date for all market participants is determined by the Securities Industry and Financial Markets Association. The specific Agency RMBS to be delivered into the contract at the settlement date are not known at the time of the transaction. The Company typically does not take delivery of TBAs, but rather enters into offsetting transactions and settles the associated receivable and payable balances with its counterparties. The Company uses TBAs to mitigate interest rate risk, usually by taking short positions. The Company also invests in TBAs as a means of acquiring additional exposure to Agency RMBS, or for speculative purposes, including holding long positions.
TBAs are accounted for by the Company as financial derivatives. The difference between the contract price and the fair value of the TBA position as of the reporting date is included in Change in net unrealized gains (losses) on financial derivatives in the Consolidated Statement of Operations. Upon settlement of the TBA contract, the realized gain (loss) on the TBA contract is equal to the net cash amount received (paid).
Options: The Company enters into swaption contracts. It may purchase or write put, call, straddle, or other similar options contracts. The Company enters into options contracts primarily to help mitigate interest rate risk. When the Company purchases an options contract, the option asset is initially recorded at an amount equal to the premium paid, if any, and is subsequently marked-to-market. Premiums paid for purchasing options contracts that expire unexercised are recognized on the expiration date as realized losses. If an options contract is exercised, the premium paid is subtracted from the proceeds of the sale or added to the cost of the purchase to determine whether the Company has realized a gain or loss on the related investment transaction. When the Company writes an options contract, the option liability is initially recorded at an amount equal to the premium received, if any, and is subsequently marked-to-market. Premiums received for writing options contracts that expire unexercised are recognized on the expiration date as realized gains. If an options contract is exercised, the premium received is subtracted from the cost of the purchase or added to the proceeds of the sale to determine whether the Company has realized a gain or loss

11



on the related investment transaction. When the Company enters into a closing transaction, the Company will realize a gain or loss depending upon whether the amount from the closing transaction is greater or less than the premiums paid or received. In general, the Company's options contracts contain forward-settling premiums. In this case, no money is exchanged upfront; instead, the agreed-upon premium is paid by the buyer upon expiration of the options contract, regardless of whether or not the options contract is exercised. Unrealized gains or (losses) resulting from the options contract being marked-to-market are included in Change in net unrealized gains (losses) on financial derivatives in the Consolidated Statement of Operations. Realized gains or (losses) are included in Realized gains (losses) on financial derivatives in the Consolidated Statement of Operations.
Futures Contracts: The Company enters into Eurodollar futures contracts and U.S. Treasury futures contracts. A futures contract is an exchange-traded agreement to buy or sell an asset for a set price on a future date. Initial margin deposits are made upon entering into futures contracts and can be either in the form of cash or securities. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by marking-to-market to reflect the current market value of the contract. Unrealized gains or (losses) are included in Change in net unrealized gains (losses) on financial derivatives in the Consolidated Statement of Operations. Variation margin payments are made or received periodically, depending upon whether unrealized losses or gains are incurred. When the contract is closed, the Company records a realized gain or loss equal to the difference between the proceeds of the closing transaction and the Company's basis in the contract. Realized gains or (losses) are included in Realized gains (losses) on financial derivatives in the Consolidated Statement of Operations.
Financial derivative assets are included in Financial derivatives–assets, at fair value on the Consolidated Balance Sheet while financial derivative liabilities are included in Financial derivatives–liabilities, at fair value on the Consolidated Balance Sheet.
(H) Repurchase Agreements: The Company enters into repurchase agreements with third-party broker-dealers, whereby it sells securities under agreements to repurchase at an agreed upon price and date. The Company accounts for repurchase agreements as collateralized borrowings, with the initial sale price representing the amount borrowed, and with the future repurchase price consisting of the amount borrowed plus interest, at the implied interest rate of the repurchase agreement, on the amount borrowed over the term of the repurchase agreement. The interest rate on a repurchase agreement is based on competitive market rates (or competitive market spreads, in the case of agreements with floating interest rates) at the time such agreement is entered into. When the Company enters into a repurchase agreement, the lender establishes and maintains an account containing cash and/or securities having a value not less than the repurchase price, including accrued interest, of the repurchase agreement. Repurchase agreements are carried at their contractual amounts, which approximate fair value due to their short-term nature.
(I) Reverse Repurchase Agreements: The Company enters into reverse repurchase agreement transactions with third-party broker-dealers, whereby it purchases securities under agreements to resell at an agreed upon price and date. The interest rate on a reverse repurchase agreement is based on competitive market rates (or competitive market spreads, in the case of agreements with floating interest rates) at the time such agreement is entered into. Reverse repurchase agreements are carried at their contractual amounts, which approximate fair value due to their short-term nature.
Repurchase and reverse repurchase agreements that are conducted with the same counterparty can be reported on a net basis if they meet the requirements of ASC 210-20, Balance Sheet Offsetting. There are currently no repurchase and reverse repurchase agreements reported on a net basis in the Company's consolidated financial statements.
(J) Securities Sold Short: The Company may purchase or engage in short sales of U.S. Treasury securities to mitigate the potential impact of changes in interest rates on the performance of its portfolio. When the Company sells securities short, it typically satisfies its security delivery settlement obligation by borrowing or purchasing the security sold short from the same or a different counterparty. When borrowing a security sold short from a counterparty, the Company generally is required to deliver cash or securities to such counterparty as collateral for the Company's obligation to return the borrowed security.
The Company has chosen to make the fair value election pursuant to ASC 825-10, Financial Instruments, for its securities sold short. Electing the fair value option allows the Company to record changes in fair value in the Consolidated Statement of Operations, which, in management's view, more appropriately reflects the results of operations for a particular reporting period as all securities activities will be recorded in a similar manner. As such, securities sold short are recorded at fair value on the Consolidated Balance Sheet and the period change in fair value is recorded in current period earnings on the Consolidated Statement of Operations as a component of Change in net unrealized gains (losses) on securities. A realized gain or loss will be recognized upon the termination of a short sale if the market price is less or greater than the original sale price. Such realized gain or loss is recorded on the Company's Consolidated Statement of Operations in Net realized gains (losses) on securities.

12



(K) Offering Costs/Deferred Offering Costs/Underwriters' Discounts: Offering costs, underwriters' discounts and commissions and fees, are charged against shareholders' equity within Additional paid-in-capital. Offering costs typically include legal, accounting, and other fees associated with the cost of raising equity capital.
(L) Share Based Compensation: The Company applies the provisions of ASC 718, Compensation—Stock Compensation ("ASC 718"), with regard to its equity incentive plan. ASC 718 covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. ASC 718 requires that compensation cost relating to share-based payment transactions be recognized in the financial statements. The cost is measured based on the fair value, at the grant date, of the equity or liability instruments issued and is amortized over the vesting period. Restricted shares issued to the Company's independent directors and partially dedicated personnel are participating securities and receive dividends prior to vesting. Fair value for such awards is based on the closing stock price on the New York Stock Exchange at the grant date. The vesting period for restricted share awards is typically one to two years. Shares issued to the Company's independent directors and partially dedicated personnel are subject to tax withholding upon vesting. The Company's independent directors and partially dedicated personnel are permitted to forfeit a portion of their vested shares to pay such withholding tax. Forfeited shares decrease the total number of shares issued and outstanding and are immediately retired upon settlement.
(M) Dividends: Dividends payable are recorded on the declaration date.
(N) Expenses: Expenses are recognized as incurred on the Consolidated Statement of Operations.
(O) Earnings Per Share: In accordance with the provisions of ASC 260, Earnings per Share, the Company calculates basic income (loss) per share by dividing net income (loss) for the period by the weighted average of the Company's common shares outstanding for that period. Diluted income (loss) per share takes into account the effect of dilutive instruments, such as share options and warrants, and uses the average share price for the period in determining the number of incremental shares that are to be added to the weighted average number of shares outstanding.
(P) Share Repurchases: Common shares that are repurchased by the Company subsequent to issuance are immediately retired upon settlement and decrease the total number of shares issued and outstanding. The cost of such share repurchases is charged against Additional paid-in-capital on the Company's Consolidated Balance Sheet.
(Q) Income Taxes: The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Code. As a REIT, the Company is generally not subject to corporate-level federal and state income tax on net income it distributes to its shareholders within the prescribed timeframes. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including distributing at least 90% of its annual taxable income to shareholders. Even if the Company qualifies as a REIT, it may be subject to certain federal, state, local and foreign taxes on its income and property, and to federal income and excise taxes on its undistributed taxable income. If the Company fails to qualify as a REIT, and does not qualify for certain statutory relief provisions, it will be subject to U.S. federal, state, and local income taxes and may be precluded from qualifying as a REIT for the four taxable years following the year in which the Company fails to qualify as a REIT.
The Company follows the authoritative guidance on accounting for and disclosure of uncertainty on tax positions, which requires management to determine whether a tax position of the Company is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. For uncertain tax positions, the tax benefit to be recognized is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The Company did not have any unrecognized tax benefits resulting from tax positions related to the current period or to 2018, 2017, 2016, or 2015 (its open tax years). In the normal course of business, the Company may be subject to examination by federal, state, local, and foreign jurisdictions, where applicable, for the current period, 2018, 2017, 2016, and 2015 (its open tax years). The Company may take positions with respect to certain tax issues which depend on legal interpretation of facts or applicable tax regulations. Should the relevant tax regulators successfully challenge any of such positions, the Company might be found to have a tax liability that has not been recorded in the accompanying consolidated financial statements. Also, management's conclusions regarding the authoritative guidance may be subject to review and adjustment at a later date based on changing tax laws, regulations, and interpretations thereof. There were no amounts accrued for penalties or interest as of or during the periods presented in these consolidated financial statements.
(R) Recent Accounting Pronouncements: In August 2018, the Financial Accounting Standards Board, or "FASB," issued ASU 2018-13, Fair Value Measurement—Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"). This amends ASC 820, Fair Value Measurement, to remove or modify various current disclosure requirements related to fair value measurement. Additionally ASU 2018-13 requires certain additional disclosures around fair value measurement. ASU 2018-13 is effective for annual periods beginning after December 15, 2019 and interim

13



periods within those years, with early adoption permitted. Entities are permitted to early adopt any removed or modified disclosures and delay adoption of the additional disclosures until their effective date. The Company has elected to early adopt the removal and modification of various disclosure requirements in accordance with ASU 2018-13; early adoption has not had a material impact on the Company's consolidated financial statements. The Company has elected not to early adopt the additional disclosure requirements. The adoption of the additional disclosure requirements, as required under ASU 2018-13, is not expected to have a material impact on the Company's consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows—Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"). This amends ASC 230, Statement of Cash Flows, to clarify how certain cash receipts and payments should be classified on the statement of cash flows. The updates that most affect the Company relate to classifying each separately identifiable source or use within the cash receipts and cash payments on the basis of the nature of the underlying cash flows and identifying such receipts and payments as operating, investing, or financing activities. The adoption of ASU 2016-15 did not have a material impact on the Company's consolidated financial statements and has been retrospectively applied.
3. Mortgage-Backed Securities
The following tables present details of the Company's mortgage-backed securities portfolio at June 30, 2019 and December 31, 2018, respectively. The Company's Agency RMBS include mortgage pass-through certificates and CMOs representing interests in or obligations backed by pools of residential mortgage loans issued or guaranteed by a U.S. government agency or government-sponsored enterprise, or "GSE." The non-Agency RMBS portfolio is not issued or guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or any agency of the U.S. Government and is therefore subject to greater credit risk.
By RMBS Type
June 30, 2019:
($ in thousands)
 
 
 
 
 
 
Gross Unrealized
 
 
 
Weighted Average
 
Current Principal
 
Unamortized Premium (Discount)
 
Amortized Cost
 
Gains
 
Losses
 
Fair Value
 
Coupon(1)
 
Yield
 
Life
(Years)
(2)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-year fixed-rate mortgages
$
159,586

 
$
2,930

 
$
162,516

 
$
3,339

 
$
(250
)
 
$
165,605

 
3.46%
 
2.97%
 
4.38
20-year fixed-rate mortgages
29,891

 
1,081

 
30,972

 
430

 

 
31,402

 
4.33%
 
3.50%
 
4.66
30-year fixed-rate mortgages
1,049,509

 
48,599

 
1,098,108

 
14,521

 
(6,382
)
 
1,106,247

 
4.19%
 
3.38%
 
6.88
Adjustable rate mortgages
39,196

 
1,456

 
40,652

 
181

 
(411
)
 
40,422

 
3.86%
 
3.05%
 
4.12
Reverse mortgages
86,722

 
7,109

 
93,831

 
1,147

 
(288
)
 
94,690

 
4.61%
 
3.07%
 
5.86
Interest only securities
 n/a

 
 n/a

 
12,244

 
126

 
(569
)
 
11,801

 
4.41%
 
3.03%
 
2.96
Total Agency RMBS
1,364,904

 
61,175

 
1,438,323

 
19,744

 
(7,900
)
 
1,450,167

 
4.15%
 
3.30%
 
6.15
Non-Agency RMBS
11,491

 
(4,260
)
 
7,231

 
2,054

 

 
9,285

 
4.10%
 
12.08%
 
5.78
Total RMBS
$
1,376,395

 
$
56,915

 
$
1,445,554

 
$
21,798

 
$
(7,900
)
 
$
1,459,452

 
4.15%
 
3.35%
 
6.15
(1)
Weighted average coupon represents the weighted average pass-through rates of the securities rather than the weighted average gross mortgage rates of the underlying collateral.
(2)
Average lives of RMBS are generally shorter than stated contractual maturities. Average lives are affected by the contractual maturities of the underlying mortgages, scheduled periodic payments of principal, and unscheduled prepayments of principal.

14



December 31, 2018:
($ in thousands)
 
 
 
 
 
 
Gross Unrealized
 
 
 
Weighted Average
 
Current Principal
 
Unamortized Premium (Discount)
 
Amortized Cost
 
Gains
 
Losses
 
Fair Value
 
Coupon(1)
 
Yield
 
Life
(Years)(2)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-year fixed-rate mortgages
$
135,537

 
$
3,307

 
$
138,844

 
$
655

 
$
(1,968
)
 
$
137,531

 
3.56%
 
2.88%
 
4.90
20-year fixed-rate mortgages
7,267

 
575

 
7,842

 

 
(337
)
 
7,505

 
4.00%
 
2.53%
 
5.88
30-year fixed-rate mortgages
1,237,047

 
57,470

 
1,294,517

 
2,731

 
(23,734
)
 
1,273,514

 
4.22%
 
3.48%
 
8.10
Adjustable rate mortgages
17,752

 
1,217

 
18,969

 
1

 
(727
)
 
18,243

 
4.02%
 
2.63%
 
3.90
Reverse mortgages
70,991

 
6,331

 
77,322

 
5

 
(1,423
)
 
75,904

 
4.61%
 
2.90%
 
5.58
Interest only securities
 n/a

 
 n/a

 
16,740

 
951

 
(1,325
)
 
16,366

 
4.41%
 
9.00%
 
4.24
Total Agency RMBS
1,468,594

 
68,900

 
1,554,234

 
4,343

 
(29,514
)
 
1,529,063

 
4.19%
 
3.45%
 
7.38
Non-Agency RMBS
13,755

 
(4,324
)
 
9,431

 
1,806

 
(4
)
 
11,233

 
4.38%
 
12.59%
 
5.69
Total RMBS
$
1,482,349

 
$
64,576

 
$
1,563,665

 
$
6,149

 
$
(29,518
)
 
$
1,540,296

 
4.19%
 
3.50%
 
7.37
(1)
Weighted average coupon represents the weighted average pass-through rates of the securities rather than the weighted average gross mortgage rates of the underlying collateral.
(2)
Average lives of RMBS are generally shorter than stated contractual maturities. Average lives are affected by the contractual maturities of the underlying mortgages, scheduled periodic payments of principal, and unscheduled prepayments of principal.
By Estimated Weighted Average Life
As of June 30, 2019:
($ in thousands)
 
Agency RMBS
 
Agency Interest Only Securities
 
Non-Agency RMBS
Estimated Weighted Average Life(1)
 
Fair
Value
 
Amortized Cost
 
Weighted Average Coupon(2)
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon(2)
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon(2)
Less than three years
 
$
38,747

 
$
38,554

 
4.86
%
 
$
4,298

 
$
4,422

 
4.34
%
 
$
4,350

 
$
4,229

 
5.47
%
Greater than three years and less than seven years
 
788,817

 
781,345

 
4.23
%
 
7,503

 
7,822

 
4.47
%
 
837

 
303

 
4.09
%
Greater than seven years and less than eleven years
 
608,822

 
604,264

 
3.95
%
 

 

 
%
 
4,098

 
2,699

 
2.89
%
Greater than eleven years
 
1,980

 
1,916

 
3.50
%
 

 

 
%
 

 

 
%
Total
 
$
1,438,366

 
$
1,426,079

 
4.13
%
 
$
11,801

 
$
12,244

 
4.41
%
 
$
9,285

 
$
7,231

 
4.10
%
(1)
Average lives of RMBS are generally shorter than stated contractual maturities.
(2)
Weighted average coupon represents the weighted average pass-through rates of the securities rather than the weighted average gross mortgage rates of the underlying collateral.
As of December 31, 2018:
($ in thousands)
 
Agency RMBS
 
Agency Interest Only Securities
 
Non-Agency RMBS
Estimated Weighted Average Life(1)
 
Fair
Value
 
Amortized Cost
 
Weighted Average Coupon(2)
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon(2)
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon(2)
Less than three years
 
$
12,667

 
$
12,796

 
4.69
%
 
$
1,129

 
$
1,671

 
4.41
%
 
$
4,635

 
$
3,975

 
4.96
%
Greater than three years and less than seven years
 
394,733

 
399,895

 
4.26
%
 
15,237

 
15,069

 
4.41
%
 
2,500

 
2,366

 
5.89
%
Greater than seven years and less than eleven years
 
1,086,032

 
1,105,538

 
4.14
%
 

 

 
%
 
4,098

 
3,090

 
2.99
%
Greater than eleven years
 
19,265

 
19,265

 
4.10
%
 

 

 
%
 

 

 
%
Total
 
$
1,512,697

 
$
1,537,494

 
4.17
%
 
$
16,366

 
$
16,740

 
4.41
%
 
$
11,233

 
$
9,431

 
4.38
%
(1)
Average lives of RMBS are generally shorter than stated contractual maturities.
(2)
Weighted average coupon represents the weighted average pass-through rates of the securities rather than the weighted average gross mortgage rates of the underlying collateral.

15



The following tables reflect the components of interest income on the Company's RMBS for the three- and six-month periods ended June 30, 2019 and 2018:
 
 
Three-Month Period Ended June 30, 2019
 
Six-Month Period Ended June 30, 2019
($ in thousands)
 
Coupon
Interest
 
Net Amortization
 
Interest
Income
 
Coupon
Interest
 
Net Amortization
 
Interest
Income
Agency RMBS
 
$
15,683

 
$
(4,209
)
 
$
11,474

 
$
31,953

 
$
(8,355
)
 
$
23,598

Non-Agency RMBS
 
109

 
131

 
240

 
221

 
263

 
484

Total
 
$
15,792

 
$
(4,078
)
 
$
11,714

 
$
32,174

 
$
(8,092
)
 
$
24,082

 
 
Three-Month Period Ended June 30, 2018
 
Six-Month Period Ended June 30, 2018
($ in thousands)
 
Coupon
Interest
 
Net Amortization
 
Interest
Income
 
Coupon
Interest
 
Net Amortization
 
Interest
Income
Agency RMBS
 
$
16,689

 
$
(3,208
)
 
$
13,481

 
$
33,597

 
$
(7,456
)
 
$
26,141

Non-Agency RMBS
 
149

 
152

 
301

 
318

 
238

 
556

Total
 
$
16,838

 
$
(3,056
)
 
$
13,782

 
$
33,915

 
$
(7,218
)
 
$
26,697

For the three-month periods ended June 30, 2019 and 2018, the Catch-up Premium Amortization Adjustment was $(0.9) million and $0.5 million, respectively. For the six-month periods ended June 30, 2019 and 2018, the Catch-up Premium Amortization Adjustment was $(1.8) million and $0.3 million, respectively.
For the three- and six-month periods ended June 30, 2019, the Company recognized a charge of $2.1 million and $3.2 million, respectively, on the cost basis of its Agency IOs, which is included in Net realized gains (losses) on securities, on the Consolidated Statement of Operations. This charge recorded was due to an adverse change in cash flows resulting from an increase in prepayments.

16



4. Valuation
The following tables present the Company's financial instruments measured at fair value on:
June 30, 2019:
(In thousands)
 
 
 
 
 
 
 
 
Description
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Mortgage-backed securities, at fair value:
 
 
 
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
 
 
 
15-year fixed-rate mortgages
 
$

 
$
165,605

 
$

 
$
165,605

20-year fixed-rate mortgages
 

 
31,402

 

 
31,402

30-year fixed-rate mortgages
 

 
1,106,247

 

 
1,106,247

Adjustable rate mortgages
 

 
40,422

 

 
40,422

Reverse mortgages
 

 
94,690

 

 
94,690

Interest only securities
 

 
6,851

 
4,950

 
11,801

Non-Agency RMBS
 

 
6,925

 
2,360

 
9,285

Mortgage-backed securities, at fair value
 

 
1,452,142

 
7,310

 
1,459,452

Financial derivatives–assets, at fair value:
 
 
 
 
 
 
 
 
TBAs
 

 
338

 

 
338

Interest rate swaps
 

 
1,253

 

 
1,253

Futures
 
240

 

 

 
240

Total financial derivatives–assets, at fair value
 
240

 
1,591

 

 
1,831

Total mortgage-backed securities and financial derivatives–assets, at fair value
 
$
240

 
$
1,453,733

 
$
7,310

 
$
1,461,283

Liabilities:
 
 
 
 
 
 
 
 
U.S. Treasury securities sold short, at fair value
 
$

 
$
(34,522
)
 
$

 
$
(34,522
)
Financial derivatives–liabilities, at fair value:
 
 
 
 
 
 
 
 
TBAs
 

 
(1,576
)
 

 
(1,576
)
Interest rate swaps
 

 
(14,315
)
 

 
(14,315
)
Total financial derivatives–liabilities, at fair value
 

 
(15,891
)
 

 
(15,891
)
Total U.S. Treasury securities sold short and financial derivatives–liabilities, at fair value
 
$

 
$
(50,413
)
 
$

 
$
(50,413
)

17



December 31, 2018:
(In thousands)
 
 
 
 
 
 
 
 
Description
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Mortgage-backed securities, at fair value:
 
 
 
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
 
 
 
15-year fixed-rate mortgages
 
$

 
$
137,531

 
$

 
$
137,531

20-year fixed-rate mortgages
 

 
7,505

 

 
7,505

30-year fixed-rate mortgages
 

 
1,273,514

 

 
1,273,514

Adjustable rate mortgages
 

 
18,243

 

 
18,243

Reverse mortgages
 

 
75,904

 

 
75,904

Interest only securities
 

 
13,534

 
2,832

 
16,366

Non-Agency RMBS
 

 
6,599

 
4,634

 
11,233

Mortgage-backed securities, at fair value
 

 
1,532,830

 
7,466

 
1,540,296

Financial derivatives–assets, at fair value:
 
 
 
 
 
 
 
 
TBAs
 

 
794

 

 
794

Interest rate swaps
 

 
11,045

 

 
11,045

Total financial derivatives–assets, at fair value
 

 
11,839

 

 
11,839

Total mortgage-backed securities and financial derivatives–assets, at fair value
 
$

 
$
1,544,669

 
$
7,466

 
$
1,552,135

Liabilities:
 
 
 
 
 
 
 
 
U.S. Treasury securities sold short, at fair value
 
$

 
$
(374
)
 
$

 
$
(374
)
Financial derivatives–liabilities, at fair value:
 
 
 
 
 
 
 
 
TBAs
 

 
(2,536
)
 

 
(2,536
)
Interest rate swaps
 

 
(6,193
)
 

 
(6,193
)
Futures
 
(7,830
)
 

 

 
(7,830
)
Total financial derivatives–liabilities, at fair value
 
(7,830
)
 
(8,729
)
 

 
(16,559
)
Total U.S. Treasury securities sold short and financial derivatives–liabilities, at fair value
 
$
(7,830
)
 
$
(9,103
)
 
$

 
$
(16,933
)
The following tables present additional information about the Company's investments which are measured at fair value for which the Company has utilized Level 3 inputs to determine fair value.
Three-month period ended June 30, 2019:
(In thousands)
Non-Agency RMBS
 
Agency RMBS
Beginning balance as of March 31, 2019
$
4,610

 
$
3,316

Purchases

 

Proceeds from sales
(1,372
)
 

Principal repayments
(119
)
 

(Amortization)/accretion, net
91

 
(304
)
Net realized gains (losses)
55

 
(199
)
Change in net unrealized gains (losses)
(147
)
 
56

Transfers:
 
 
 
Transfers into level 3

 
3,353

Transfers out of level 3
(758
)
 
(1,272
)
Ending balance as of June 30, 2019
$
2,360

 
$
4,950

All amounts of net realized and changes in net unrealized gains (losses) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gains (losses) for both Level 3 financial instruments held by the Company at June 30, 2019, as well as Level 3 financial instruments disposed of

18



by the Company during the three-month period ended June 30, 2019. For Level 3 financial instruments held by the Company as of June 30, 2019, change in net unrealized gains (losses) of $(0.1) million and $(89) thousand, for the three-month period ended June 30, 2019 relate to non-Agency RMBS and Agency RMBS, respectively.
At June 30, 2019, the Company transferred $2.0 million of RMBS from Level 3 to Level 2 and $3.4 million of RMBS from Level 2 to Level 3. Transfers between hierarchy levels are based on the availability of sufficient observable inputs to meet Level 2 versus Level 3 criteria. The level designation of each financial instrument is reassessed at the end of each period, and is based on pricing information received from third party pricing sources.
Three-month period ended June 30, 2018:
(In thousands)
Non-Agency RMBS
 
Agency RMBS
Beginning balance as of March 31, 2018
$
5,355

 
$
5,138

Purchases

 
160

Proceeds from sales

 

Principal repayments
(188
)
 

(Amortization)/accretion, net
126

 
(415
)
Net realized gains (losses)

 
(41
)
Change in net unrealized gains (losses)
(34
)
 
253

Transfers:
 
 
 
Transfers into level 3
1,734

 

Transfers out of level 3

 
(1,469
)
Ending balance as of June 30, 2018
$
6,993

 
$
3,626

All amounts of net realized and changes in net unrealized gains (losses) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gains (losses) for both Level 3 financial instruments held by the Company at June 30, 2018, as well as Level 3 financial instruments disposed of by the Company during the three-month period ended June 30, 2018. For Level 3 financial instruments held by the Company as of June 30, 2018, change in net unrealized gains (losses) of $(65) thousand and $0.2 million, for the three-month period ended June 30, 2018 relate to non-Agency RMBS and Agency RMBS, respectively.
At June 30, 2018, the Company transferred $1.5 million of RMBS from Level 3 to Level 2 and $1.7 million of RMBS from Level 2 to Level 3. Transfers between these hierarchy levels were based on the availability of sufficient observable inputs to meet Level 2 versus Level 3 criteria. The level designation of each financial instrument is reassessed at the end of each period, and is based on pricing information received from third party pricing sources.
Six-month period ended June 30, 2019:
(In thousands)
Non-Agency RMBS
 
Agency RMBS
Beginning balance as of December 31, 2018
$
4,634

 
$
2,832

Purchases

 

Proceeds from sales
(1,371
)
 

Principal repayments
(572
)
 

(Amortization)/accretion, net
176

 
(503
)
Net realized gains (losses)
54

 
(862
)
Change in net unrealized gains (losses)
197

 
592

Transfers:
 
 
 
Transfers into level 3

 
3,353

Transfers out of level 3
(758
)
 
(462
)
Ending balance as of June 30, 2019
$
2,360

 
$
4,950

All amounts of net realized and changes in net unrealized gains (losses) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gains (losses) for both Level 3 financial instruments held by the Company at June 30, 2019, as well as Level 3 financial instruments disposed of by the Company during the six-month period ended June 30, 2019. For Level 3 financial instruments held by the Company as

19



of June 30, 2019, change in net unrealized gains (losses) of $0.2 million and $(27.0) thousand, for the six-month period ended June 30, 2019 relate to non-Agency RMBS and Agency RMBS, respectively.
At June 30, 2019, the Company transferred $1.2 million of RMBS from Level 3 to Level 2 and $3.4 million of RMBS from Level 2 to Level 3. Transfers between hierarchy levels are based on the availability of sufficient observable inputs to meet Level 2 versus Level 3 criteria. The level designation of each financial instrument is reassessed at the end of each period, and is based on pricing information received from third party pricing sources.
Six-month period ended June 30, 2018:
(In thousands)
Non-Agency RMBS
 
Agency RMBS
Beginning balance as of December 31, 2017
$
8,832

 
$
2,254

Purchases

 
160

Proceeds from sales
(3,638
)
 

Principal repayments
(418
)
 

(Amortization)/accretion, net
171

 
(692
)
Net realized gains (losses)
1,254

 
(165
)
Change in net unrealized gains (losses)
(942
)
 
499

Transfers:
 
 
 
Transfers into level 3
1,734

 
1,570

Transfers out of level 3

 

Ending balance as of June 30, 2018
$
6,993

 
$
3,626

All amounts of net realized and changes in net unrealized gains (losses) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gains (losses) for both Level 3 financial instruments held by the Company as of June 30, 2018, as well as Level 3 financial instruments disposed of by the Company during the six-month period ended June 30, 2018. For Level 3 financial instruments held by the Company as of June 30, 2018, change in net unrealized gains (losses) of $(15) thousand and $0.7 million, for the six-month period ended June 30, 2018 relate to non-Agency RMBS and Agency RMBS, respectively.
At June 30, 2018, the Company transferred $3.3 million of RMBS from Level 2 to Level 3. Transfers between these hierarchy levels are based on the availability of sufficient observable inputs to meet Level 2 versus Level 3 criteria. The level designation of each financial instrument is reassessed at the end of each period, and is based on pricing information received from third party pricing sources.

20



The following tables identify the significant unobservable inputs that affect the valuation of the Company's Level 3 assets and liabilities as of June 30, 2019 and December 31, 2018:
June 30, 2019:
 
 
Range
 
 
Description
 
Fair Value
 
Valuation Technique
 
Significant
Unobservable Input
 
Min
 
Max
 
Weighted Average(1)
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Non-Agency RMBS
 
$
1,705

 
Market quotes
 
Non-Binding Third-Party Valuation
 
$
61.34

 
$
83.77

 
$
79.98

Agency RMBS–Interest Only Securities
 
1,222

 
Market quotes
 
Non-Binding Third-Party Valuation
 
$
8.30

 
$
13.18

 
$
11.75

Non-Agency RMBS
 
655

 
Discounted Cash Flows
 
Yield
 
8.5
%
 
8.5
%
 
8.5
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
48.7
%
 
48.7
%
 
48.7
%
 
 
 
 
 
 
Projected Collateral Losses
 
2.5
%
 
2.5
%
 
2.5
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
8.0
%
 
8.0
%
 
8.0
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
40.8
%
 
40.8
%
 
40.8
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Agency RMBS–Interest Only Securities
 
3,728

 
Option Adjusted Spread ("OAS")
 
LIBOR OAS (2)
 
77

 
1,241

 
425

 
 
 
 
 
 
Projected Collateral Prepayments
 
46.9
%
 
90.8
%
 
75.9
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
9.2
%
 
53.1
%
 
24.1
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
(1)
Averages are weighted based on the fair value of the related instrument.
(2)
Shown in basis points.
December 31, 2018:
 
 
Range
 
 
Description
 
Fair Value
 
Valuation Technique
 
Significant
Unobservable Input
 
Min
 
Max
 
Weighted Average(1)
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Non-Agency RMBS
 
$
2,745

 
Market quotes
 
Non-Binding Third-Party Valuation
 
$
83.59

 
$
86.59

 
$
85.65

Non-Agency RMBS
 
1,889

 
Discounted Cash Flows
 
Yield
 
3.4
%
 
5.4
%
 
4.5
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
50.2
%
 
66.4
%
 
56.6
%
 
 
 
 
 
 
Projected Collateral Losses
 
2.3
%
 
8.6
%
 
4.9
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
7.5
%
 
12.3
%
 
9.6
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
17.8
%
 
39.9
%
 
28.9
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Agency RMBS–Interest Only Securities
 
2,832

 
Option Adjusted Spread ("OAS")
 
LIBOR OAS (2)
 
319

 
1,439

 
734

 
 
 
 
 
 
Projected Collateral Prepayments
 
33.9
%
 
79.5
%
 
59.4
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
20.5
%
 
66.1
%
 
40.6
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
(1)
Averages are weighted based on the fair value of the related instrument.
(2)
Shown in basis points.

21



Third-party non-binding valuations are validated by comparing such valuations to internally generated prices based on the Company's models and, when available, to recent trading activity in the same or similar instruments. For those instruments valued using discounted cash flows, collateral prepayments, losses, recoveries, and scheduled amortization are projected over the remaining life of the collateral and expressed as a percentage of the collateral's current principal balance. For those assets valued using the LIBOR Option Adjusted Spread, or "OAS," valuation methodology, cash flows are projected using the Company's models over multiple interest rate scenarios, and these projected cash flows are then discounted using the LIBOR rates implied by each interest rate scenario. The LIBOR OAS of an asset is then computed as the unique constant yield spread that, when added to all LIBOR rates in each interest rate scenario generated by the model, will equate (a) the expected present value of the projected asset cash flows over all model scenarios to (b) the actual current market price of the asset. LIBOR OAS is therefore model-dependent. Generally speaking, LIBOR OAS measures the additional yield spread over LIBOR that an asset provides at its current market price after taking into account any interest rate options embedded in the asset.
Material changes in any of the inputs above in isolation could result in a significant change to reported fair value measurements. Fair value measurements are impacted by the interrelationships of these inputs. For example, a higher expectation of collateral prepayments will generally result in a lower expectation of collateral losses. Conversely, higher losses will generally result in lower prepayments.
The following table summarizes the estimated fair value of all other financial instruments not included in the disclosures above as of June 30, 2019 and December 31, 2018:
 
 
June 30, 2019
 
December 31, 2018
(In thousands)
 
Fair Value
 
Carrying Value
 
Fair Value
 
Carrying Value
Other financial instruments
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
41,473

 
$
41,473

 
$
18,585

 
$
18,585

Due from brokers
 
41,838

 
41,838

 
24,051

 
24,051

Reverse repurchase agreements
 
40,097

 
40,097

 
379

 
379

Liabilities:
 
 
 
 
 
 
 
 
Repurchase agreements
 
1,442,043

 
1,442,043

 
1,481,561

 
1,481,561

Due to brokers
 
751

 
751

 
1,325

 
1,325

Cash and cash equivalents includes cash held in an interest bearing overnight account, for which fair value equals the carrying value, and cash held in money market accounts, which are liquid in nature and for which fair value equals the carrying value; such assets are considered Level 1 assets. Due from brokers and Due to brokers include collateral transferred to or received from counterparties, along with receivables and payables for open and/or closed derivative positions. These receivables and payables are short term in nature and any collateral transferred consists primarily of cash; fair value of these items approximates carrying value and such items are considered Level 1 assets and liabilities. The Company's repurchase and reverse repurchase agreements are carried at cost, which approximates fair value due to their short term nature. Repurchase agreements and reverse repurchase agreements are classified as Level 2 assets and liabilities based on the adequacy of the collateral and their short term nature.
5. Financial Derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. Specifically, the Company's primary source of financing is repurchase agreements and the Company enters into financial derivative and other instruments to manage exposure to variable cash flows on portions of its borrowings under those repurchase agreements. Since the interest rates on repurchase agreements typically change with market interest rates such as LIBOR, the Company is exposed to constantly changing interest rates, which accordingly affects cash flows associated with the Company's borrowings. To mitigate the effect of changes in these interest rates and their related cash flows, the Company may enter into a variety of derivative contracts, including interest rate swaps, futures, swaptions, and TBAs. Additionally, from time to time, the Company may use short positions in U.S. Treasury securities to mitigate its intere