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EX-32 - EXHIBIT 32 - MTGE Investment Corp.mtge20150930ex32.htm
EX-31.1 - EXHIBIT 31.1 - MTGE Investment Corp.mtge20150930ex311.htm
EX-31.2 - EXHIBIT 31.2 - MTGE Investment Corp.mtge20150930ex312.htm
EX-3.2 - EXHIBIT 3.2 - MTGE Investment Corp.mtge20150930ex3_2.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2015

Commission file number 001-35260
AMERICAN CAPITAL MORTGAGE INVESTMENT CORP.
(Exact name of registrant as specified in its charter)
 
Maryland
 
45-0907772
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
2 Bethesda Metro Center
14th Floor
Bethesda, Maryland 20814
(Address of principal executive offices)
 
(301) 968-9220
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports 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 þ.        No ¨.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes þ.        No ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
þ
 
Accelerated filer
o
 
 
 
 
 
Non-accelerated filer
o
(Do not check if a smaller reporting company)
Smaller Reporting Company
o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ¨        No. þ
 
The number of shares of the issuer’s common stock, $0.01 par value, outstanding as of November 1, 2015 was 50,010,446





AMERICAN CAPITAL MORTGAGE INVESTMENT CORP.
TABLE OF CONTENTS
 

PART I. FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements
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 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults upon Senior Securities
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
 
 
 
Signatures
 


1



PART I

FINANCIAL INFORMATION

Item 1. Financial Statements
    
AMERICAN CAPITAL MORTGAGE INVESTMENT CORP.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
         
 
September 30, 2015
 
December 31, 2014
 
(unaudited)
 
 
Assets:
 
 
 
Agency securities, at fair value (including pledged securities of $3,180,798 and $4,235,235, respectively)
$
3,356,523

 
$
4,384,139

Non-agency securities, at fair value (including pledged securities of $1,314,009 and $940,981, respectively)
1,479,586

 
1,168,834

U.S. Treasury securities, at fair value (including pledged securities of $147,454 and $707,284, respectively)
147,454

 
758,629

Cash and cash equivalents
170,745

 
203,431

Restricted cash and cash equivalents
76,868

 
82,144

Interest receivable
11,586

 
15,249

Derivative assets, at fair value
14,519

 
28,574

Receivable for securities sold
167,433

 
26,747

Receivable under reverse repurchase agreements
691,772

 
214,399

Mortgage servicing rights, at fair value
83,495

 
93,640

Other assets
58,016

 
55,466

Total assets
$
6,257,997

 
$
7,031,252

Liabilities:
 
 
 
Repurchase agreements
$
3,805,390

 
$
5,423,630

Federal Home Loan Bank advances
487,900

 

Payable for securities purchased
167,703

 
49,755

Derivative liabilities, at fair value
80,139

 
75,981

Dividend payable
21,121

 
34,374

Obligation to return securities borrowed under reverse repurchase agreements, at fair value
603,709

 
230,136

Accounts payable and other accrued liabilities
40,443

 
41,407

Total liabilities
5,206,405

 
5,855,283

Stockholders’ equity:
 
 
 
Preferred stock, $0.01 par value; 50,000 shares authorized:
 
 
 
8.125% Series A Cumulative Redeemable Preferred Stock; 2,200 (aggregate liquidation preference of $55,000) and 2,200 shares issued and outstanding, respectively
53,039

 
53,039

Common stock, $0.01 par value; 300,000 shares authorized, 50,010 and 51,165 shares issued and outstanding, respectively
500

 
512

Additional paid-in capital
1,181,634

 
1,198,560

Retained deficit
(183,581
)
 
(76,142
)
Total stockholders’ equity
1,051,592

 
1,175,969

Total liabilities and stockholders’ equity
$
6,257,997

 
$
7,031,252

See accompanying notes to consolidated financial statements.

2



AMERICAN CAPITAL MORTGAGE INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Interest income:
 
 
 
 
 
 
 
Agency securities
$
19,988

 
$
27,208

 
$
75,455

 
$
92,939

Non-agency securities
19,760

 
16,324

 
54,414

 
47,794

Other
67

 
114

 
197

 
247

Interest expense
(7,586
)
 
(6,407
)
 
(22,601
)
 
(21,808
)
Net interest income
32,229

 
37,239

 
107,465

 
119,172

 
 
 
 
 
 
 
 
Servicing:
 
 
 
 
 
 
 
Servicing income
11,576

 
13,081

 
34,768

 
34,034

Servicing expense
(15,580
)
 
(16,213
)
 
(47,149
)
 
(44,861
)
Net servicing loss
(4,004
)
 
(3,132
)
 
(12,381
)
 
(10,827
)
 
 
 
 
 
 
 
 
Other gains (losses):
 
 
 
 
 
 
 
Realized gain (loss) on agency securities, net
175

 
685

 
(5,552
)
 
(8,396
)
Realized gain on non-agency securities, net
8

 
17,403

 
6,405

 
31,795

Realized loss on periodic settlements of interest rate swaps, net
(3,793
)
 
(5,226
)
 
(12,537
)
 
(15,400
)
Realized gain (loss) on other derivatives and securities, net
(27,724
)
 
13,704

 
(43,023
)
 
3,236

Unrealized gain (loss) on agency securities, net
32,583

 
(18,446
)
 
12,877

 
127,447

Unrealized loss on non-agency securities, net
(13,104
)
 
(21,103
)
 
(27,033
)
 
(11,255
)
Unrealized loss on other derivatives and securities, net
(18,654
)
 
(3,303
)
 
(26,388
)
 
(71,608
)
Unrealized loss on mortgage servicing rights
(5,260
)
 
(3,076
)
 
(3,591
)
 
(3,705
)
Impairment of intangible asset
(10,000
)
 

 
(10,000
)
 

Total other gains (losses), net
(45,769
)
 
(19,362
)
 
(108,842
)
 
52,114

 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
Management fees
4,250

 
4,544

 
13,183

 
13,169

General and administrative expenses
1,845

 
1,908

 
5,923

 
5,584

Total expenses
6,095

 
6,452

 
19,106

 
18,753

 
 
 
 
 
 
 
 
Income (loss) before provision for income tax
(23,639
)
 
8,293

 
(32,864
)
 
141,706

Provision for excise and income tax
(373
)
 

 
(42
)
 
(356
)
Net income (loss)
(24,012
)
 
8,293

 
(32,906
)
 
141,350

Dividend on preferred stock
(1,117
)
 
(1,117
)
 
(3,351
)
 
(1,601
)
Net income (loss) available to common shareholders
$
(25,129
)
 
$
7,176

 
$
(36,257
)
 
$
139,749

 
 
 
 
 
 
 
 
Net income (loss) per common share — basic and diluted
$
(0.49
)
 
$
0.14

 
$
(0.71
)
 
$
2.73

 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding — basic
50,815

 
51,142

 
51,052

 
51,185

Weighted average number of common shares outstanding — diluted
50,828

 
51,158

 
51,064

 
51,192

 
 
 
 
 
 
 
 
Dividend declared per common share
$
0.40

 
$
0.65

 
$
1.40

 
$
1.95

See accompanying notes to consolidated financial statements.

3



AMERICAN CAPITAL MORTGAGE INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
(unaudited)

 
Preferred Stock
 
Common Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings (Deficit)
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
Balance, December 31, 2013

 
$

 
51,356

 
$
514

 
$
1,201,826

 
$
(99,620
)
 
$
1,102,720

Net income

 

 

 

 

 
141,350

 
141,350

Issuance of preferred stock
2,200

 
53,039

 

 

 

 

 
53,039

Repurchase of common stock

 

 
(214
)
 
(3
)
 
(4,205
)
 

 
(4,208
)
Stock-based compensation

 

 

 

 
703

 

 
703

Preferred dividends declared

 

 

 

 

 
(1,601
)
 
(1,601
)
Common dividends declared

 

 

 

 

 
(99,726
)
 
(99,726
)
Balance, September 30, 2014
2,200

 
$
53,039

 
51,142

 
$
511

 
$
1,198,324

 
$
(59,597
)
 
$
1,192,277

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, December 31, 2014
2,200

 
$
53,039

 
51,165

 
$
512

 
$
1,198,560

 
$
(76,142
)
 
$
1,175,969

Net loss

 

 

 

 

 
(32,906
)
 
(32,906
)
Repurchase of common stock

 

 
(1,182
)
 
(12
)
 
(18,062
)
 

 
(18,074
)
Stock-based compensation

 

 
27

 

 
1,136

 

 
1,136

Preferred dividends declared

 

 

 

 

 
(3,351
)
 
(3,351
)
Common dividends declared

 

 

 

 

 
(71,182
)
 
(71,182
)
Balance, September 30, 2015
2,200

 
$
53,039

 
50,010

 
$
500

 
$
1,181,634

 
$
(183,581
)
 
$
1,051,592

See accompanying notes to consolidated financial statements.


4



AMERICAN CAPITAL MORTGAGE INVESTMENT CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
For the Nine Months Ended September 30,
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
(32,906
)
 
$
141,350

Adjustments to reconcile net income to net cash flows from operating activities:
 
 
 
Amortization of net premium on agency securities
22,719

 
26,586

Accretion of net discount on non-agency securities
(27,102
)
 
(30,486
)
Realization of cash flows from MSR
7,875

 
2,830

Unrealized loss (gain) on securities, MSR and derivatives, net
44,135

 
(40,879
)
Realized loss on agency securities, net
5,552

 
8,396

Realized gain on non-agency securities, net
(6,405
)
 
(31,795
)
Realized loss on other derivatives and securities, net
55,560

 
14,004

Impairment of intangible asset
10,000

 

Stock-based compensation
1,136

 
703

Decrease in interest receivable
3,663

 
6,097

Decrease in other assets
6,977

 
20,119

Increase (decrease) in operating accounts payable and other accrued liabilities
3,022

 
(855
)
Net cash flows from operating activities
94,226

 
116,070

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of agency securities
(1,186,729
)
 
(343,694
)
Purchases of non-agency securities
(870,777
)
 
(571,871
)
Purchases of MSR, net of purchase price adjustments
(4,177
)
 
(87,820
)
Proceeds from sale of agency securities
1,772,536

 
2,067,118

Proceeds from sale of non-agency securities
385,480

 
461,415

Principal collections on agency securities
401,626

 
418,891

Principal collections on non-agency securities
181,543

 
87,087

Net payments on reverse repurchase agreements
(477,373
)
 
(722,707
)
Purchases of U.S. Treasury securities
(4,224,798
)
 
(1,909,460
)
Proceeds from sale of U.S. Treasury securities
5,198,095

 
2,806,869

Proceeds from terminations of interest rate swaptions

 
17,525

Payment of premiums for interest rate swaptions

 
(1,552
)
Decrease (increase) in restricted cash
5,276

 
(67,156
)
Other investing cash flows, net
(51,887
)
 
15,896

  Net cash flows from investing activities
1,128,815

 
2,170,541

CASH FLOWS USED IN FINANCING ACTIVITIES:
 
 
 
Dividends paid
(87,786
)
 
(100,522
)
Proceeds from preferred stock offerings, net of offering costs

 
53,039

Net payments for repurchase of common shares
(18,074
)
 
(4,208
)
Proceeds from repurchase agreements and Federal Home Loan Bank advances
38,330,944

 
26,437,702

Repayments on repurchase agreements and Federal Home Loan Bank advances
(39,480,811
)
 
(28,674,082
)
Net cash used in financing activities
(1,255,727
)
 
(2,288,071
)
Net decrease in cash and cash equivalents
(32,686
)
 
(1,460
)
Cash and cash equivalents at beginning of the period
203,431

 
206,398

Cash and cash equivalents at end of period
$
170,745

 
$
204,938

See accompanying notes to consolidated financial statements.

5



AMERICAN CAPITAL MORTGAGE INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 1. Unaudited Interim Consolidated Financial Statements

The unaudited interim consolidated financial statements of American Capital Mortgage Investment Corp. (referred to throughout this report as the "Company", "we", "us" and "our") are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.

Our unaudited interim consolidated financial statements include the accounts of our wholly-owned subsidiaries, American Capital Mortgage Investment TRS, LLC, Woodmont Insurance Co., LLC ("Woodmont") and American Capital Mortgage 2013, LLC and, in turn, its wholly-owned subsidiary Residential Credit Solutions, Inc. ("RCS"). Significant intercompany accounts and transactions have been eliminated. In the opinion of management, all adjustments, consisting solely of normal recurring accruals, necessary for the fair presentation of financial statements for the interim period have been included. The current period’s results of operations are not necessarily indicative of results that ultimately may be achieved for the year.

Note 2. Organization
We were incorporated in Maryland on March 15, 2011 and commenced operations on August 9, 2011 following the completion of our initial public offering ("IPO"). We are externally managed by American Capital MTGE Management, LLC (our "Manager"), an affiliate of American Capital, Ltd. ("American Capital"). Our common stock is traded on the NASDAQ Global Select Market under the symbol "MTGE."

We invest in, finance and manage a leveraged portfolio of real estate-related investments, which we define to include agency residential mortgage-backed securities ("RMBS"), non-agency mortgage investments, other mortgage-related investments, and healthcare-related real estate investments. Agency RMBS include residential mortgage pass-through certificates and collateralized mortgage obligations ("CMOs") structured from residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by a government-sponsored enterprise ("GSE"), such as Federal National Mortgage Association ("Fannie Mae") and Federal Home Loan Mortgage Corporation ("Freddie Mac"), or by a U.S. Government agency, such as Government National Mortgage Association ("Ginnie Mae"). Non-agency mortgage investments include RMBS backed by residential mortgages that are not guaranteed by a GSE or U.S. Government agency. Non-agency mortgage investments may also include prime and non-prime residential mortgage loans. Other mortgage-related investments may include mortgage servicing rights ("MSR"), GSE credit risk transfer securities ("CRT"), commercial mortgage-backed securities ("CMBS"), commercial mortgage loans and mortgage-related derivatives. Healthcare-related real estate investments may include equity investments in properties subject to long-term triple-net leases with third party operators and debt investments in skilled nursing facility and senior housing properties secured by mortgages on the underlying real estate and personal property.
Our objective is to provide attractive risk-adjusted returns to our stockholders over the long-term through a combination of dividends and net book value appreciation. In pursuing this objective, we rely on our Manager’s expertise to construct and manage a diversified investment portfolio by identifying asset classes that, when properly financed and hedged, are designed to produce attractive returns across a variety of market conditions and economic cycles, considering the risks associated with owning such investments.
We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code"). As such, we are required to distribute annually at least 90% of our taxable net income. As long as we continue to qualify as a REIT, we will generally not be subject to U.S. Federal or state corporate taxes on our taxable net income to the extent that we distribute all of our annual taxable net income to our stockholders. It is our intention to distribute 100% of our taxable net income, after application of available tax attributes, within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year.


6


Note 3. Summary of Significant Accounting Policies

Fair Value of Financial Assets

We have elected the option to account for all of our financial assets, including all mortgage-related investments, at estimated fair value, with changes in fair value reflected in income during the period in which they occur. In management's view, this election more appropriately reflects the results of our operations for a particular reporting period, as financial asset fair value changes are presented in a manner consistent with the presentation and timing of the fair value changes of hedging instruments. See Note 9 - Fair Value Measurements.

Interest Income

Interest income is accrued based on the outstanding principal amount of the securities and their contractual terms. Premiums or discounts associated with the purchase of agency RMBS and non-agency securities of high credit quality are amortized or accreted into interest income, respectively, over the projected lives of the securities, including contractual payments and estimated prepayments, using the effective interest method.

We estimate long-term prepayment speeds using a third-party service and market data. The third-party service estimates prepayment speeds for our securities using models that incorporate the mortgage rates, age, size and loan-to-value ratios of the outstanding underlying loans, as well as current mortgage rates, forward yield curves, volatility and other factors. We review the prepayment speeds estimated by the third-party service and compare the results to market consensus prepayment speeds, if available. We also consider historical prepayment speeds and current market conditions to validate the reasonableness of the prepayment speeds estimated by the third-party service, and based on our Manager’s judgment, we may make adjustments to its estimates. Actual and anticipated prepayment experience is reviewed at least quarterly and effective yields are recalculated when differences arise between the previously estimated future prepayments and the amounts actually received plus currently anticipated future prepayments. If the actual and anticipated future prepayment experience differs from our prior estimate of prepayments, we are required to record an adjustment in the current period to the amortization or accretion of premiums and discounts for the cumulative difference in the effective yield through the reporting date.

At the time we purchase non-agency securities and loans that are not of high credit quality, we determine an effective yield based on our estimate of the timing and amount of future cash flows and our cost basis. Our initial cash flow estimates for these investments are based on our observations of current information and events and include assumptions related to interest rates, prepayment rates and the impact of default and severity rates on the timing and amount of credit losses. On at least a quarterly basis, we review the estimated cash flows and make appropriate adjustments, based on inputs and analysis received from external sources, internal models, and our judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Any resulting changes in effective yield are recognized prospectively based on the current amortized cost of the investment as adjusted for credit impairment, if any.

Mortgage Servicing Rights, at Fair Value

Our MSR represent the right to service mortgage loans for a servicing fee. MSR are reported at fair value on our consolidated balance sheets, with changes in fair value related to changes in valuation inputs and assumptions reported as unrealized gain (loss) on MSR on the consolidated statements of operations. Servicing fees, incentive fees and ancillary income are reported within servicing income on the consolidated statements of operations. The related servicing expenses and realization of cash flows related to underlying loan repayments, net of recoveries of contractual prepayment protection, are recorded in servicing expenses on the consolidated statements of operations. See Note 10 - Mortgage Servicing Rights for further discussion on MSR.

The accounting model used to evaluate whether a transfer of MSR qualifies as a sale is based on a risks and rewards approach, as MSR are not financial assets. In certain cases where we transfer the economics of MSR while retaining the actual servicing function, we retain the risk associated with servicing and, as a result, the transfer does not qualify for sale accounting. As such, we retain the MSR, together with an offsetting financing liability on our consolidated balance sheets. We have elected the option to account for MSR financing liabilities at estimated fair value, with changes in fair value reflected in income during the period in which they occur. See Note 12 - Accounts Payable and Other Accrued Liabilities for the presentations of our mortgage servicing liability.

We may be obligated to fund advances of principal and interest payments due to third party loan investors prior to receiving payment on the loans from the individual borrowers. We may also be obligated to fund advances of real estate taxes

7


and insurance, protective advances to preserve the value of the underlying property, and expenses associated with remedial action in respect of defaulted loans. These servicing advances are reported within other assets on the consolidated balance sheets.

Repurchase Agreements

We finance the acquisition of agency RMBS and certain non-agency securities for our investment portfolio through repurchase transactions under master repurchase agreements. We account for repurchase transactions as collateralized financing transactions which are carried at their contractual amounts, including accrued interest, as specified in the respective transaction agreements. The contractual amounts approximate fair value due to their short-term nature.

Reverse Repurchase Agreements and Obligation to Return Securities Borrowed under Reverse Repurchase Agreements

From time to time we borrow securities to cover short sales of U.S. Treasury securities through reverse repurchase transactions under our master repurchase agreements (see Derivatives below). We account for these as securities borrowing transactions and recognize an obligation to return the borrowed securities at fair value on the consolidated balance sheets based on the value of the underlying borrowed securities as of the reporting date. Our reverse repurchase agreements generally mature daily. The fair value of our reverse repurchase agreements is assumed to equal cost as the interest rates are reset daily.
Derivatives
We utilize a risk management strategy, under which we may use a variety of derivative instruments to hedge some of our exposure to market risks, including interest rate risk, prepayment risk, extension risk and credit risk. The objective of our risk management strategy is to reduce fluctuations in net book value over a range of market conditions. The principal instruments that we currently use are interest rate swaps and options to enter into interest rate swaps ("interest rate swaptions"). We also utilize forward contracts for the purchase or sale of agency RMBS, or to-be-announced forward ("TBA") contracts, and short sales of U.S. Treasury securities and U.S. Treasury futures contracts. We may also purchase or write put or call options on TBA securities and we may invest in other types of mortgage derivatives, such as synthetic total return swaps.
We also enter into TBA contracts as a means of investing in and financing agency RMBS (thereby increasing our "at
risk" leverage) or as a means of disposing of or reducing our exposure to agency RMBS (thereby reducing our "at risk" leverage). Pursuant to TBA contracts, we agree to purchase or sell, for future delivery, agency RMBS with certain principal and interest terms and certain types of collateral, but the particular agency RMBS to be delivered are not identified until shortly before the TBA settlement date. We may also choose, prior to settlement, to move the settlement of these securities out to a later date by entering into an offsetting short or long position (referred to as a "pair off"), net settling the paired off positions for cash, and simultaneously purchasing or selling a similar TBA contract for a later settlement date. This transaction is commonly referred to as a "dollar roll." The agency RMBS purchased or sold for a forward settlement date are typically priced at a discount to agency RMBS for settlement in the current month. This difference (or discount) is referred to as the "price drop." The price drop is the economic equivalent of net interest carry income on the underlying agency RMBS over the roll period (interest income less implied financing cost) and is commonly referred to as "dollar roll income (loss)." Consequently, forward purchases of agency RMBS and dollar roll transactions represent a form of off-balance sheet financing.
We recognize all derivative instruments as either assets or liabilities on the balance sheets, measured at fair value. As we have not designated any derivatives as hedging instruments, all changes in fair value are reported in earnings in our consolidated statements of operations in unrealized gain (loss) on other derivatives and securities, net during the period in which they occur. Derivatives in a gain position are reported as derivative assets at fair value and derivatives in a loss position are reported as derivative liabilities at fair value in our consolidated balance sheets. Cash receipts and payments related to derivative instruments are classified in our consolidated statements of cash flows according to the underlying nature or purpose of the derivative transaction, generally in the investing section.
Our derivative agreements generally contain provisions that allow for netting or setting off derivative assets and liabilities with each counterparty; however, we report related assets and liabilities on a gross basis in our consolidated balance sheets.

The use of derivative instruments creates exposure to credit risk relating to potential losses that could be recognized in the event that the counterparties to these instruments fail to perform their obligations under the contracts. We attempt to minimize this risk by limiting our counterparties to major financial institutions with acceptable credit ratings, monitoring positions with individual counterparties and adjusting posted collateral as required.


8


Interest rate swap agreements

We use interest rate swaps to hedge the variable cash flows associated with short-term borrowings made under our repurchase agreement and other financing facilities. Under our interest rate swap agreements, we typically pay a fixed rate and receive a floating rate based on one, three or six-month LIBOR ("payer swaps") with terms up to 15 years. The floating rate we receive under our swap agreements has the effect of offsetting the repricing characteristics of our repurchase agreements and cash flows on such liabilities. Our swap agreements are privately negotiated in the over-the-counter ("OTC") market and may be centrally cleared through a registered commodities exchange ("centrally cleared swaps").
    
We estimate the fair value of our centrally cleared interest rate swaps using the daily settlement price determined by the respective exchange. Centrally cleared swaps are valued by the exchange using a pricing model that references the underlying rates, including the overnight index swap rate and LIBOR forward rate, to produce the daily settlement price. We estimate the fair value of our "non-centrally cleared" interest rate swaps based on valuations obtained from third-party pricing services and the swap counterparty (collectively, “third-party valuations”). The third-party valuations are model-driven using observable inputs consisting of LIBOR and the forward yield curve. We also consider the creditworthiness of both us and our counterparties and the impact of netting and credit enhancement provisions contained in each derivative agreement, such as collateral postings. All of our "non-centrally cleared" interest rate swaps are subject to bilateral collateral arrangements. Consequently, no credit valuation adjustment was made in determining the fair value of such instruments.

The payment of periodic settlements of net interest on interest rate swaps is reported in realized loss on periodic settlements of interest rate swaps, net in our consolidated statements of operations. Cash payments received or paid for the early termination of an interest rate swap agreement are recorded as realized gain (loss) on other derivatives and securities, net in our consolidated statements of operations. Changes in fair value of our interest rate swap agreements are reported in unrealized gain (loss) on other derivatives and securities, net in our consolidated statements of operations.

Interest rate swaptions

We purchase interest rate swaptions to help mitigate the potential impact of larger, more rapid changes in interest rates
on the performance of our investment portfolio. The interest rate swaptions provide us the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay or receive interest rates in the future. The premium paid for interest rate swaptions is reported as a derivative asset in our consolidated balance sheets. We estimate the fair value of interest rate swaptions based on the fair value of the future interest rate swap that we have the option to enter into as well as the remaining length of time that we have to exercise the option. The difference between the premium and the fair value of the swaption is reported in unrealized gain (loss) on other derivatives and securities, net in our consolidated statements of operations. If a swaption expires unexercised, the realized loss on the swaption would be equal to the premium paid and reported in realized gain (loss) on other derivatives and securities, net in our consolidated statements of operations. If we exercise a swaption, the realized gain or loss on the swaption would be equal to the difference between the fair value of the underlying interest rate swap and the premium paid and reported in realized gain (loss) on other derivatives and securities, net in our consolidated statements of operations.

Interest rate swaption agreements are privately negotiated in the OTC market and are not subject to central clearing. We estimate the fair value of our interest rate swaption agreements based on model-driven valuations obtained from third-party
pricing services and the swaption counterparty. These estimates incorporate observable inputs and include the fair value of the future interest rate swaps that we have the option to enter into, as well as the remaining length of time that we have to exercise the options, adjusted for non-performance risk, if any.

TBA securities

A TBA security 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 stated maturity on an agreed-upon future date. The specific agency RMBS delivered into the contract upon the settlement date, published each month by the Securities Industry and Financial Markets Association, are not known at the time of the transaction. We may enter into TBA contracts as a means of hedging against short-term changes in interest rates. We may also enter into TBA contracts as a means of acquiring or disposing of agency RMBS and we may from time to time utilize TBA dollar roll transactions to finance agency RMBS purchases.

We account for all TBA contracts as derivatives since we cannot assert that it is probable at the inception and throughout the term of the contract that it will not settle net and will result in physical delivery of an agency security when it is issued. A TBA dollar roll transaction is a series of derivative transactions. The net settlement of a TBA contract is reported as realized

9


gain (loss) on other derivatives and securities, net and changes in the fair value of our TBA contracts are reported as unrealized gain (loss) on other derivatives and securities, net in our consolidated statements of operations.

We estimate the fair value of TBA securities based on similar methods used to value our agency RMBS.

Forward commitments to purchase or sell specified securities

We may enter into a forward commitment to purchase or sell specified securities as a means of acquiring assets or as a hedge against short-term changes in interest rates. Such forward commitments usually require physical settlement. Contracts for the purchase or sale of specified securities are accounted for as derivatives if the delivery of the specified agency RMBS and settlement extends beyond established market conventions. Realized gains and losses associated with forward commitments are recognized in realized gain (loss) on other derivatives and securities, net and unrealized gains and losses are recognized in unrealized gain (loss) on other derivatives and securities, net on our consolidated statements of operations.

We estimate the fair value of forward commitments to purchase or sell specified RMBS based on methods used to value our RMBS, as well as the remaining length of time of the forward commitment.

U.S. Treasury securities

We purchase or sell short U.S. Treasury securities and U.S. Treasury futures contracts to help mitigate the potential impact of changes in interest rates on the performance of our portfolio. Realized gains and losses associated with purchases and short sales of U.S. Treasury securities and U.S. Treasury futures contracts are recognized in realized gain (loss) on other derivatives and securities, net, and unrealized gains and losses are recognized in unrealized gain (loss) on other derivatives and securities, net on our consolidated statements of operations.

Note 4. Agency Securities
The following tables summarize our investments in agency RMBS as of September 30, 2015 and December 31, 2014 (dollars in thousands):
 
September 30, 2015
 
Fannie Mae
 
Freddie Mac
 
Total
Agency RMBS:
 
 
 
 
 
Par value
$
2,460,707

 
$
717,522

 
$
3,178,229

Unamortized premium
118,685

 
37,324

 
156,009

Amortized cost
2,579,392

 
754,846

 
3,334,238

Gross unrealized gains
27,136

 
6,874

 
34,010

Gross unrealized losses
(7,804
)
 
(3,921
)
 
(11,725
)
Agency RMBS, at fair value
$
2,598,724

 
$
757,799

 
$
3,356,523

 
 
 
 
 
 
Weighted average coupon as of September 30, 2015
3.49
%
 
3.57
%
 
3.51
%
Weighted average yield as of September 30, 2015
2.64
%
 
2.70
%
 
2.65
%
Weighted average yield for the three months ended September 30, 2015
2.38
%
 
2.34
%
 
2.37
%
Weighted average yield for the nine months ended September 30, 2015
2.53
%
 
2.58
%
 
2.54
%

 
 
September 30, 2015
 
 
Amortized Cost
 
Gross Unrealized Gain
 
Gross Unrealized Loss
 
Fair Value
Agency RMBS:
 
 
 
 
 
 
 
 
Fixed rate
 
$
3,225,756

 
$
29,780

 
$
(11,725
)
 
$
3,243,811

Adjustable rate
 
108,482

 
4,230

 

 
112,712

Total
 
$
3,334,238

 
$
34,010

 
$
(11,725
)
 
$
3,356,523


10



 
December 31, 2014
 
Fannie Mae

Freddie Mac

Total
Agency RMBS:





Par value
$
3,333,348


$
857,059


$
4,190,407

Unamortized premium
141,252


43,070


184,322

Amortized cost
3,474,600


900,129


4,374,729

Gross unrealized gains
26,102


7,550


33,652

Gross unrealized losses
(18,575
)

(5,667
)

(24,242
)
Agency RMBS, at fair value
$
3,482,127


$
902,012


$
4,384,139

 
 
 
 



Weighted average coupon as of December 31, 2014
3.37
%

3.50
%

3.39
%
Weighted average yield as of December 31, 2014
2.54
%

2.65
%

2.56
%
Weighted average yield for the year ended December 31, 2014
2.48
%
 
2.58
%
 
2.50
%

 
 
December 31, 2014
 
 
Amortized Cost
 
Gross Unrealized Gain
 
Gross Unrealized Loss
 
Fair Value
Agency RMBS:
 
 
 
 
 
 
 
 
Fixed rate
 
$
4,252,616

 
$
30,059

 
$
(24,242
)
 
$
4,258,433

Adjustable rate
 
122,113

 
3,593

 

 
125,706

Total
 
$
4,374,729

 
$
33,652

 
$
(24,242
)
 
$
4,384,139


Actual maturities of agency RMBS are generally shorter than the stated contractual maturities. Actual maturities are affected by the contractual lives of the underlying mortgages, periodic principal payments and principal prepayments.

The following table summarizes our agency RMBS as of September 30, 2015 and December 31, 2014 according to their estimated weighted average life classification (dollars in thousands):

 
September 30, 2015
 
December 31, 2014
 
 
 
 
 
 
Weighted Average
 
 
 
 
 
Weighted Average
Weighted Average Life
 
Fair
Value
 
Amortized
Cost
 
Yield
 
Coupon
 
Fair
Value
 
Amortized
Cost
 
Yield
 
Coupon
Greater than three years and less than or equal to five years
 
$
970,357


$
957,345


2.28
%

3.25
%

$
1,528,121


$
1,520,350


2.13
%

3.05
%
Greater than five years and less than or equal to 10 years
 
2,377,594


2,368,398


2.80
%

3.62
%

2,827,653


2,826,297


2.79
%

3.58
%
Greater than 10 years
 
8,572


8,495


3.07
%

3.50
%

28,365


28,082


3.12
%

3.52
%
Total
 
$
3,356,523


$
3,334,238


2.65
%

3.51
%

$
4,384,139


$
4,374,729


2.56
%

3.39
%
As of both September 30, 2015 and December 31, 2014, none of our agency RMBS had an estimated weighted average life of less than 3.2 years. As of both September 30, 2015 and December 31, 2014, the estimated weighted average life of our agency security portfolio was 6.8 years, which incorporates anticipated future prepayment assumptions. As of September 30, 2015 and December 31, 2014, our weighted average expected constant prepayment rate ("CPR") over the remaining life of our aggregate agency investment portfolio was 8.6% and 8.2%, respectively. Our estimates may differ materially for different types of securities and thus individual holdings may have a wide range of projected CPRs.

11


Realized Gains and Losses
The following table summarizes our net realized gains and losses from the sale of agency RMBS during the three and nine months ended September 30, 2015 and 2014 (dollars in thousands): 
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015
 
2014

2015
 
2014
Proceeds from agency RMBS sold
 
$
536,661

 
$
400,042


$
1,772,536

 
$
2,067,118

Increase (decrease) in receivable for agency RMBS sold
 
(141,887
)
 
(77,918
)

67,055

 
(570,029
)
Less agency RMBS sold, at cost
 
(394,599
)
 
(321,439
)

(1,845,143
)
 
(1,505,485
)
Net realized gain (loss) on sale of agency RMBS
 
$
175

 
$
685


$
(5,552
)
 
$
(8,396
)
 
 
 
 
 
 
 
 
 
Gross realized gains on sale of agency RMBS
 
$
2,226

 
$
1,552


$
6,190

 
$
9,382

Gross realized losses on sale of agency RMBS
 
(2,051
)
 
(867
)

(11,742
)
 
(17,778
)
Net realized gain (loss) on sale of agency RMBS
 
$
175

 
$
685


$
(5,552
)
 
$
(8,396
)
Pledged Assets
The following tables summarize our agency RMBS pledged as collateral under repurchase agreements, derivative agreements and FHLB advances by type as of September 30, 2015 and December 31, 2014 (dollars in thousands):
 
 
September 30, 2015
Agency RMBS Pledged (1)
 
Fannie Mae
 
Freddie Mac
 
Total
Under Repurchase Agreements
 
 
 
 
 
 
Fair value
 
$
2,156,625

 
$
695,633

 
$
2,852,258

Accrued interest on pledged agency RMBS
 
5,958

 
1,957

 
7,915

Under Derivative Agreements
 
 
 
 
 
 
Fair value
 
5,548

 
2,172

 
7,720

Accrued interest on pledged agency RMBS
 
16

 
6

 
22

Under FHLB Advances
 
 
 
 
 
 
Fair value
 
271,524

 
49,296

 
320,820

Accrued interest on pledged agency RMBS
 
756

 
142

 
898

Total Fair Value of Agency RMBS Pledged and Accrued Interest
 
$
2,440,427

 
$
749,206

 
$
3,189,633

————————
(1)
Agency RMBS pledged do not include pledged amounts of $66.0 million under repurchase agreements related to agency RMBS sold but not yet settled as of September 30, 2015.
 
 
December 31, 2014
Agency RMBS Pledged
 
Fannie Mae
 
Freddie Mac
 
Total
Under Repurchase Agreements
 
 
 
 
 
 
Fair value
 
$
3,395,257

 
$
838,627

 
$
4,233,884

Accrued interest on pledged agency RMBS
 
9,089

 
2,335

 
11,424

Under Derivative Agreements
 
 
 
 
 
 
Fair value
 
677

 
674

 
1,351

Accrued interest on pledged agency RMBS
 
2

 
2

 
4

Total Fair Value of Agency RMBS Pledged and Accrued Interest
 
$
3,405,025

 
$
841,638

 
$
4,246,663


12


The following table summarizes our agency RMBS pledged as collateral under repurchase agreements by remaining maturity as of September 30, 2015 and December 31, 2014 (dollars in thousands):
 
 
September 30, 2015
 
December 31, 2014
Remaining Maturity
 
Fair Value
 
Amortized
Cost
 
Accrued Interest
 
Fair Value
 
Amortized
Cost
 
Accrued Interest
30 days or less
 
$
1,238,132

 
$
1,228,764

 
$
3,387

 
$
1,711,727

 
$
1,707,149

 
$
4,718

31 - 59 days
 
321,909

 
320,536

 
899

 
507,160

 
503,833

 
1,310

60 - 90 days
 
263,996

 
262,481

 
754

 
525,089

 
524,291

 
1,352

Greater than 90 days
 
1,028,221

 
1,023,705

 
2,875

 
1,489,908

 
1,489,667

 
4,044

Total
 
$
2,852,258

 
$
2,835,486

 
$
7,915

 
$
4,233,884

 
$
4,224,940

 
$
11,424


As of September 30, 2015 and December 31, 2014, none of our repurchase agreement borrowings backed by agency RMBS were due on demand or mature overnight. As of September 30, 2015, all of our FHLB advances backed by agency RMBS had remaining maturities greater than 1 year.

Note 5. Non-Agency Securities
The following tables summarize our non-agency securities as of September 30, 2015 and December 31, 2014 (dollars in thousands):
September 30, 2015
 
 
Fair
  Value
 
Gross Unrealized
 
Amortized Cost
 
Premium (Discount)
 
Par/ Current Face
 
Weighted Average
Category
 
 
Gains
 
Losses
 
 
 
 
Coupon (1)
 
Yield
Prime
 
$
434,333

 
$
9,843

 
$
(1,769
)
 
$
426,259

 
$
(23,131
)
 
$
449,390

 
3.44
%
 
4.40
%
CRT
 
207,287

 

 
(9,529
)
 
216,816

 
3,996

 
212,820

 
4.05
%
 
5.22
%
Alt-A
 
448,859

 
32,585

 
(6,572
)
 
422,846

 
(155,940
)
 
578,786

 
1.62
%
 
6.53
%
Option-ARM
 
162,081

 
8,241

 
(5,032
)
 
158,872

 
(36,923
)
 
195,795

 
0.46
%
 
5.60
%
Subprime
 
227,026

 
3,317

 
(406
)
 
224,115

 
(15,259
)
 
239,374

 
3.28
%
 
4.42
%
Total
 
$
1,479,586

 
$
53,986

 
$
(23,308
)
 
$
1,448,908

 
$
(227,257
)
 
$
1,676,165

 
2.52
%
 
5.28
%
————————
(1)
Coupon rates are floating, except for $229.9 million, $26.6 million and $176.4 million fair value of fixed-rate prime, Alt-A and subprime non-agency securities, respectively, as of September 30, 2015.
December 31, 2014
 
 
Fair
  Value
 
Gross Unrealized
 
Amortized Cost
 
Premium (Discount)
 
Par/ Current Face
 
Weighted Average
Category
 
 
Gains
 
Losses
 
 
 
 
Coupon (1)
 
Yield
Prime
 
$
178,215

 
$
11,346

 
$
(596
)
 
$
167,464

 
$
(25,977
)
 
$
193,441

 
3.03
%
 
6.42
%
CRT
 
104,123

 
88

 
(5,893
)
 
109,929

 
4,150

 
105,779

 
4.21
%
 
5.46
%
Alt-A
 
486,254

 
42,536

 
(4,090
)
 
447,808

 
(169,221
)
 
617,029

 
1.67
%
 
6.54
%
Option-ARM
 
173,727

 
11,317

 
(2,473
)
 
164,883

 
(42,338
)
 
207,221

 
0.43
%
 
5.88
%
Subprime
 
226,515

 
5,818

 
(342
)
 
221,039

 
(29,143
)
 
250,182

 
2.70
%
 
4.57
%
Total
 
$
1,168,834

 
$
71,105

 
$
(13,394
)
 
$
1,111,123

 
$
(262,529
)
 
$
1,373,652

 
2.06
%
 
5.92
%
————————
(1)
Coupon rates are floating, except for $2.5 million, $29.3 million and $151.2 million fair value of fixed-rate prime, Alt-A and subprime non-agency securities, respectively, as of December 31, 2014.

13


The following table summarizes our non-agency securities at fair value, by their estimated weighted average life classifications as of September 30, 2015 and December 31, 2014 (dollars in thousands): 
 
 
September 30, 2015
 
December 31, 2014
Weighted Average Life
 
Fair Value
 
Amortized
Cost
 
Weighted
Average
Yield
 
Weighted Average Coupon
 
Fair Value
 
Amortized
Cost
 
Weighted
Average
Yield
 
Weighted Average Coupon
≤ 5 years
 
$
425,185

 
$
413,074

 
5.23
%
 
2.76
%
 
$
436,385

 
$
422,400

 
5.15
%
 
2.85
%
> 5 to ≤ 7 years
 
698,253

 
674,599

 
5.26
%
 
2.13
%
 
486,869

 
446,967

 
6.68
%
 
1.29
%
> 7 years
 
356,148

 
361,235

 
5.38
%
 
3.02
%
 
245,580

 
241,756

 
5.89
%
 
2.43
%
Total
 
$
1,479,586

 
$
1,448,908

 
5.28
%
 
2.52
%
 
$
1,168,834

 
$
1,111,123

 
5.92
%
 
2.06
%

Our Prime non-agency RMBS include investments in securitization trusts collateralized by prime mortgage loans, which are residential mortgage loans that are considered to have been originated with relatively stringent underwriting standards at the time of origination. Our Prime securities with a combined fair value of $206.6 million as of September 30, 2015 are collateralized by loans that were originated between 2002 and 2006, a period of generally weaker underwriting standards and elevated housing prices. As a result, there is still material credit risk embedded in these vintages. As of September 30, 2015, Prime securities also include $227.7 million in fair value of securities with underlying mortgage loans that were originated with more stringent underwriting between 2012 and 2015. As of September 30, 2015, our Prime securities have both fixed and floating rate coupons ranging from 0.8% to 6.5%, and have underlying collateral with weighted average coupons ranging from 2.4% to 5.7%.

Our CRT securities reference the performance of loans that have been guaranteed by Fannie Mae and Freddie Mac subject to their underwriting standards. As of September 30, 2015, our CRT securities have floating rate coupons ranging from 2.8% to 5.7%, with weighted average coupons of underlying collateral ranging from 3.6% to 4.6%. The loans underlying our CRT securities were originated between 2012 and 2015.

Our Alt-A non-agency RMBS are collateralized by Alt-A mortgage loans that were originated from 2002 to 2007. Alt-A, or alternative A-paper, mortgage loans are considered to have more credit risk than prime mortgage loans and less credit risk than sub-prime mortgage loans. Alt-A loans are typically characterized by borrowers with less than full documentation, lower credit scores, higher loan-to-value ratios and a higher percentage of investment properties. As of September 30, 2015, our Alt-A securities have both fixed and floating rate coupons ranging from 0.3% to 6.5% with weighted average coupons of underlying collateral ranging from 2.7% to 6.9%.

Our Option-ARM non-agency RMBS include senior tranches in securitization trusts that are collateralized by residential mortgages that have origination and underwriting characteristics similar to Alt-A mortgage loans, with the added feature of providing underlying mortgage borrowers the option, within certain constraints, to make lower payments than otherwise required by the stated interest rate for a number of years, leading to negative amortization and increased loan balances. This additional feature can increase the credit risk of these securities. As of September 30, 2015, our Option-ARM securities have coupons ranging from 0.3% to 1.1% and have underlying collateral with weighted average coupons between 2.7% and 4.0%. The loans underlying our Option-ARM securities were originated between 2004 and 2007.

Our Subprime non-agency RMBS issued prior to 2015 include investments in securitization trusts collateralized by residential mortgages originated during or before 2007 that were originally considered to be of lower credit quality. As of September 30, 2015, our Subprime securities issued prior to 2015 have a fair value of $99.6 million with fixed and floating rate coupons ranging from 0.3% to 5.2% and have underlying collateral with weighted-average coupons ranging from 4.4% to 5.9%. Additionally, we have classified certain non-performing loans that were securitized in 2014 and 2015 as Subprime securities. These securitizations are backed by loans originated during or before 2014 and, as of September 30, 2015, have a fair value of $127.4 million. As of September 30, 2015, our Subprime securities issued in 2014 and 2015 have fixed rate coupons ranging from 3.2% to 4.3% and have underlying collateral with weighted-average coupons ranging from 4.9% to 7.6%.

More than 83% of our non-agency RMBS are rated below investment grade or have not been rated by credit agencies as of September 30, 2015.

14


Realized Gains and Losses
The following table summarizes our net realized gains and losses from the sale of non-agency securities during the three and nine months ended September 30, 2015 and 2014 (dollars in thousands): 
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Proceeds from non-agency securities sold
 
$
166,502

 
$
166,204

 
$
385,480

 
$
461,415

Increase in receivable for non-agency RMBS sold
 

 
10,514

 

 
10,514

Less: non-agency securities sold, at cost
 
(166,494
)
 
(159,315
)
 
(379,075
)
 
(440,134
)
Net realized gain on sale of non-agency securities
 
$
8

 
$
17,403

 
$
6,405

 
$
31,795

 
 
 
 
 
 
 
 
 
Gross realized gain on sale of non-agency securities
 
$
1,769

 
$
18,436

 
$
8,662

 
$
36,731

Gross realized loss on sale of non-agency securities
 
(1,761
)
 
(1,033
)
 
(2,257
)
 
(4,936
)
Net realized gain on sale of non-agency securities
 
$
8

 
$
17,403

 
$
6,405

 
$
31,795


Pledged Assets
Non-agency securities with a fair value of $1.3 billion and $0.9 billion were pledged as collateral under financing arrangements as of September 30, 2015 and December 31, 2014, respectively, none of which were due on demand or mature overnight.
The following table summarizes our non-agency securities pledged as collateral under financing arrangements by remaining maturity as of September 30, 2015 and December 31, 2014 (dollars in thousands):
 
 
September 30, 2015
 
December 31, 2014
Remaining Maturity
 
Fair Value
 
Amortized
Cost
 
Accrued Interest
 
Fair Value
 
Amortized
Cost
 
Accrued Interest
30 days or less
 
$
1,042,281

 
$
1,018,538

 
$
1,369

 
$
791,654

 
$
770,604

 
$
1,151

31 - 59 days
 

 

 

 
106,097

 
98,690

 
77

60 - 90 days
 
38,312

 
35,388

 
37

 
43,230

 
39,280

 
40

Greater than 90 days
 
233,416

 
231,188

 
677

 

 

 

Total
 
$
1,314,009

 
$
1,285,114

 
$
2,083

 
$
940,981

 
$
908,574

 
$
1,268


Note 6. Repurchase Agreements and Other Financing Arrangements

We pledge certain of our securities as collateral under repurchase and other financing arrangements with financial institutions, the terms and conditions of which are negotiated on a transaction-by-transaction basis. Interest rates on these borrowings are generally based on LIBOR plus or minus a margin and amounts available to be borrowed are dependent upon the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, type of security and liquidity conditions within the banking, mortgage finance and real estate industries. In response to declines in fair value of pledged securities, lenders may require us to post additional collateral or pay down borrowings to re-establish agreed upon collateral requirements, referred to as margin calls. As of September 30, 2015 and December 31, 2014, we have met all margin call requirements and had no agency or non-agency repurchase agreements with original overnight maturities. Repurchase agreements are carried at cost, which approximates fair value due to their short-term nature.


15



As of September 30, 2015 and December 31, 2014, our borrowings under repurchase agreements had the following collateral characteristics (dollars in thousands):
 
 
September 30, 2015
 
December 31, 2014
 
 
 
 
Weighted Average
 
 
 
Weighted Average
Collateral Type
 
Borrowings
Outstanding
 
Interest Rate
 
Days
to Maturity
 
Borrowings
Outstanding
 
Interest Rate
 
Days
to Maturity
Agency securities (1)
 
$
2,741,464

 
0.53
%
 
260
 
$
4,002,291

 
0.42
 %
 
245
Non-agency securities
 
837,769

 
1.70
%
 
23
 
715,704

 
1.67
 %
 
20
U.S. Treasury securities (2)
 
226,157

 
0.43
%
 
1
 
705,635

 
(0.13
)%
 
7
Total repurchase agreements
 
$
3,805,390

 
0.78
%
 
192
 
$
5,423,630

 
0.51
 %
 
190
————————
(1)
Repurchase agreements borrowings secured by agency securities include $67.8 million of repurchase agreements related to agency RMBS sold but not yet settled as of September 30, 2015.
(2)  
Repurchase agreements borrowings secured by U.S. Treasury securities include $79.2 million of repurchase agreements related to U.S Treasury securities sold but not yet settled as of September 30, 2015.

The following table summarizes our borrowings under repurchase arrangements and weighted average interest rates classified by remaining maturities as of September 30, 2015 and December 31, 2014 (dollars in thousands):

 
September 30, 2015
 
December 31, 2014
 
 
 
 
Weighted Average
 
 
 
Weighted Average
 
 
Borrowings
Outstanding
 
Interest Rate
 
Days
to Maturity
 
Borrowings
Outstanding
 
Interest Rate
 
Days
to Maturity
Agency and non-agency
 
 
 
 
 
 
 
 
 
 
 
 
≤ 1 month
 
$
1,990,088

 
0.94
%
 
17
 
$
2,245,188

 
0.71
 %
 
13
> 1 to ≤ 2 months
 
342,811

 
0.49
%
 
47
 
568,014

 
0.55
 %
 
45
> 2 to ≤ 3 months
 
283,189

 
0.66
%
 
79
 
540,201

 
0.48
 %
 
74
> 3 to ≤ 6 months
 
348,145

 
0.66
%
 
117
 
508,216

 
0.43
 %
 
142
> 6 to ≤ 9 months
 

 
%
 
0
 
123,947

 
0.51
 %
 
246
> 9 to ≤ 12 months
 
100,000

 
0.61
%
 
351
 
217,429

 
0.51
 %
 
327
> 12 months
 
515,000

 
0.69
%
 
1132
 
515,000

 
0.63
 %
 
1405
Total
 
3,579,233

 
0.81
%
 
204
 
4,717,995

 
0.61
 %
 
210

 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
 
226,157

 
0.43
%
 
1
 
705,635

 
(0.13
)%
 
7
Total repurchase agreements
 
$
3,805,390

 
0.78
%
 
192
 
$
5,423,630

 
0.51
 %
 
190
We had repurchase agreements with 32 and 31 financial institutions as of September 30, 2015 and December 31, 2014, respectively. In addition, less than 5% of stockholders' equity was at risk due to collateral pledged in excess of borrowings under repurchase agreements with any one counterparty, with the top five counterparties representing less than 23% of our equity at risk as of September 30, 2015.

We had agency RMBS with fair values of $2.9 billion and $4.2 billion as of September 30, 2015 and December 31, 2014, respectively, and non-agency securities with fair values of $1.1 billion and $0.9 billion pledged as collateral against repurchase agreements as of September 30, 2015 and December 31, 2014, respectively.

Federal Home Loan Bank Advances

In April 2015, Woodmont was accepted for membership in the Federal Home Loan Bank ("FHLB") of Des Moines. As a member of the FHLB, Woodmont has access to a variety of products and services offered by the FHLB, including secured advances. The ability to borrow from the FHLB is subject to Woodmont's continued creditworthiness, pledging of sufficient eligible collateral to secure advances and compliance with certain agreements with the FHLB. Each advance requires approval

16



by the FHLB and is secured by collateral in accordance with the FHLB’s credit and collateral guidelines, as may be revised from time to time by the FHLB.

As of September 30, 2015, Woodmont had $487.9 million in outstanding secured advances, with a weighted average borrowing rate of 0.27%, a weighted average term to maturity of 4.9 years, floating monthly interest rate resets and a one month cancellation feature. These advances were collateralized by $320.8 million and $213.9 million in agency and non-agency securities, respectively, as of September 30, 2015.

The ability to borrow from the FHLB is subject to the Company pledging sufficient eligible collateral to secure advances and maintaining compliance with certain agreements with the FHLB. Each advance requires approval by the FHLB and is secured by collateral in accordance with the FHLB’s credit and collateral guidelines, as may be revised from time to time by the FHLB. Eligible collateral may include conventional one to four family residential mortgage loans, commercial real estate loans, agency RMBS and non-agency RMBS with credit ratings of A and above.

Note 7. Derivatives and Other Securities
In connection with our risk management strategy, we hedge a portion of our exposure to market risks, including interest rate risk, prepayment risk and credit risk, by entering into derivative and other hedging instrument contracts. We may enter into agreements for interest rate swaps, interest rate swaptions, interest rate cap or floor contracts and futures or forward contracts. We may also purchase or short TBA and U.S. Treasury securities, purchase or write put or call options on TBA securities or we may invest in other types of derivative securities, including synthetic total return swaps and credit default swaps. Our risk management strategy attempts to manage the overall risk of the portfolio and reduce fluctuations in book value. We do not use derivative or other hedging instruments for speculative purposes. Derivatives have not been designated as hedging instruments. We do not offset our derivatives and related cash collateral with the same counterparties under any master netting arrangements. For additional information regarding our derivative instruments and our overall risk management strategy, please refer to the discussion of derivatives in Note 3.

The table below presents the balance sheet location and fair value information for our derivatives outstanding as of September 30, 2015 and December 31, 2014 (in thousands):
 
 
September 30, 2015
 
December 31, 2014
Interest rate swaps
 
$

 
$
9,414

Interest rate swaptions
 
2,252

 
5,464

TBA securities
 
11,912

 
13,495

Interest only swaps
 
355

 
201

Derivative assets, at fair value
 
$
14,519

 
$
28,574

 
 
 
 
 
Interest rate swaps
 
$
75,261

 
$
73,052

TBA securities
 
1,511

 
1,863

Credit default swaps
 
1,528

 

U.S. Treasury futures
 
1,839

 
1,066

Derivative liabilities, at fair value
 
$
80,139

 
$
75,981



17



The following table summarizes the effect of our outstanding derivatives and other securities on our consolidated statements of operations during the three and nine months ended September 30, 2015 and 2014 (in thousands):

 
 
For the Three Months Ended September 30,
 
 
2015
 
2014
 
 
Realized Loss on Periodic Settlements of Interest Rate Swaps, net
Realized Gain (Loss) on Other Derivatives and Securities, net
Unrealized Gain (Loss) on Other Derivatives and Securities, net
 
Realized Loss on Periodic Settlements of Interest Rate Swaps, net
Realized Gain (Loss) on Other Derivatives and Securities, net
Unrealized Gain (Loss) on Other Derivatives and Securities, net
Interest rate swaps
 
$
(3,793
)
$
(23,540
)
$
(20,279
)
 
$
(5,226
)
$

$
13,445

Interest rate swaptions
 

(1,273
)
(1,085
)
 

(719
)
(514
)
TBA securities
 

(251
)
15,242

 

16,840

(15,004
)
U.S. Treasuries
 

1,899

72

 

(222
)
(145
)
U.S. Treasury futures
 

(2,156
)
(2,519
)
 

(653
)
559

Short sales of U.S. Treasuries
 

(3,389
)
(11,729
)
 

(2,964
)
(377
)
REIT equity investments
 



 

1,188

(1,375
)
Mortgage options
 



 

234

108

Interest only swaps
 

513

439

 



Credit default swaps
 

459

1,545

 



Credit default option
 

14

(340
)
 



Total
 
$
(3,793
)
$
(27,724
)
$
(18,654
)
 
$
(5,226
)
$
13,704

$
(3,303
)

 
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
 
Realized Loss on Periodic Settlements of Interest Rate Swaps, net
Realized Gain (Loss) on Other Derivatives and Securities, net
Unrealized Gain (Loss) on Other Derivatives and Securities, net
 
Realized Loss on Periodic Settlements of Interest Rate Swaps, net
Realized Gain (Loss) on Other Derivatives and Securities, net
Unrealized Gain (Loss) on Other Derivatives and Securities, net
Interest rate swaps
 
$
(12,537
)
$
(53,114
)
$
(13,103
)
 
$
(15,400
)
$
68

$
(64,757
)
Interest rate swaptions
 

(1,793
)
(1,419
)
 

(17,551
)
(8,882
)
TBA securities
 

13,249

(1,231
)
 

22,832

(3,086
)
U.S. Treasuries
 

10,993

(666
)
 

2,536

12,293

U.S. Treasury futures
 

(4,934
)
(773
)
 

(4,630
)
(2,202
)
Short sales of U.S. Treasuries
 

(8,473
)
(10,795
)
 

(8,928
)
(5,444
)
REIT equity investments
 



 

8,675

502

Mortgage options
 

22


 

234

(32
)
Interest only swaps
 

229

128

 



Credit default swaps
 

784

1,471

 



Credit default option
 

14


 



Total
 
$
(12,537
)
$
(43,023
)
$
(26,388
)
 
$
(15,400
)
$
3,236

$
(71,608
)

18




The following tables summarize changes in notional amounts for our outstanding derivatives and other securities for the nine months ended September 30, 2015 and 2014 (in thousands):
 
December 31, 2014
Notional
Amount
 
Additions/ Long Positions
 
Expirations/
Terminations/ Short Positions
 
September 30, 2015
Notional
Amount
Interest rate swaps
$
4,015,000

 
275,000

 
(2,000,000
)
 
$
2,290,000

Interest rate swaptions
$
550,000

 

 
(150,000
)
 
$
400,000

TBA securities
$
296,172

 
24,366,983

 
(24,132,682
)
 
$
530,473

U.S. Treasuries
$
756,500

 
3,150,750

 
(3,759,750
)
 
$
147,500

U.S. Treasury futures
$
(150,000
)
 
450,000

 
(450,000
)
 
$
(150,000
)
Short sales of U.S. Treasuries
$
(228,500
)
 
1,143,200

 
(1,514,700
)
 
$
(600,000
)
Mortgage options
$

 
50,000

 
(50,000
)
 
$

Interest only swaps
$
48,739

 

 
(6,988
)
 
$
41,751

Credit default swaps
$

 
99,500

 
(50,000
)
 
$
49,500

Credit default options
$

 
50,000

 
(50,000
)
 
$


 
December 31, 2013
Notional
Amount
 
Additions/ Long Positions
 
Expirations/
Terminations/ Short Positions
 
September 30, 2014
Notional
Amount
Interest rate swaps
$
3,240,000

 
875,000

 
(150,000
)
 
$
3,965,000

Interest rate swaptions
$
2,100,000

 
275,000

 
(1,900,000
)
 
$
475,000

TBA securities
$
(773,816
)
 
15,525,174

 
(13,834,986
)
 
$
916,372

U.S. Treasuries
$
656,000

 
832,570

 
(1,016,570
)
 
$
472,000

U.S. Treasury futures
$
(150,000
)
 
450,000

 
(450,000
)
 
$
(150,000
)
Short sales of U.S. Treasuries
$
(23,000
)
 
1,085,500

 
(1,797,000
)
 
$
(734,500
)
Mortgage options
$

 
100,000

 
(200,000
)
 
$
(100,000
)
Interest Rate Swap Agreements
As of September 30, 2015 and December 31, 2014, our derivative portfolio included interest rate swaps, which have the effect of modifying the repricing characteristics of our repurchase agreements and cash flows on such liabilities. Our interest rate swaps are used to manage the interest rate risk created by our use of short-term repurchase agreements. Under our interest rate swaps, we typically pay a fixed rate and receive a floating rate based on LIBOR with terms usually ranging up to 15 years. As of September 30, 2015 and December 31, 2014, we had interest rate swap agreements summarized in the tables below (dollars in thousands).
 
 
 
 
September 30, 2015
 
December 31, 2014
Interest Rate Swaps
 
Balance Sheet Location
 
Notional Amount
 
Fair Value
 
Notional Amount
 
Fair Value
Interest rate swap assets
 
Derivative assets, at fair value
 
$

 
$

 
$
925,000

 
$
9,414

Interest rate swap liabilities
 
Derivative liabilities, at fair value
 
2,290,000

 
(75,261
)
 
3,090,000

 
(73,052
)
 
 
 
 
$
2,290,000

 
$
(75,261
)
 
$
4,015,000

 
$
(63,638
)

19



September 30, 2015

 
Notional
Amount
 
Fair Value
 
Weighted Average
Current Maturity Date for Interest Rate Swaps (1)
 
 
 
Fixed
Pay Rate
(2)
 
Receive 
Rate (3)
 
Maturity
(Years)
 ≤ 3 years
 
$
865,000


$
(6,407
)

1.09
%

0.32
%

2.1
> 3 to ≤ 5 years
 
550,000


(11,219
)

1.72
%

0.32
%

3.7
> 5 to ≤ 7 years
 
625,000


(43,044
)

3.16
%

0.31
%

6.1
> 7 years
 
250,000


(14,591
)

2.71
%

0.31
%

8.2
Total
 
$
2,290,000


$
(75,261
)

1.98
%

0.32
%

4.2
December 31, 2014
 
 
Notional
Amount
 
Fair Value
 
Weighted Average
Current Maturity Date for Interest Rate Swaps (4)
 
 
 
Fixed
Pay Rate
(2)
 
Receive 
Rate
(3)
 
Maturity
(Years)
 ≤ 3 years
 
$
1,065,000

 
$
(1,635
)
 
0.97
%
 
0.23
%
 
1.6
> 3 to ≤ 5 years
 
850,000

 
(4,441
)
 
1.91
%
 
0.23
%
 
4.2
> 5 to ≤ 7 years
 
1,625,000

 
(38,780
)
 
2.66
%
 
0.23
%
 
6.0
> 7 years
 
475,000

 
(18,782
)
 
2.87
%
 
0.25
%
 
8.2
Total
 
$
4,015,000

 
$
(63,638
)
 
2.08
%
 
0.23
%
 
4.7
————————
(1) 
Includes swaps with an aggregate notional of $0.7 billion with deferred start dates averaging 0.8 years from September 30, 2015.
(2) 
Excluding forward starting swaps, the weighted average pay rate was 1.36% and 1.24% as of September 30, 2015 and December 31, 2014, respectively.
(3) 
Weighted average receive rate excludes impact of forward starting interest rate swaps.
(4) 
Includes swaps with an aggregate notional of $2.1 billion with deferred start dates averaging 1.1 years from December 31, 2014.
As of September 30, 2015, interest rate swaps with a notional amount of $1.2 billion and liability fair value of $(62.8) million were centrally cleared on a registered exchange.

20



Interest Rate Swaption Agreements
Our interest rate swaption agreements provide us the option to enter into interest rate swap agreements in the future where we would pay a fixed rate and receive LIBOR. The following tables present certain information about our interest rate swaption agreements as of September 30, 2015 and December 31, 2014 (dollars in thousands):
September 30, 2015
 
 
Option
 
Underlying Swap
Current Option Expiration Date
 
Cost
 
Fair Value
 
Weighted Average Years to Expiration
 
Notional Amount
 
Pay Rate
 
Weighted Average Term (Years)
 
 
 
 
 
 
≤ 3 months
 
$
5,359

 
$
1,439

 
0.2
 
$
200,000

 
3.12
%
 
9.6
> 3 to ≤ 12 months
 
1,308

 
7

 
0.5
 
100,000

 
4.13
%
 
7.0
> 24 months
 
2,735

 
806

 
2.1
 
100,000

 
3.21
%
 
5.0
Total / weighted average
 
$
9,402

 
$
2,252

 
0.8
 
$
400,000

 
3.40
%
 
7.8
December 31, 2014
 
 
Option
 
Underlying Swap
Current Option Expiration Date
 
Cost
 
Fair Value
 
Weighted Average Years to Expiration
 
Notional Amount
 
Pay Rate
 
Weighted Average Term (Years)
 
 
 
 
 
 
≤ 3 months
 
$
4,013

 
$
1,972

 
0.1
 
$
150,000

 
2.78
%
 
4.3
> 3 to ≤ 12 months
 
3,139

 
1,432

 
0.9
 
200,000

 
3.29
%
 
8.8
>12 to ≤ 24 months
 
1,308

 
207

 
1.3
 
100,000

 
4.13
%
 
7.0
> 24 months
 
2,735

 
1,853

 
2.9
 
100,000

 
3.21
%
 
5.0
Total / weighted average
 
$
11,195

 
$
5,464

 
1.1
 
$
550,000

 
3.29
%
 
6.5
TBA Securities
As of September 30, 2015 and December 31, 2014, we had contracts to purchase ("long position") and sell ("short position") TBA securities on a forward basis, presented in the following table (in thousands): 
 
 
September 30, 2015
 
December 31, 2014
Purchase and Sale Contracts for TBA Securities
 
Notional 
Amount (1)

Fair
Value (2)

Notional 
Amount (1)

Fair
Value (2)
TBA assets
 
 
 
 
 
 
 
 
Purchase of TBA securities
 
$
886,364

 
$
10,751

 
$
829,030

 
$
8,226

Sale of TBA securities
 
(103,869
)
 
1,161

 
(74,758
)
 
5,269

Total TBA assets
 
782,495

 
11,912

 
754,272

 
13,495

 
 
 
 
 
 
 
 
 
TBA liabilities
 
 
 
 
 
 
 
 
Purchase of TBA securities
 

 

 
199,000

 
(595
)
Sale of TBA securities
 
(252,022
)
 
(1,511
)
 
(657,100
)
 
(1,268
)
Total TBA liabilities
 
(252,022
)
 
(1,511
)
 
(458,100
)
 
(1,863
)
Total net TBA
 
$
530,473

 
$
10,401

 
$
296,172

 
$
11,632

————————
(1) 
Notional amount represents the par value or principal balance of the underlying agency security.
(2) 
Fair value represents the current market value of the agency RMBS underlying the TBA contract as of period end, less the forward price to be paid for the underlying agency RMBS.

21



U.S. Treasury Securities and Futures
We purchase or sell short U.S. Treasury securities and U.S. Treasury futures contracts to help mitigate the potential impact of changes in interest rates on the performance of our portfolio. We had U.S. Treasury securities with a fair value of $147.5 million and $758.6 million and a face amount of $147.5 million and $756.5 million as of September 30, 2015 and December 31, 2014, respectively, which are presented as U.S. Treasury securities, at fair value on the consolidated balance sheets. In addition, we had short positions in U.S. Treasury futures with a notional amount of $(150.0) million as of both September 30, 2015 and December 31, 2014. These short U.S. Treasury futures had fair values of $(1.8) million and $(1.1) million as of September 30, 2015 and December 31, 2014, respectively, and are presented in derivative assets (liabilities), at fair value on the consolidated balance sheets.
Credit Risk-Related Contingent Features
The use of derivatives creates exposure to credit risk relating to potential losses that could be recognized in the event that the counterparties to these instruments fail to perform their obligations under the contracts. We minimize this risk by limiting our counterparties for instruments which are not centrally cleared on a registered exchange to major financial institutions with acceptable credit ratings and monitoring positions with individual counterparties. In addition, both we and our counterparties may be required to pledge assets as collateral for our derivatives, whose amounts vary over time based on the market value, notional amount and remaining term of the derivative contract. In the event of a default by a counterparty, we may not receive payments provided for under the terms of our derivative agreements, and may have difficulty obtaining our assets pledged as collateral for our derivatives. The cash and cash equivalents pledged as collateral for our derivative instruments is included in restricted cash and cash equivalents on our consolidated balance sheets.
Each of our ISDA Master Agreements contains provisions pursuant to which we are required to fully collateralize our obligations under our interest rate swap agreements if at any point the fair value of the swap represents a liability greater than the minimum transfer amount contained within our ISDA Master Agreements. We are also required to post initial collateral upon execution of certain of our swap transactions. If we breach any of these provisions, we will be required to settle our obligations under the agreements at their termination values, which approximates fair value.
Further, each of our ISDA Master Agreements also contains a cross default provision under which a default under certain of our other indebtedness in excess of a certain threshold causes an event of default under the agreement. Threshold amounts vary by lender. Following an event of default, we could be required to settle our obligations under the agreements at their termination values. Additionally, under certain of our ISDA Master Agreements, we could be required to settle our obligations under the agreements at their termination values if we fail to maintain either our REIT status or certain minimum stockholders’ equity thresholds, or comply with limits on our leverage above certain specified levels. As of September 30, 2015, the fair value of the additional collateral that could be required to be posted as a result of the credit-risk related contingent features being triggered was not material to our consolidated financial statements.

Concerning our non-centrally cleared interest rate swap and swaption agreements, we did not have counterparty credit risk with any single counterparty in excess of 1% of our stockholders’ equity, as of September 30, 2015.

In the case of centrally cleared interest rate swap contracts, we could be exposed to credit risk if the central clearing agency or a clearing member defaults on its respective obligation to perform under the contract; however, the risk is considered minimal due to initial and daily exchange of mark to market margin requirements and the clearinghouse guarantee fund and other resources that are available in the event of a clearing member default.


22



Note 8. Offsetting Assets and Liabilities
Certain of our repurchase agreements and derivative transactions are governed by underlying agreements that generally provide for a right of offset under master netting arrangements (or similar agreements), including in the event of default or in the event of bankruptcy of either party to the transactions.  We present our assets and liabilities subject to such arrangements on a gross basis in our consolidated balance sheets. 
The following tables present information about our assets and liabilities that are subject to such agreements and can potentially be offset on our consolidated balance sheets as of September 30, 2015 and December 31, 2014 (in thousands):

Offsetting of Financial Assets and Derivative Assets:
 
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Amounts Presented
in the Consolidated Balance Sheets
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
 
 
 
 
 
Financial Instruments
 
Collateral Received (1)
 
Net Amount
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps and swaptions (2)(3)
 
$
2,252

 
$

 
$
2,252

 
$
(1,444
)
 
$
(806
)
 
$
2

Receivable under reverse repurchase agreements
 
691,772

 

 
691,772

 
(631,135
)
 
(60,637
)
 

Total
 
$
694,024

 
$

 
$
694,024

 
$
(632,579
)
 
$
(61,443
)
 
$
2

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps and swaptions (2)
 
$
14,878

 
$

 
$
14,878

 
$
(5,192
)
 
$
(3,059
)
 
$
6,627

Receivable under reverse repurchase agreements
 
214,399

 

 
214,399

 
(214,399
)
 

 

Total
 
$
229,277

 
$

 
$
229,277

 
$
(219,591
)
 
$
(3,059
)
 
$
6,627


Offsetting of Financial Liabilities and Derivative Liabilities:
 
 
Gross Amounts of Recognized Liabilities
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Amounts Presented
in the Consolidated Balance Sheets
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
 
 
 
 
 
Financial Instruments
 
Collateral Pledged (1)
 
Net Amount
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps (2)
 
$
75,261

 
$

 
$
75,261

 
$
(1,444
)
 
$
(73,817
)
 
$

Repurchase agreements
 
3,805,390

 

 
3,805,390

 
(631,135
)
 
(3,174,255
)
 

FHLB advances
 
487,900

 

 
487,900

 

 
(487,900
)
 

Total
 
$
4,368,551

 
$

 
$
4,368,551

 
$
(632,579
)
 
$
(3,735,972
)
 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps (2)
 
$
73,052

 
$

 
$
73,052

 
$
(5,192
)
 
$
(67,860
)
 
$

Repurchase agreements
 
5,423,630

 

 
5,423,630

 
(214,399
)
 
(5,209,231
)
 

Total
 
$
5,496,682

 
$

 
$
5,496,682

 
$
(219,591
)
 
$
(5,277,091
)
 
$

————————
(1)
Includes cash and securities received / pledged as collateral, at fair value. Amounts presented are limited to collateral pledged sufficient to reduce the net amount to zero on a counterparty by counterparty basis, as applicable. Refer to Notes 4 and 5 for additional information regarding assets pledged as collateral.
(2) 
Reported under derivative assets / liabilities, at fair value in the accompanying consolidated balance sheets. Refer to Note 7 for a reconciliation of derivative assets / liabilities, at fair value to their sub-components.
(3) 
Interest rate swaps and swaptions are subject to master netting arrangements which could reduce our maximum amount of loss due to credit risk by $1.4 million as of September 30, 2015.

23



Note 9. Fair Value Measurements
We have elected the option to account for all of our financial assets, including RMBS, at fair value, with changes in fair value reflected in income during the period in which they occur. We have determined that this presentation most appropriately represents our financial results and position. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, based on the assumptions market participants would use when pricing an asset or liability.
We determine the fair value of our agency and non-agency securities, including securities held as collateral, based upon fair value estimates obtained from multiple third-party pricing services and dealers. In determining fair value, third-party pricing sources use various valuation approaches, including market and income approaches. Factors used by third-party sources in estimating the fair value of an instrument may include observable inputs such as recent trading activity, credit data, volatility statistics, and other market data that are current as of the measurement date. The availability of observable inputs can vary by instrument and is affected by a wide variety of factors, including the type of instrument, whether the instrument is new and not yet established in the marketplace and other characteristics particular to the instrument. Third-party pricing sources may also use certain unobservable inputs, such as assumptions of future levels of prepayment, default and loss severity, especially when estimating fair values for securities with lower levels of recent trading activity. When possible, we make inquiries of third-party pricing sources to understand their use of significant inputs and assumptions.
We review the various third-party fair value estimates and perform procedures to validate their reasonableness, including an analysis of the range of third-party estimates for each position, comparison to recent trade activity for similar securities, and our Manager's review for consistency with market conditions observed as of the measurement date. While we do not adjust prices we obtain from third-party pricing sources, we will exclude third-party prices for securities from our determination of fair value if we determine (based on our validation procedures and our Manager's market knowledge and expertise) that the price is significantly different than observable market data would indicate and we cannot obtain a satisfactory understanding from the third party source as to the significant inputs used to determine the price.

We determine the fair value of our MSR based upon third party estimates, corroborated by internally developed discounted cash flow models that utilize observable market-based inputs and include substantial unobservable market data inputs (including prepayment speeds, delinquency levels and discount rates).
We utilize a three-level valuation hierarchy for disclosure of fair value measurement. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument’s categorization within the hierarchy is based upon the lowest level of input that is significant to the fair value measurement. We use the results of the validation procedures described above as part of our determination of the appropriate fair value measurement hierarchy classification. The three levels of hierarchy are defined as follows:
Level 1 Inputs - Quoted prices (unadjusted) for identical unrestricted assets and liabilities in active markets that are accessible at the measurement date.
Level 2 Inputs - Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 Inputs - Significant unobservable market inputs that are supported by little or no market activity. The unobservable inputs represent the assumptions that market participants would use to price the assets and liabilities.

24



The following tables present our financial instruments carried at fair value as of September 30, 2015 and December 31, 2014, on the consolidated balance sheets by the valuation hierarchy, as described above (in thousands):
 
 
September 30, 2015
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
Agency securities
 
$

 
$
3,356,523

 
$

 
$
3,356,523

Non-agency securities
 

 
1,479,586

 

 
1,479,586

U.S. Treasury securities
 
147,454

 

 

 
147,454

Derivative assets
 

 
14,519

 

 
14,519

MSR assets
 

 

 
83,495

 
83,495

Total
 
$
147,454

 
$
4,850,628

 
$
83,495

 
$
5,081,577

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Derivative liabilities
 
$

 
$
80,139

 
$

 
$
80,139

Obligation to return securities borrowed under reverse repurchase agreements
 
603,709

 

 

 
603,709

MSR financing liabilities
 

 

 
13,656

 
13,656

Total
 
$
603,709

 
$
80,139

 
$
13,656

 
$
697,504

 
 
December 31, 2014
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
Agency securities
 
$

 
$
4,384,139

 
$

 
$
4,384,139

Non-agency securities
 

 
1,168,834

 

 
1,168,834

U.S. Treasury securities
 
758,629

 

 

 
758,629

Derivative assets
 

 
28,574

 

 
28,574

MSR assets
 

 

 
93,640

 
93,640

Total
 
$
758,629

 
$
5,581,547

 
$
93,640

 
$
6,433,816

 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
Derivative liabilities
 
$

 
$
75,981

 
$

 
$
75,981

Obligation to return securities borrowed under reverse repurchase agreements
 
230,136

 

 

 
230,136

MSR financing liabilities
 

 

 
14,003

 
14,003

Total
 
$
230,136

 
$
75,981

 
$
14,003

 
$
320,120

Our agency and non-agency securities are valued using the various market data described above, which include inputs determined to be observable or whose significant value drivers are observable. Accordingly, our agency and non-agency securities are classified as Level 2 in the fair value hierarchy as of September 30, 2015.
For information regarding valuation of our derivative instruments, please refer to the discussion of derivative and other hedging instruments in Note 3. Our interest rate swaps and other derivatives are classified as Level 2 in the fair value hierarchy.
The fair value of our obligation to return securities borrowed under reverse repurchase agreements is based upon the value of the underlying borrowed U.S. Treasury securities as of the reporting date. Both U.S. Treasury securities and our obligation to return borrowed U.S. Treasury securities are classified as Level 1 in the fair value hierarchy.
Excluded from the table above are financial instruments, including cash and cash equivalents, restricted cash, receivables, payables, borrowings under repurchase agreements and FHLB advances, which are presented in our consolidated financial statements at cost, which is determined to approximate fair value, primarily due to the short duration of these instruments.  The

25



cost basis of repurchase agreement borrowings with initial terms of greater than one year is determined to approximate fair value, primarily as such agreements have floating rates based on an index plus or minus a fixed spread and the fixed spread is generally consistent with those demanded in the market. We estimate the fair value of these instruments using Level 2 inputs.
The following table presents a summary of the changes in fair value for Level 3 assets carried at fair value for the nine months ended September 30, 2015 and 2014 (in thousands):
 
 
For the Nine Months Ended September 30, 2015
 
 
MSR Under Secured Financing (1)
 
Purchased MSR (2)
 
Total MSR
Balance as of December 31, 2014
 
$
14,003

 
$
79,637

 
$
93,640

Losses included in net income:
 
 
 
 
 
 
Realized losses
 
(1,632
)
 
(7,875
)
 
(9,507
)
Unrealized gains (losses)
 
1,285

 
(3,591
)
 
(2,306
)
Total net losses included in net income
 
(347
)
 
(11,466
)
 
(11,813
)
Purchases, net of purchase price adjustments
 

 
1,668

 
1,668

Balance as of September 30, 2015
 
$
13,656

 
$
69,839

 
$
83,495


 
 
For the Nine Months Ended September 30, 2014
 
 
MSR Under Secured Financing (1)
 
Purchased MSR (2)
 
Total MSR
Balance as of December 31, 2013
 
$
15,608

 
$

 
$
15,608

Losses included in net income:
 
 
 
 
 
 
Realized losses
 
(968
)
 
(2,830
)
 
(3,798
)
Unrealized losses
 
(170
)
 
(3,705
)
 
(3,875
)
Total net losses included in net income
 
(1,138
)
 
(6,535
)
 
(7,673
)
Purchases, net of purchase price adjustments
 

 
92,379

 
92,379

Balance as of September 30, 2014
 
$
14,470

 
$
85,844

 
$
100,314

————————
(1)
Losses related to MSR under secured financing are offset in their entirety by gains associated with related MSR financing liabilities.
(2) 
Realized losses on purchased MSR are included in servicing expense and unrealized gains (losses) on purchased MSR are included in unrealized gain (loss) on mortgage servicing rights on the consolidated statements of operations.
We use third-party pricing providers in the fair value measurement of our Level 3 MSR. The significant unobservable inputs used in estimating the fair value measurement of our Level 3 MSR assets and financing liabilities include assumptions for underlying loan constant prepayment rates and delinquency rates, as well as discount rates. We review the various third-party fair value estimates used to determine the fair value of our MSR and perform procedures to validate their reasonableness. In reviewing the estimated fair values of our Level 3 MSR, we use internal models and estimates of prepayment and
delinquency rates on the loans underlying our MSR.
The following table presents the range of our estimates of loan constant voluntary prepayment rates and constant default rates, together with the discount rates used by third-party pricing providers in estimating the fair value of our Level 3 MSR as of September 30, 2015 (dollars in thousands):

26



 
 
September 30, 2015
Unobservable Level 3 Input
 
Fair Value
 
Minimum
 
Weighted
Average
 
Maximum
MSR treated as financing arrangements:
 
$
13,656

 
 
 
 
 
 
Constant prepayment rate
 
 
 
4.0%
 
15.2%
 
37.2%
Constant default rate
 
 
 
2.5%
 
7.8%
 
30.9%
Discount rate
 
 
 
12.0%
 
12.0%
 
12.0%
Purchased MSR:
 
69,839

 
 
 
 
 
 
Constant prepayment rate
 
 
 
8.7%
 
8.9%
 
9.1%
Constant default rate
 
 
 
0.2%
 
0.3%
 
0.4%
Discount rate
 
 
 
8.3%
 
8.9%
 
9.3%
Total
 
$
83,495

 
 
 
 
 
 
Our MSR treated as financing arrangements relate to private label mortgages with an average origination year of 2005, whereas our purchased MSR relate to more recently originated mortgages that conform to GSE underwriting standards. Private label originations from the pre-2009 era have experienced heightened default rates relative to recently originated conforming mortgages. As such, we anticipate that the default rate and discount rate for our MSR treated as financing arrangements will exceed the default rate and discount rate for our purchased MSR.
A significant increase in any one of these individual inputs in isolation would likely result in a decrease in fair value measurement. Additionally, a change in the assumption used for discount rates may be accompanied by a directionally similar change in the assumption used for the probability of delinquency and a directionally opposite change in the assumption used for prepayment rates. Overall MSR market conditions could have a more significant impact on our Level 3 fair values than changes in any one unobservable input.
Note 10. Mortgage Servicing Rights
Our $83.5 million balance of MSR as of September 30, 2015 includes $13.7 million related to RCS' acquisition of certain MSR covering private label residential mortgage pools, for which RCS entered into sale and assignment agreements with a third party to transfer its interest in the excess MSR while retaining the actual servicing function. These transfers do not qualify for sale accounting and are treated as financing arrangements, under which we recognize both MSR assets and corresponding MSR financing liabilities. Changes in the fair value of assets and liabilities resulting from MSR financing transactions have no net impact on the consolidated statements of operations.
RCS purchased the remaining $69.8 million of MSR under transactions qualifying for sale accounting, representing approximately 32 thousand underlying loans, with a combined unpaid principal balance of approximately $6.6 billion, as of September 30, 2015. We have elected to account for all MSR assets and MSR financing liabilities at estimated fair value with changes in fair value reported in net income. The following table summarizes activity related to MSR accounted for as purchases during the nine months ended September 30, 2015 and 2014 (dollars in thousands):
 
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
Beginning balance
 
$
79,637

 
$

Additions from purchases of MSR
 
1,668

 
93,414

Changes in fair value due to:
 
 
 
 
Changes in valuation inputs or assumptions used in valuation model
 
(3,591
)
 
(3,705
)
Other changes in fair value (1)
 
(7,875
)
 
(2,830
)
Other changes (2)
 

 
(1,035
)
Ending balance
 
$
69,839

 
$
85,844

————————
1.
Other changes in fair value primarily represents changes due to the realization of cash flows.
2.
Other changes includes purchase price adjustments related to contractual prepayment protection.

27



The following table presents the components of net servicing loss for the three and nine months ended September 30, 2015 and 2014 (dollars in thousands):
 
 
For the Three Months Ended September 30,

For the Nine Months Ended September 30,
 
 
2015

2014

2015

2014
Servicing fee income
 
$
8,312


$
9,247


$
24,046


$
22,572

Incentive, ancillary and other income
 
3,264


3,834


10,722


11,462

Servicing income
 
11,576


13,081


34,768


34,034

 
 







Employee compensation and benefit costs
 
7,907


8,678


22,926


25,353

Facility costs
 
2,450


3,831


7,870


10,111

Realization of cash flows from MSR
 
2,642


1,728


7,875


2,830

Other servicing costs
 
2,581


1,976


8,478


6,567

Servicing expense
 
15,580


16,213


47,149


44,861

 
 
 
 
 
 
 
 
 
Net servicing loss
 
$
(4,004
)

$
(3,132
)

$
(12,381
)

$
(10,827
)
Risk Mitigation Activities
The Company’s acquisitions of MSR expose us to certain risks, including interest rate risk and representation and warranty risk. A significant decline in interest rates could lead to higher-than-expected prepayments that could reduce the value of the MSR. Our primary method of managing the prepayment risk associated with our MSR portfolio is asset selection, both in respect of products and the originators of the underlying loans. Representation and warranty risk refers to the representations and warranties we make (or are deemed to have made) to the applicable investor (including, without limitation, the GSEs) regarding, among other things, the origination and servicing of mortgage loans with respect to which we have acquired MSR. We mitigate representation and warranty risk through our due diligence in connection with MSR acquisitions, including counterparty reviews and loan file reviews, as well as negotiated contractual protections from our MSR transaction counterparties with respect to origination and prior servicing.
Note 11. Other Assets
The following table summarizes our other assets as of September 30, 2015 and December 31, 2014 (dollars in thousands):
 
 
September 30, 2015
 
December 31, 2014
Property and equipment, at cost
 
$
4,969

 
$
4,809

Accumulated depreciation
 
(2,932
)
 
(1,877
)
Net property and equipment
 
2,037

 
2,932

Servicing advances
 
21,652

 
24,393

FHLB membership stock
 
19,526

 

Prepaid expenses
 
5,762

 
7,089

Intangible asset
 
5,000

 
15,000

Other
 
4,039

 
6,052

Total other assets
 
$
58,016

 
$
55,466

Servicing Advances
We are required to fund cash advances in connection with our servicing operations. These servicing advances are reported within other assets on the consolidated balance sheets and represent advances for principal and interest, property taxes and insurance, as well as certain out-of-pocket expenses incurred by the Company in the performance of its servicing obligations.

28



Federal Home Loan Bank Membership Stock

As a condition of our membership in the FHLB of Des Moines, we are obligated to purchase membership and activity-based stock in the FHLB based upon the aggregate amount of advances. As of September 30, 2015, we held $19.5 million of membership and activity-based stock. FHLB stock is carried at cost, which equals par value, and can only be redeemed or sold at its par value, and only to the FHLB of Des Moines.
Impairment of Intangible Asset

During the three months ended September 30, 2015, we recorded a $(10.0) million intangible asset impairment charge based on a revised estimated fair value of RCS’ servicing licenses and approvals.  We reduced our estimate of the intangible asset’s fair value as a result of certain financial and economic factors, including the current secondary market for mortgage servicing rights. The fair value of intangible assets of $5.0 million as of September 30, 2015 was estimated based upon a combination of internal models and third party inputs and is considered a Level 3 measurement.

Note 12. Accounts Payable and Other Accrued Liabilities
The following table summarizes our accounts payable and other accrued liabilities as of September 30, 2015 and December 31, 2014 (dollars in thousands):
 
 
September 30, 2015
 
December 31, 2014
Cash collateral held on derivatives
 
$
821

 
$
2,298

Due to manager
 
1,803

 
1,763

Swaption premium payable
 

 
520

Payable for MSR purchased
 
171

 
2,680

Accrued interest
 
5,975

 
4,642

MSR, at fair value (1)
 
13,656

 
14,003

Other accounts payable and accrued expenses
 
18,017

 
15,501

Total accounts payable and other accrued liabilities
 
$
40,443

 
$
41,407

—————— 
(1)
MSR financing represents our obligations associated with excess MSR transferred to a third party which are accounted for as financing arrangements. We have elected the option to account for MSR financing at estimated fair value with changes in fair value reported in net income.
Note 13. Stockholders’ Equity

Redeemable Preferred Stock

Pursuant to our charter, we are authorized to designate and issue up to 50.0 million shares of preferred stock in one or more classes or series. Our Board of Directors has designated 2.3 million shares as 8.125% Series A Cumulative Redeemable Preferred Stock ("Series A Preferred Stock"). As of September 30, 2015, we had 47.8 million of authorized but unissued shares of preferred stock. Shares of our Series A Preferred Stock are redeemable at $25.00 per share plus accumulated and unpaid dividends (whether or not declared) exclusively at our option commencing on May 22, 2019, or earlier under certain circumstances intended to preserve our qualification as a REIT for Federal income tax purposes. Dividends are payable quarterly in arrears on the 15th day of each January, April, July and October. As of September 30, 2015, we had declared all required quarterly dividends on the Series A Preferred Stock.

Our Board of Directors may designate additional series of authorized preferred stock ranking junior to or in parity with
the Series A Preferred Stock or designate additional shares of the Series A Preferred Stock and authorize the issuance of such
shares.

Common Stock Repurchase Program

Our Board of Directors adopted a program that authorizes repurchases of our common stock up to a specified amount. In
October 2015, our Board of Directors extended its authorization through December 31, 2016. Shares of our common stock may be purchased in the open market, including through block purchases, or through privately negotiated transactions, or

29



pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The timing, manner, price and amount of any repurchases will be determined at our discretion and the program may be suspended, terminated or modified at any time for any reason. Among other factors, we intend to only consider repurchasing shares of our common stock when the purchase price is less than our estimate of our current net asset value per common share. Generally, when we repurchase our common stock at a discount to our net asset value, the net asset value of our remaining shares of common stock outstanding increases. In addition, we do not intend to repurchase any shares from directors, officers or other affiliates. The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.

During the three and nine months ended September 30, 2015, we repurchased approximately 1.2 million shares of our common stock at an average repurchase price of $15.29 per share, including expenses, totaling $18.1 million. As of September 30, 2015, we had $116.9 million authorized for additional repurchases of our common stock.

Long-Term Incentive Plan

We sponsor the American Capital Mortgage Investment Corp. Amended and Restated Equity Incentive Plan ("Incentive Plan" or "plan") to provide for the issuance of equity-based awards, including stock options, restricted stock, restricted stock units ("RSU") and unrestricted stock. We issued 27,244 shares of common stock related to the time vesting of RSU awards during the nine months ended September 30, 2015. We issued 22,839 shares of common stock related to the time vesting of RSU awards during the year ended December 31, 2014.

Net Income per Common Share

Basic net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share assumes the conversion, exercise or issuance of all potential common stock equivalents unless the effect is to reduce a loss or increase the income per share. Shares subject to performance conditions have been excluded from diluted net income per common share.

The following summarizes the net income per common share for the three and nine months ended September 30, 2015 and 2014 (in thousands, except per share data):
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Weighted average common shares calculation:
 
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
 
50,815

 
51,142

 
51,052

 
51,185

Effect of stock based compensation
 
13

 
16

 
12

 
7

Diluted weighted average common shares outstanding
 
50,828

 
51,158

 
51,064

 
51,192

Net income (loss) available to common shareholders
 
$
(25,129
)
 
$
7,176

 
$
(36,257
)
 
$
139,749

Net income (loss) per common share — basic and diluted
 
$
(0.49
)
 
$
0.14

 
$
(0.71
)
 
$
2.73




30



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") provides readers of our consolidated financial statements a narrative from the perspective of management, and should be read in conjunction with the consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q. Our MD&A is presented in six sections:
Executive Overview
Financial Condition
Results of Operations
Liquidity and Capital Resources
Off-Balance Sheet Arrangements
Forward-Looking Statements
EXECUTIVE OVERVIEW
The size and composition of our investment portfolio depend on investment strategies implemented by our Manager, the accessibility of investment capital and overall market conditions, including the availability of attractively priced investments and suitable financing to leverage our investment portfolio appropriately. Market conditions are influenced by, among other things, current levels of and expectations for future levels of interest rates, mortgage prepayments, market liquidity, housing prices, unemployment rates, general economic conditions, government participation in the mortgage market, and regulations or legal settlements that impact other real estate-related activities.
Our Investment Strategy
Our objective is to provide attractive risk-adjusted returns to our stockholders over the long-term through a combination of dividends and net book value appreciation. In pursuing this objective, we rely on our Manager's expertise to construct and manage a diversified real estate-related investment portfolio by identifying investments that, when properly financed and hedged, produce attractive returns across a variety of market conditions and economic cycles, when compared to the risks associated with owning such investments. Specifically, our investment strategy is designed to:
manage a leveraged portfolio of real estate-related investments to generate attractive risk-adjusted returns;
capitalize on discrepancies in the relative valuations in the real estate-related investments market;
manage financing, interest rate, prepayment rate and credit risks;
preserve our net book value;
provide regular quarterly distributions to our stockholders;
qualify as a REIT; and
remain exempt from the requirements of the Investment Company Act of 1940, as amended (the "Investment Company Act").
Our Risk Management Strategy
We use a variety of strategies to hedge a portion of our exposure to market risks, including interest rate, prepayment, extension and credit risks and certain risks related to our healthcare-related real estate investments to the extent that our Manager deems prudent, taking into account our investment strategy, the cost of the hedging transactions and our intention to qualify as a REIT. As a result, we may not hedge certain interest rate, prepayment, extension or credit risks if our Manager believes that bearing such risks enhances our return relative to our risk/return profile, or would negatively impact our REIT status.
Interest Rate Risk. We hedge some of our exposure to potential interest rate mismatches between the interest we earn on our longer term investments and the interest we pay on our shorter term borrowings. Because a majority of our funding is in the form of repurchase agreements, our financing costs fluctuate based on short-term interest rate indices, such as the London Interbank Offered Rate, or LIBOR. Because the vast majority of our investments are assets that have fixed rates of interest and could mature in up to 40 years, the interest we earn on those assets generally does not move in tandem with the interest rates that we pay on our financing repurchase agreements, which generally have a maturity of less than one year. We may experience reduced income, losses, or a significant reduction in our book value due to adverse interest rate movements. In order to attempt to mitigate a portion of such

31



risk, we utilize certain hedging techniques to attempt to lock in a portion of the net spread between the interest we earn on our assets and the interest we pay on our financing arrangements.
Additionally, because prepayments on residential mortgages generally accelerate when interest rates decrease and slow when interest rates increase, mortgage securities typically have "negative convexity." In other words, certain mortgage securities in which we invest may increase in price more slowly than similar duration bonds or even fall in value as interest rates decline. Conversely, certain mortgage securities in which we invest may decrease in value more quickly than similar duration bonds as interest rates increase. In order to manage this risk, we monitor, among other things, the "duration gap" between our mortgage assets and our hedge portfolio as well as our convexity exposure. Duration is an estimate of the relative expected percentage change in market value of our mortgage assets or our hedge portfolio that would be caused by a parallel change in short and long-term interest rates. Convexity exposure relates to the way the duration of our mortgage assets or our hedge portfolio changes when the interest rate or prepayment environment changes.

The value of our mortgage assets may also be adversely impacted by fluctuations in the shape of the yield curve or by changes in the market's expectation about the volatility of future interest rates. We analyze our exposure to non-parallel changes in interest rates and to changes in the market's expectation of future interest rate volatility and take actions to attempt to mitigate these risks.

Prepayment Risk. Because residential borrowers have the option to prepay their mortgage loans at par at any time, we face the risk that we will experience a return of principal on our investments faster than anticipated. Prepayment risk generally increases when interest rates decline. In this scenario, our financial results may be adversely affected as we may have to invest returned principal at lower yields.

Extension Risk. Because residential borrowers have the option to make only scheduled payments on their mortgage loans, rather than prepay their mortgage loans, we face the risk that a return of capital on our investment will occur slower than anticipated. Extension risk generally increases when interest rates rise. In this scenario, our financial results may be adversely affected as we may have to finance our investments at potentially higher costs without the ability to reinvest principal into higher yielding securities.
Credit Risk. We accept mortgage credit exposure at levels our Manager deems prudent within the context of our diversified investment strategy. Therefore, we may retain all or a portion of the credit risk on the loans underlying our non-agency securities, as well as any future investments in CMBS and individual residential and commercial mortgages. We seek to manage this risk through prudent asset selection, pre-acquisition due diligence, post-acquisition performance monitoring, and sale of assets where we identify negative credit trends. We may also manage credit risk with credit default swaps or other financial derivatives that our Manager believes are appropriate. Additionally, we vary the percentage mix of our non-agency mortgage investments and agency mortgage investments in an effort to actively adjust our credit exposure and to improve the risk/return profile of our investment portfolio.
Risks Related to Potential Healthcare-Related Real Estate Investments. For the healthcare-related real estate investments in which we may invest, we would be exposed to the ongoing ability of our tenant (the facility operator) to satisfy its lease obligations, including payment of rent, or of the borrower to make principal and interest payments. As such, our healthcare-related investments will be heavily dependent upon the successful operation of the facilities by our third party partners. These borrowers and operators may be impacted by factors specific to the healthcare space, including, but not limited to, regulatory changes, government reimbursement reductions and revisions to licensure or certification requirements. Additionally, real estate investments are relatively illiquid, generally cannot be sold quickly and may be subject to impairment charges based on factors such as market conditions and operator performance. We will seek to manage these risks through detailed pre-transaction due diligence of target properties and associated operators, prudent asset selection, and active post-acquisition monitoring.

The principal instruments that we use to hedge a portion of our exposure to interest rate, prepayment and extension risks are interest rate swaps and options to enter into interest rate swaps ("interest rate swaptions"). We also utilize forward contracts for the purchase or sale of agency RMBS on a generic pool, or a TBA contract, basis and on a non-generic, specified pool basis, and we utilize U.S. Treasury securities and U.S. Treasury futures contracts, primarily through short sales. We may also purchase or write put or call options on TBA securities and we may invest in other types of mortgage derivatives, such as interest and principal-only securities.

32




Our hedging instruments are generally not designed to protect our net book value from "spread risk" (also referred to as "basis risk"), which is the risk of an increase of the market spread between the yield on our assets and the benchmark yield on U.S. Treasury securities or interest rate swap rates. The inherent spread risk associated with our assets and the resulting fluctuations in fair value of these securities can occur independent of interest rates and may relate to other factors impacting the mortgage and fixed income markets, such as actual or anticipated monetary policy actions by the U.S. Federal Reserve ("Fed"), liquidity, or changes in required rates of return on different assets. Consequently, while we use interest rate swaps and other supplemental hedges to attempt to protect our net book value against moves in interest rates, such instruments typically will not protect our net book value against spread risk, and, therefore, our net book value could decline.
The risk management actions we take may lower our earnings and dividends in the short term to further our objective of maintaining attractive levels of earnings and dividends over the long term. In addition, some of our hedges are intended to provide protection against larger rate moves and as a result may be relatively ineffective for smaller changes in interest rates. There can be no certainty that our Manager's projections of our exposures to interest rates, prepayments, extension, credit or other risks will be accurate or that our hedging activities will be effective and, therefore, actual results could differ materially.
Income from hedging transactions that we enter into to manage risk may not constitute qualifying gross income under one or both of the gross income tests applicable to REITs. Therefore, we may have to limit our use of certain advantageous hedging techniques, which could expose us to greater risks than we would otherwise want to bear, or implement those hedges through a taxable REIT subsidiary ("TRS"). Implementing our hedges through a TRS could increase the cost of our hedging activities because a TRS is subject to tax on income and gains.
Trends and Recent Market Impacts
The first three quarters of 2015 were challenging for the entire fixed income market as global economic weakness, particularly in Europe and China, created uncertainty for the U.S. economic and interest rate outlook. This uncertainty fueled interest rate volatility and wider spreads between most fixed income securities and benchmark interest rates. Against this backdrop, we prioritized risk management, operating with lower leverage and a smaller net duration gap (the difference between the estimated interest rate sensitivity of our assets and our liabilities and hedges), thereby preserving our ability to take advantage of potential future opportunities that we believe could enhance our longer-term earnings potential.
First Quarter Highlights
During the first quarter, U.S. interest rates declined, consistent with the general decline in interest rates across the globe. The yield on the 10-year U.S. Treasury note fell 24 basis points ("bps") to end the first quarter at 1.93%. Despite the modest aggregate decline in interest rates, intra-quarter swings were extreme by historical standards. The yield on the 10-year U.S. Treasury note fell 50 bps in January, increased 60 bps in February and early March, and ended the quarter with another 30 bps decline.
Prior to the first quarter of 2015, we made several changes to the composition of our asset and hedge portfolios that were intended to mitigate the negative impact of interest rate volatility. In particular, we reduced our exposure to higher coupon, generic agency MBS; lowered our net duration gap; and reduced leverage. During the first quarter, we maintained a net duration gap of less than one year and further reduced our “at risk” leverage, inclusive of our net TBA position, to 4.5x as of March 31, 2015. Together, these actions, combined with the strong performance of agency and non-agency securities, drove our aggregate economic return of 2.7% for the first quarter, comprised of $0.50 of dividends per common share and a $0.09 increase in our net book value per common share.
Non-agency securities performed well during the first quarter of 2015 as a result of moderate national house price appreciation and favorable market dynamics due to the shrinking supply of legacy non-agency securities. In response to these favorable market conditions, we increased our non-agency portfolio to $1.3 billion as of March 31, 2015 from $1.2 billion as of December 31, 2014, driven in large part by our increased investment allocation to GSE credit risk transfer ("CRT") securities. We opportunistically increased our investments in CRT securities to approximately 15% of our non-agency portfolio as of March 31, 2015, compared to approximately 9% at the beginning of 2015.
Second Quarter Highlights
Interest rates increased in the second quarter, more than reversing the decline in the first quarter. The yield curve also steepened appreciably during the quarter. The 10-year U.S. Treasury rate ended the quarter at 2.33%, 40 bps higher than March 31, 2015 and 16 bps higher than December 31, 2014. The spread between 2- and 10-year U.S. Treasury rates increased 32 bps to 169 bps as of June 30, 2015. Despite the yield curve steepening, option adjusted spreads (“OAS”), or the spread between

33



agency MBS and other benchmark interest rates adjusted for the cost of the embedded prepayment optionality inherent in agency MBS, widened significantly during the second quarter.
Our "at risk" leverage declined to 4.1x as of June 30, 2015, our lowest leverage level since our initial public offering. Consistent with the reduction in our overall leverage level, we reduced the size of our agency investment portfolio to $3.5 billion as of June 30, 2015, from $4.7 billion as of December 31, 2014. Additionally, we increased our agency portfolio allocation to 30-year fixed rate securities up to 66% as of June 30, 2015, from 50% as of December 31, 2014 and decreased our agency portfolio allocation to 15-year fixed rate securities down to 25% as of June 30, 2015 from 43% as of December 31, 2014. Our interest rate risk position remained relatively low during the second quarter, but ended the quarter with a net duration gap in excess of one year. The increase in our net duration gap as of June 30, 2015 was primarily due to the extension in asset durations resulting from the increase in long term interest rates that occurred in the second quarter.
U.S. housing indicators remained positive in the second quarter, with home price appreciation, new and existing home sales, and household formation all showing year-over-year improvement. As a result, legacy RMBS performed well on both an absolute and relative basis during the quarter. Despite strong underlying credit fundamentals, CRT securities performed relatively poorly during the quarter as the issuance of new securities resulted in significant intra-quarter spread volatility.
In response to favorable housing market conditions, we increased our non-agency portfolio to $1.5 billion as of June 30, 2015 from $1.2 billion as of December 31, 2014, driven in large part by our increased investment allocation to CRT securities and investments in jumbo prime AAA securities. Our allocation to Prime securities increased significantly in the second quarter as we acquired $219 million of jumbo prime AAA securities, funded with advances from the Federal Home Loan Bank of Des Moines. The Jumbo AAA securities that we purchased are backed by collateral with strong credit characteristics and benefit from structural credit enhancement. These instruments also have prepayment and interest rate characteristics similar to agency MBS. During the quarter, we also reduced our exposure to Alt-A, Option ARM and subprime mortgages.
MTGE’s economic return for the second quarter was (3.7)%, comprised of a book value loss of $(1.30) and dividends paid of $0.50 per common share. The decline in our book value was driven by the combination of wider OAS and the steepening of the yield curve that occurred during the quarter.
Third Quarter Highlights
Interest rates declined and the yield curve flattened moderately during the third quarter. The yield on the 10-year U.S. Treasury note fell 27 bps to 2.06%, while the yield on the 2-year U.S. Treasury note remained unchanged during the quarter. More importantly, the benchmark swap rates significantly out performed U.S. Treasury rates. As a result, the spread on agency MBS relative to our interest rate swap hedges widened materially during the quarter, driving a $(0.77) per common share decline in our net book value to $19.93 per common share as of September 30, 2015. Including $0.40 in dividends per common share, economic return for the quarter was a loss of (1.8)%.     
Given the cumulative spread widening during the second and third quarters, we chose to increase our “at risk” leverage to 4.7x as of September 30, 2015, with the majority of our asset purchases concentrated in 30-year MBS, as we continued to reduce our position in shorter duration, lower yielding 15-year MBS. Our net duration gap decreased to less than one year as of September 30, 2015, driven by our larger hedge portfolio and the significant decline in swap rates and corresponding reduction in our asset duration.
Key U.S. housing indicators, such as house prices, home sales and household formation, improved in the third quarter. Despite these favorable housing trends, our non-agency portfolio was negatively impacted by spread widening associated with the broader fixed income market. The composition of our non-agency portfolio was relatively unchanged during the quarter.
Share Repurchases
During the third quarter, we repurchased 1.2 million shares of our common stock at an average price of $15.29 per common share, totaling approximately $18.1 million, including expenses. Our decision to repurchase shares of our common stock is based on a variety of factors, including our price to net book value ratio, an assessment of the overall investment landscape for relevant assets, our views on interest rates and our overall expectations about the drivers and sustainability of share price weakness among other factors. Since commencing a stock repurchase program in the fourth quarter of 2012, we have repurchased 9.3 million shares of our outstanding common stock for total consideration of approximately $183.1 million, including expenses. As of September 30, 2015, we had $116.9 million available under our current Board of Director authorization for repurchases of our common stock. In October 2015, our Board of Directors extended its authorization through December 31, 2016.

34



The table below summarizes interest rates and prices for generic agency RMBS as of the end of each respective quarter since September 30, 2014.
Interest Rate / Security (1)
 
September 30, 2015
 
June 30, 2015
 
March 31, 2015
 
December 31, 2014
 
September 30, 2014
LIBOR:
 
 
 
 
 
 
 
 
 
 
1-Month
 
0.19
%
 
0.19
%
 
0.18
%
 
0.17
%
 
0.16
%
3-Month
 
0.33
%
 
0.28
%
 
0.27
%
 
0.26
%
 
0.24
%
U.S. Treasury Securities:
 
 
 
 
 
 
 
 
 
 
2-Year U.S. Treasury
 
0.64
%
 
0.64
%
 
0.56
%
 
0.67
%
 
0.58
%
5-Year U.S. Treasury
 
1.37
%
 
1.63
%
 
1.37
%
 
1.65
%
 
1.78
%
10-Year U.S. Treasury
 
2.06
%
 
2.33
%
 
1.93
%
 
2.17
%
 
2.51
%
Interest Rate Swap Rates:
 
 
 
 
 
 
 
 
 
 
2-Year Swap Rate
 
0.76
%
 
0.89
%
 
0.81
%
 
0.89
%
 
0.83
%
5-Year Swap Rate
 
1.40
%
 
1.77
%
 
1.53
%
 
1.77
%
 
1.95
%
10-Year Swap Rate
 
2.01
%
 
2.44
%
 
2.03
%
 
2.29
%
 
2.65
%
30-Year Fixed Rate Agency Price:
 
 
 
 
 
 
 
 
 
 
3.5%
 
$
104.31

 
$
103.02

 
$
105.05

 
$
104.28

 
$
102.23

4.0%
 
$
106.67

 
$
105.91

 
$
106.92

 
$
106.75

 
$
105.41

4.5%
 
$
108.41

 
$
108.09

 
$
109.08

 
$
108.56

 
$
107.91

15-Year Fixed Rate Agency Price:
 
 
 
 
 
 
 
 
 
 
2.5%
 
$
101.94

 
$
101.17

 
$
102.71

 
$
101.81

 
$
100.55

3.0%
 
$
104.11

 
$
103.57

 
$
104.83

 
$
103.91

 
$
102.98

3.5%
 
$
105.61

 
$
105.44

 
$
106.09

 
$
105.61

 
$
105.11

 ________________________
(1) 
Price information is for generic instruments only and is not reflective of our specific portfolio holdings. Price information can vary by source. Prices in the table above were obtained from a combination of Bloomberg and dealer indications. Interest rates were obtained from Bloomberg.

The table below summarizes pay-ups on specified pools over the corresponding generic agency RMBS as of the end of each respective quarter for a select sample of specified securities. Price information provided in the table below is for illustrative purposes only and is not meant to be reflective of our specific portfolio holdings. Actual pay-ups are dependent on specific securities held in our portfolio and prices can vary depending on the source.
Specified Mortgage Pool Pay-ups over Generic TBA Price (1)(2)
 
September 30, 2015
 
June 30, 2015
 
March 31, 2015
 
December 31, 2014
 
September 30, 2014
30-Year Lower Loan Balance (3):
 
 
 
 
 
 
 
 
 
 
3.0%
 
$
0.23

 
$
0.20

 
$
0.27

 
$
0.34

 
$
0.38

3.5%
 
$
0.75

 
$
0.50

 
$
0.88

 
$
0.45

 
$
0.37

4.0%
 
$
1.52

 
$
0.98

 
$
1.91

 
$
0.98

 
$
0.67

30-Year HARP (4):
 
 
 
 
 
 
 
 
 
 
3.5%
 
$
0.09

 
$
0.08

 
$
0.17

 
$
0.05

 
$
0.01

4.0%
 
$
0.59

 
$
0.53

 
$
0.89

 
$
0.30

 
$
0.15

 ________________________ 
(1) 
Source: Bloomberg and dealer indications.
(2) 
"Pay-ups" represent the value of the price premium of specified securities over generic TBA pools. The table above includes pay-ups for newly originated specified pools. Price information is provided for information only and is not meant to be reflective of our specific portfolio holdings. Prices can vary materially depending on the source.
(3) 
Lower loan balance pay-ups for pools with original loan balances from $85,000 to $110,000.
(4) 
HARP pay-ups for pools backed by 100% refinance loans with original loan-to-value ratios between 95% and 100%.

Our subsidiary, Residential Credit Solutions, Inc. ("RCS"), is a fully-licensed mortgage servicer based in Fort Worth, Texas that has approvals from Fannie Mae, Freddie Mac, and Ginnie Mae to hold and manage MSR and residential mortgage

35



loans. During the first three quarters of 2015, we continued to integrate the servicing platform into the broader MTGE operations, implement cost savings opportunities and focus on servicing performing conforming loans. While net servicing losses incurred since our acquisition of RCS are due largely to sub-scale servicing volumes, we continue to be cautious in our acquisition of MSR, as the risk-adjusted returns for these assets remain unattractive in our judgment. As of September 30, 2015, we held MSR with a fair value of $83.5 million, down from $93.6 million as of December 31, 2014, due primarily to portfolio runoff, partially offset by unrealized gains. Additionally, during the third quarter, we recorded a $(10.0) million intangible asset impairment charge based on a revised estimated fair value of RCS’ servicing licenses and approvals.  We reduced our estimate of the intangible asset’s fair value as a result of certain financial and economic factors, including the current secondary market for mortgage servicing rights.
As we look forward, if spreads on agency and non-agency RMBS continue to widen or if interest rate volatility returns to more normal levels, we would expect to opportunistically reposition our portfolio toward more normal risk levels, which would likely mean increasing leverage and/or increasing our net duration gap, potentially improving our expected return on equity.
For the estimated impact of changes in interests rates and mortgage spreads on our net book value please refer to "Quantitative and Qualitative Disclosures about Market Risk" under Item 3 of this Quarterly Report on Form 10-Q.
Summary of Critical Accounting Estimates

Our critical accounting estimates relate to the fair value of our investments and derivatives and the recognition of interest income. Certain of these items involve estimates that require management to make judgments that are subjective in nature. We rely on our Manager's experience and analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. Under different conditions, we could report materially different amounts based on such estimates. Our significant accounting policies are described in Note 3 to the consolidated financial statements included under Item 1 of this Quarterly Report on Form 10-Q.

We have not designated any derivatives as hedging instruments and therefore all changes in fair value are reflected in income during the period in which they occur. We also have elected the option to account for all of our financial assets, including all mortgage-related investments, at fair value, with changes in fair value reflected in income during the period in which they occur. In management's view, this election more appropriately reflects the results of our operations for a particular reporting period, as financial asset fair value changes are presented in a manner consistent with the presentation and timing of the fair value changes of economic hedging instruments.

FINANCIAL CONDITION
As of September 30, 2015, our investment portfolio with a fair value of $5.5 billion was comprised of $3.4 billion of agency RMBS, $0.5 billion in net long TBA positions, $1.5 billion of non-agency securities and $0.1 billion of MSR.

Our TBA positions are recorded as derivative instruments in our accompanying consolidated financial statements, with the TBA dollar roll transactions representing a form of off-balance sheet financing. As of September 30, 2015, our TBA position with a net long notional of $0.5 billion had a net carrying value of $10.4 million reported in derivative assets/(liabilities) on our consolidated balance sheets. The net carrying value represents the difference between the fair value of the underlying agency security in the TBA contract and the cost basis or the forward price to be paid or received for the underlying agency security.
The table below presents our condensed consolidated balance sheets as of September 30, 2015 and December 31, 2014 (dollars in thousands, except per share amounts): 
 
 
September 30, 2015
 
December 31, 2014
Balance Sheet Data:
 
 
 
 
Total agency and non-agency securities
 
$
4,836,109

 
$
5,552,973

Total assets
 
$
6,257,997

 
$
7,031,252

Total repurchase agreements and advances
 
$
4,293,290

 
$
5,423,630

Total liabilities
 
$
5,206,405

 
$
5,855,283

Total stockholders’ equity
 
$
1,051,592

 
$
1,175,969

Net book value per common share
 
$
19.93

 
$
21.91


36



The following tables summarize certain characteristics of our RMBS portfolio by issuer and investment category as of September 30, 2015 and December 31, 2014 (dollars in thousands):

 
September 30, 2015
  
 
Fair Value
 
Amortized Cost Basis
 
Par Value
 
Weighted Average
Coupon
 
Yield (1)
Fannie Mae

$
2,598,724


$
2,579,392


$
2,460,707


3.49
%

2.64
%
Freddie Mac

757,799


754,846


717,522


3.57
%

2.70
%
Agency RMBS total

3,356,523


3,334,238


3,178,229


3.51
%

2.65
%
Non-agency securities

1,479,586


1,448,908


1,676,165


2.52
%

5.28
%
Total

$
4,836,109


$
4,783,146


$
4,854,394


3.17
%

3.45
%
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 
 
Fair Value
 
Amortized Cost Basis
 
Par Value
 
Weighted Average
 
 
Coupon
 
Yield (1)
Fannie Mae
 
$
3,482,127

 
$
3,474,600

 
$
3,333,348

 
3.37
%
 
2.54
%
Freddie Mac
 
902,012

 
900,129

 
857,059

 
3.50
%
 
2.65
%
Agency RMBS total
 
4,384,139

 
4,374,729

 
4,190,407

 
3.39
%
 
2.56
%
Non-agency securities
 
1,168,834

 
1,111,123

 
1,373,652

 
2.06
%
 
5.92
%
Total
 
$
5,552,973

 
$
5,485,852

 
$
5,564,059

 
3.06
%
 
3.24
%
 
————————
(1) 
The weighted average agency security yield incorporates an average future CPR assumption of 9% and 8% as of September 30, 2015 and December 31, 2014, respectively, based on forward rates. For non-agency securities, the weighted average yield is based on estimated cash flows that incorporate expected credit losses.


37



Agency RMBS
As detailed in the tables below, both the weighted average agency RMBS portfolio yield and the weighted average projected CPR increased slightly from December 31, 2014 to September 30, 2015. The increase in average agency yield was due primarily to a rebalancing in favor of 30-year securities and away from lower yielding 15-year securities.
The following table summarizes certain characteristics of our agency RMBS portfolio by term and coupon as of September 30, 2015 (dollars in thousands):
 
 
September 30, 2015
 
 
Fair Value
 
Amortized Cost Basis
 
Par Value
 
Weighted Average
 
 
Yield
 
Projected CPR
Fixed rate
 
 
 
 
 
 
 
 
 
 
≤ 15-year
 
 
 
 
 
 
 
 
 
 
2.5%
 
$
153,060

 
$
150,472

 
$
149,237

 
2.27
%
 
9
%
3.0%
 
336,847

 
332,308

 
322,325

 
2.21
%
 
9
%
3.5%
 
348,140

 
343,867

 
328,052

 
2.32
%
 
10
%
4.0%
 
166,725

 
165,575

 
155,688

 
2.19
%
 
11
%
4.5%
 
14,214

 
14,316

 
13,450

 
2.64
%
 
11
%
≤ 15-year total
 
1,018,986

 
1,006,538

 
968,752

 
2.26
%
 
10
%
20-year
 
 
 
 
 
 
 
 
 
 
3.0%
 
75,155

 
74,976

 
72,619

 
2.33
%
 
10
%
3.5%
 
103,222

 
100,879

 
97,818

 
2.88
%
 
9
%
4.0%
 
4,458

 
4,354

 
4,136

 
2.70
%
 
13
%
5.0%
 
2,217

 
2,199

 
2,011

 
2.20
%
 
19
%
20-year total
 
185,052

 
182,408

 
176,584

 
2.64
%
 
9
%
30-year
 
 
 
 
 
 
 
 
 
 
3.0%
 
53,914

 
52,826

 
52,629

 
3.01
%
 
%
3.5%
 
1,124,295

 
1,127,336

 
1,070,899

 
2.74
%
 
7
%
4.0%
 
766,061

 
763,097

 
713,247

 
2.94
%
 
9
%
4.5%
 
73,976

 
72,571

 
67,197

 
3.20
%
 
9
%
30-year total
 
2,018,246

 
2,015,830

 
1,903,972

 
2.84
%
 
8
%
Pass through agency RMBS
 
3,222,284

 
3,204,776

 
3,049,308

 
2.64
%
 
8
%
Agency CMO
 
21,527

 
20,980

 
18,811

 
2.89
%
 
7
%
Total fixed-rate agency RMBS
 
3,243,811

 
3,225,756

 
3,068,119

 
2.65
%
 
8
%
Adjustable rate agency RMBS
 
112,712

 
108,482

 
110,110

 
2.83
%
 
15
%
Total agency RMBS
 
$
3,356,523

 
$
3,334,238

 
$
3,178,229

 
2.65
%
 
9
%

38



The percentage of our fixed-rate agency RMBS portfolio allocated to HARP and lower loan balance securities was 88% (not including our net long TBA position) as of September 30, 2015 as detailed in the following table (dollars in thousands):
 
 
September 30, 2015
  
 
Fair Value
 
Amortized Cost Basis
 
Par Value
 
Weighted Average
Coupon
 
Yield
 
Projected CPR
HARP (1)
 
$
915,833

 
$
911,868

 
$
869,289

 
3.58
%
 
2.84
%
 
7
%
Lower loan balance (2)
 
1,929,376

 
1,918,961

 
1,822,807

 
3.51
%
 
2.53
%
 
9
%
Other
 
377,075

 
373,947

 
357,212

 
3.68
%
 
2.76
%
 
9
%
Pass through agency RMBS
 
3,222,284

 
3,204,776

 
3,049,308

 
3.55
%
 
2.64
%
 
8
%
Agency CMO
 
21,527

 
20,980

 
18,811

 
3.05
%
 
2.89
%
 
7
%
Total fixed-rate agency RMBS
 
3,243,811

 
3,225,756

 
3,068,119

 
3.54
%
 
2.65
%
 
8
%
Adjustable rate agency RMBS
 
112,712

 
108,482

 
110,110

 
2.57
%
 
2.83
%
 
15
%
Total agency RMBS
 
$
3,356,523

 
$
3,334,238

 
$
3,178,229

 
3.51
%
 
2.65
%
 
9
%
————————
(1)
HARP securities are defined as pools backed by 100% refinance loans with LTV greater than or equal to 80%. Our HARP securities had a weighted average LTV of 119% and 124% for 15-year and 30-year securities, respectively, as of September 30, 2015. Includes $493.4 million of >105% LTV pools which are not deliverable into TBA securities.
(2)
Lower loan balance securities represent pools with maximum original loan balances less than or equal to $150,000. Our lower loan balance securities had a weighted average original loan balance of $105,752 and $87,203 for 15-year and 30-year securities, respectively, as of September 30, 2015.


39



The following table summarizes certain characteristics of our agency RMBS portfolio by term and coupon as of December 31, 2014 (dollars in thousands):
 
 
December 31, 2014
 
 
Fair Value
 
Amortized Cost Basis
 
Par Value
 
Weighted Average
 
 
Yield
 
Projected CPR
Fixed rate
 
 
 
 
 
 
 
 
 
 
≤ 15-year
 
 
 
 
 
 
 
 
 
 
2.5%
 
$
587,127

 
$
589,786

 
$
574,772

 
1.89
%
 
8
%
3.0%
 
605,346

 
599,126

 
580,701

 
2.25
%
 
9
%
3.5%
 
289,367

 
284,999

 
272,918

 
2.41
%
 
10
%
4.0%
 
218,026

 
216,503

 
202,751

 
2.17
%
 
11
%
4.5%
 
17,308

 
17,352

 
16,271

 
2.67
%
 
11
%
≤ 15-year total
 
1,717,174

 
1,707,766

 
1,647,413

 
2.15
%
 
9
%
20-year
 
 
 
 
 
 
 
 
 
 
3.0%
 
70,689

 
71,191

 
68,647

 
2.27
%
 
9
%
3.5%
 
114,113

 
111,683

 
108,207

 
2.87
%
 
9
%
4.0%
 
5,320

 
5,208

 
4,945

 
2.72
%
 
12
%
5.0%
 
2,471

 
2,448

 
2,228

 
2.14
%
 
18
%
20-year total
 
192,593

 
190,530

 
184,027

 
2.63
%
 
9
%
30-year
 
 
 
 
 
 
 
 
 
 
3.5%
 
1,418,564

 
1,427,505

 
1,355,051

 
2.75
%
 
7
%
4.0%
 
818,553

 
817,528

 
761,885

 
2.97
%
 
7
%
4.5%
 
87,621

 
85,834

 
79,705

 
3.27
%
 
9
%
30-year total
 
2,324,738

 
2,330,867

 
2,196,641

 
2.84
%
 
7
%
Pass through agency RMBS
 
4,234,505

 
4,229,163

 
4,028,081

 
2.55
%
 
8
%
Agency CMO
 
23,928

 
23,453

 
38,387

 
2.92
%
 
7
%
Total fixed-rate agency RMBS
 
4,258,433

 
4,252,616

 
4,066,468

 
2.56
%
 
8
%
Adjustable rate agency RMBS
 
125,706

 
122,113

 
123,939

 
2.83
%
 
14
%
Total agency RMBS
 
$
4,384,139

 
$
4,374,729

 
$
4,190,407

 
2.56
%
 
8
%

The percentage of our fixed-rate agency RMBS portfolio allocated to HARP and lower loan balance securities was 87% as of December 31, 2014, as detailed in the following table (dollars in thousands):
 
 
December 31, 2014
  
 
Fair Value
 
Amortized Cost Basis
 
Par Value
 
Weighted Average
Coupon
 
Yield
 
Projected CPR
HARP (1)
 
$
1,238,790

 
$
1,236,608

 
$
1,175,541

 
3.58
%
 
2.80
%
 
7
%
Lower loan balance (2)
 
2,476,825

 
2,471,101

 
2,349,679

 
3.47
%
 
2.55
%
 
8
%
Other
 
518,890

 
521,454

 
502,861

 
2.81
%
 
1.96
%
 
9
%
Pass through agency RMBS
 
4,234,505

 
4,229,163

 
4,028,081

 
3.42
%
 
2.55
%
 
8
%
Agency CMO
 
23,928

 
23,453

 
38,387

 
3.05
%
 
2.92
%
 
7
%
Total fixed-rate agency RMBS
 
4,258,433

 
4,252,616

 
4,066,468

 
3.42
%
 
2.56
%
 
8
%
Adjustable rate agency RMBS
 
125,706

 
122,113

 
123,939

 
2.60
%
 
2.83
%
 
14
%
Total agency RMBS
 
$
4,384,139

 
$
4,374,729

 
$
4,190,407

 
3.39
%
 
2.56
%
 
8
%
————————

40



(1) 
HARP securities are defined as pools backed by 100% refinance loans with LTVs greater than or equal to 80%. Our HARP securities had a weighted average LTV of 110% and 125% for 15-year and 30-year securities, respectively, as of December 31, 2014. Includes $601.2 million of >105% LTV pools which are not deliverable into TBA securities.
(2) 
Lower loan balance securities represent pools with maximum original loan balances less than or equal to $150,000. Our lower loan balance securities had a weighted average original loan balance of $102,962 and $88,127 for 15-year and 30-year securities, respectively, as of December 31, 2014.


TBA Investments
As of September 30, 2015 and December 31, 2014, we had contracts to purchase ("long position") and sell ("short position") TBA securities on a forward basis. The following tables summarize our net long and (short) TBA positions as of September 30, 2015 and December 31, 2014 (dollars in thousands):
 
 
September 30, 2015
 
 
Notional Amount (1)
 
Cost Basis (2)
 
Market
Value
(3)
 
Net Carrying Value (4)
 
 
 
15- Year
 
 
 
 
 
 
 
 
2.5%
 
$
(42,173
)
 
$
(42,791
)
 
$
(42,990
)
 
$
(199
)
3.0%
 
(142,470
)
 
(147,268
)
 
(148,324
)
 
(1,056
)
3.5%
 
(67,379
)
 
(70,902
)
 
(71,158
)
 
(256
)
Subtotal
 
(252,022
)
 
(260,961
)
 
(262,472
)
 
(1,511
)
30-Year
 
 
 
 
 
 
 
 
3.0%
 
467,300

 
464,846

 
472,594

 
7,748

3.5%
 
82,729

 
82,808

 
85,800

 
2,992

4.0%
 
232,466

 
246,803

 
247,975

 
1,172

Subtotal
 
782,495

 
794,457

 
806,369

 
11,912

Portfolio total
 
$
530,473

 
$
533,496

 
$
543,897

 
$
10,401

 
 
December 31, 2014
 
 
Notional Amount (1)
 
Cost Basis (2)
 
Market
Value
(3)
 
Net Carrying Value (4)
 
 
 
15- Year
 
 
 
 
 
 
 
 
2.5%
 
$
169,660

 
$
171,059

 
$
172,756

 
$
1,697

3.0%
 
178,000

 
185,601

 
184,983

 
(618
)
3.5%
 
(69,778
)
 
(73,720
)
 
(73,673
)
 
47

Subtotal
 
277,882

 
282,940

 
284,066

 
1,126

30-Year
 
 
 
 
 


 
 
3.0%
 
556,200

 
556,494

 
562,478

 
5,984

3.5%
 
83,770

 
86,848

 
87,357

 
509

4.0%
 
(609,180
)
 
(652,752
)
 
(648,713
)
 
4,039

4.5%
 
(12,500
)
 
(13,545
)
 
(13,571
)
 
(26
)
Subtotal
 
18,290

 
(22,955
)
 
(12,449
)
 
10,506

Portfolio total
 
$
296,172

 
$
259,985

 
$
271,617

 
$
11,632

————————
(1) 
Notional amount represents the par value or principal balance of the underlying agency RMBS.
(2) 
Cost basis represents the forward price to be paid for the underlying agency RMBS.
(3) 
Market value represents the current market value of the agency RMBS underlying the TBA contracts as of period end.
(4) 
Net carrying value represents the difference between the market value of the TBA contract as of period end and the cost basis and is reported in derivative assets / (liabilities), at fair value in our consolidated balance sheets.


41



Non-Agency Investments
Non-agency security yields are based on our estimate of the timing and amount of future cash flows and our amortized cost basis. Our cash flow estimates for these investments are based on our observations of current information and events and include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses and other factors.
The following tables summarize our non-agency securities portfolio as of September 30, 2015 and December 31, 2014 (dollars in thousands):
September 30, 2015
 
 
Fair
  Value
 
Gross Unrealized
 
Amortized Cost
 
Discount
 
Par/ Current Face
 
Weighted Average
Category
 
 
Gains
 
Losses
 
 
 
 
Coupon (1)
 
Yield
Prime
 
$
434,333

 
$
9,843

 
$
(1,769
)
 
$
426,259

 
$
(23,131
)
 
$
449,390

 
3.44
%
 
4.40
%
CRT
 
207,287

 

 
(9,529
)
 
216,816

 
3,996

 
212,820

 
4.05
%
 
5.22
%
Alt-A
 
448,859

 
32,585

 
(6,572
)
 
422,846

 
(155,940
)
 
578,786

 
1.62
%
 
6.53
%
Option-ARM
 
162,081

 
8,241

 
(5,032
)
 
158,872

 
(36,923
)
 
195,795

 
0.46
%
 
5.60
%
Subprime
 
227,026

 
3,317

 
(406
)
 
224,115

 
(15,259
)
 
239,374

 
3.28
%
 
4.42
%
Total
 
$
1,479,586

 
$
53,986

 
$
(23,308
)
 
$
1,448,908

 
$
(227,257
)
 
$
1,676,165

 
2.52
%
 
5.28
%
————————
(1)
Coupon rates are floating, except for $229.9 million, $26.6 million and $176.4 million fair value of fixed-rate prime, Alt-A, and subprime non-agency securities, respectively, as of September 30, 2015.
December 31, 2014
 
 
Fair
  Value
 
Gross Unrealized
 
Amortized Cost
 
Discount
 
Par/ Current Face
 
Weighted Average
Category
 
 
Gains
 
Losses
 
 
 
 
Coupon (1)
 
Yield
Prime
 
$
178,215

 
$
11,346

 
$
(596
)
 
$
167,464

 
$
(25,977
)
 
$
193,441

 
3.03
%
 
6.42
%
CRT
 
104,123

 
88

 
(5,893
)
 
109,929

 
4,150

 
105,779

 
4.21
%
 
5.46
%
Alt-A
 
486,254

 
42,536

 
(4,090
)
 
447,808

 
(169,221
)
 
617,029

 
1.67
%
 
6.54
%
Option-ARM
 
173,727

 
11,317

 
(2,473
)
 
164,883

 
(42,338
)
 
207,221

 
0.43
%
 
5.88
%
Subprime
 
226,515

 
5,818

 
(342
)
 
221,039

 
(29,143
)
 
250,182

 
2.70
%
 
4.57
%
Total
 
$
1,168,834

 
$
71,105

 
$
(13,394
)
 
$
1,111,123

 
$
(262,529
)
 
$
1,373,652

 
2.06
%
 
5.92
%
————————
(1)  
Coupon rates are floating, except for $2.5 million, $29.3 million and $151.2 million fair value of fixed-rate prime and Alt-A and subprime non-agency securities, respectively, as of December 31, 2014.

The following table summarizes our non-agency securities by their estimated weighted average life classifications as of September 30, 2015 and December 31, 2014 (dollars in thousands): 
 
 
September 30, 2015
 
December 31, 2014
Weighted Average Life
 
Fair Value
 
Amortized
Cost
 
Weighted
Average
Yield
 
Weighted Average Coupon
 
Fair Value
 
Amortized
Cost
 
Weighted
Average
Yield
 
Weighted Average Coupon
≤ 5 years
 
$
425,185

 
$
413,074

 
5.23
%
 
2.76
%
 
$
436,385

 
$
422,400

 
5.15
%
 
2.85
%
> 5 to ≤ 7 years
 
698,253

 
674,599

 
5.26
%
 
2.13
%
 
486,869

 
446,967

 
6.68
%
 
1.29
%
> 7 years
 
356,148

 
361,235

 
5.38
%
 
3.02
%
 
245,580

 
241,756

 
5.89
%
 
2.43
%
Total
 
$
1,479,586

 
$
1,448,908

 
5.28
%
 
2.52
%
 
$
1,168,834

 
$
1,111,123

 
5.92
%
 
2.06
%

42



Our non-agency securities are subject to risk of loss with regard to principal and interest payments. As of September 30, 2015 and December 31, 2014, other than $214 million in Prime, fixed-rate, jumbo AAA securities purchased during the second and third quarters of 2015, our non-agency securities were generally either assigned below investment grade ratings by rating agencies, or were not rated. Credit ratings are based on the par value of the non-agency securities. However, the legacy non-agency securities in our portfolio were generally purchased at a significant discount to par value. The following table summarizes the credit ratings of our non-agency securities as of September 30, 2015 and December 31, 2014:
Credit Rating (1)
September 30, 2015
 
December 31, 2014
AAA
14
%
 
%
BBB
2
%
 
1
%
BB
4
%
 
4
%
B
5
%
 
5
%
Below B
38
%
 
53
%
Not Rated
37
%
 
37
%
Total
100
%
 
100
%
————————
(1)
Represents the lowest of Standard and Poor's, Moody's and Fitch credit ratings, stated in terms of the S&P equivalent, as of each respective balance sheet date.
We evaluate each investment based on the characteristics of the underlying collateral and securitization structure, rather than relying on rating agencies. These securities were collateralized by mortgages with original weighted average amortized loan to value ratios ("LTV") of 78% and 75% as of September 30, 2015 and December 31, 2014. However, as the home values associated with these mortgages have generally experienced significant price declines since origination and LTV is calculated based on the original home values, we believe that current market-based LTV would be significantly higher. Additionally, as of September 30, 2015 and December 31, 2014, 17% and 21%, respectively, of the mortgages underlying these securities were either 60 or more days delinquent, undergoing foreclosure or bankruptcy processes, or held as real estate owned by the trusts. Credit enhancement, or protection provided at the security level to absorb future credit losses due to defaults on underlying collateral, is another important component of this evaluation. Our non-agency securities had weighted average credit enhancements of 13% and 9% as of September 30, 2015 and December 31, 2014, respectively.

43



The following tables present the fair value and weighted average purchase price for each of our non-agency securities categories, together with certain of their respective underlying loan collateral attributes and current performance metrics as of September 30, 2015 and December 31, 2014 (fair value dollars in thousands):
September 30, 2015
 
 
Fair
  Value
 
Weighted Average Purchase Price
 
Weighted Average
Collateral Attributes
 
Weighted Average
Current Performance
Category
 
 
 
Loan Age (months)
 
Original LTV
 
Original FICO (1)
 
60+ Day Delinquent (2)
 
3-Month CPR (3)
Prime
 
$
434,333

 
$
92.28

 
63
 
71
%
 
749
 
4
%
 
15
%
CRT
 
207,287

 
100.08

 
21
 
77
%
 
757
 
%
 
11
%
Alt-A
 
448,859

 
67.75

 
120
 
76
%
 
712
 
15
%
 
14
%
Option-ARM
 
162,081

 
76.11

 
116
 
75
%
 
707
 
21
%
 
11
%
Subprime
 
227,026

 
94.06

 
110
 
98
%
 
580
 
58
%
 
28
%
Total
 
$
1,479,586

 
$
82.39

 
88
 
78
%
 
708
 
17
%
 
16
%
December 31, 2014
 
 
Fair
  Value
 
Weighted Average Purchase Price
 
Weighted Average
Collateral Attributes
 
Weighted Average
Current Performance
Category
 
 
 
Loan Age (months)
 
Original LTV
 
Original FICO (1)
 
60+ Day Delinquent (2)
 
3-Month CPR (3)
Prime
 
$
178,215

 
$
82.45

 
114
 
73
%
 
734
 
8
%
 
15
%
CRT
 
104,123

 
103.95

 
19
 
73
%
 
761
 
%
 
8
%
Alt-A
 
486,254

 
68.79

 
111
 
76
%
 
712
 
17
%
 
9
%
Option-ARM
 
173,727

 
76.12

 
107
 
75
%
 
707
 
23
%
 
8
%
Subprime
 
226,515

 
87.50

 
111
 
78
%
 
615
 
48
%
 
9
%
Total
 
$
1,168,834

 
$
79.35

 
103
 
75
%
 
700
 
21
%
 
10
%
————————
(1)
FICO represents a mortgage industry accepted credit score of a borrower based on a scale of 300 to 850 with a score of 850 being the highest quality rating.
(2) 
60+ day delinquent represents the percentage of mortgage loans underlying each category of non-agency securities that were delinquent for at least 60 days.
(3) 
Three-month CPR is reflective of the prepayment and default rate on the underlying securitization; however, it does not necessarily indicate the proceeds received on our non-agency securities. Proceeds received for each security are dependent on the position of the individual security within the structure of each deal.    
The mortgage loans underlying our non-agency securities are located throughout the United States. The following table presents the six states with the largest geographic concentrations of underlying mortgages as of September 30, 2015 and December 31, 2014:
 
 
% of Non-Agency Portfolio
 
 
September 30, 2015
 
December 31, 2014
California
 
36
%
 
37
%
Florida
 
8
%
 
9
%
New York
 
5
%
 
5
%
Virginia
 
4
%
 
4
%
New Jersey
 
4
%
 
3
%
Maryland
 
4
%
 
4
%
Total
 
61
%
 
62
%


44



Mortgage Servicing Rights
On November 27, 2013, one of our wholly-owned subsidiaries acquired RCS, which has approvals from Fannie Mae, Freddie Mac and Ginnie Mae to hold and manage MSR. The MSR acquired in conjunction with this acquisition and those subsequently purchased represent the right to service mortgage loans. We did not originate the mortgage loans underlying our MSR. As of September 30, 2015, our purchased MSR had a fair market value of $69.8 million.
 
The following table summarizes certain underlying loan characteristics for our purchased MSR as of September 30, 2015 and December 31, 2014:
 
 
September 30, 2015
 
December 31, 2014
Unpaid principal balance (in thousands)
 
$
6,591,510

 
$
7,136,994

Number of loans
 
32,096

 
33,911

Average Loan Size (in thousands)
 
$
205

 
$
210

Average Loan Age (months)
 
31

 
23

Average Coupon
 
3.79
%
 
3.80
%
Average Original Loan-to-Value
 
75
%
 
75
%
Average Original FICO
 
760

 
760

60+ delinquencies
 
0.19
%
 
0.12
%

Financing and Hedging
As of September 30, 2015 and December 31, 2014, our borrowings under repurchase agreements had the following characteristics (dollars in thousands):
 
 
September 30, 2015
 
December 31, 2014
 
 
 
 
Weighted Average
 
 
 
Weighted Average
Collateral Type
 
Borrowings
Outstanding
 
Interest Rate
 
Days
to Maturity
 
Borrowings
Outstanding
 
Interest Rate
 
Days
to Maturity
Agency securities (1)
 
$
2,741,464

 
0.53
%
 
260
 
$
4,002,291

 
0.42
 %
 
245
Non-agency securities
 
837,769

 
1.70
%
 
23
 
715,704

 
1.67
 %
 
20
U.S. Treasury securities (2)
 
226,157

 
0.43
%
 
1
 
705,635

 
(0.13
)%
 
7
Total repurchase agreements
 
3,805,390

 
0.78
%
 
192
 
$
5,423,630

 
0.51
 %
 
190
————————
(1)
Repurchase agreements borrowings secured by agency securities include $67.8 million of repurchase agreements related to agency RMBS sold but not yet settled as of September 30, 2015.
(2)  
Repurchase agreements borrowings secured by U.S. Treasury securities include $79.2 million of repurchase agreements related to U.S. Treasury securities sold but not yet settled as of September 30, 2015.


45



The following table summarizes our borrowings under repurchase arrangements and weighted average interest rates classified by remaining maturities as of September 30, 2015 and December 31, 2014 (dollars in thousands): 

 
September 30, 2015
 
December 31, 2014
 
 
 
 
Weighted Average
 
 
 
Weighted Average
 
 
Borrowings
Outstanding
 
Interest Rate
 
Days to Maturity
 
Borrowings
Outstanding
 
Interest Rate
 
Days to Maturity
Agency and non-agency
 
 
 
 
 
 
 
 
 
 
 
 
≤ 1 month
 
$
1,990,088

 
0.94
%
 
17
 
$
2,245,188

 
0.71
 %
 
13
> 1 to ≤ 2 months
 
342,811

 
0.49
%
 
47
 
568,014

 
0.55
 %
 
45
> 2 to ≤ 3 months
 
283,189

 
0.66
%
 
79
 
540,201

 
0.48
 %
 
74
> 3 to ≤ 6 months
 
348,145

 
0.66
%
 
117
 
508,216

 
0.43
 %
 
142
> 6 to ≤ 9 months
 

 
%
 
0
 
123,947

 
0.51
 %
 
246
> 9 to ≤ 12 months
 
100,000

 
0.61
%
 
351
 
217,429

 
0.51
 %
 
327
> 12 months
 
515,000

 
0.69
%
 
1132
 
515,000

 
0.63
 %
 
1405
Total
 
3,579,233

 
0.81
%
 
204
 
4,717,995

 
0.61
 %
 
210

 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
 
226,157

 
0.43
%
 
1
 
705,635

 
(0.13
)%
 
7
Total repurchase agreements
 
$
3,805,390

 
0.78
%
 
192
 
$
5,423,630

 
0.51
 %
 
190

In April 2015, our wholly owned subsidiary, Woodmont Insurance Co., LLC ("Woodmont"), was accepted for membership in the Federal Home Loan Bank ("FHLB") of Des Moines. As a member of the FHLB, Woodmont has access to a variety of products and services offered by the FHLB, including secured advances.

As of September 30, 2015, Woodmont had $487.9 million in outstanding secured advances, with a weighted average borrowing rate of 0.27%, a weighted average term to maturity of 4.9 years, floating monthly interest rate resets and a one month cancellation feature. These advances were collateralized by $320.8 million and $213.9 million in agency and non-agency securities, respectively, as of September 30, 2015.

As of September 30, 2015 and December 31, 2014, we had interest rate swap agreements outstanding where we pay a fixed rate and receive a floating rate based on LIBOR, summarized in the tables below (dollars in thousands):
September 30, 2015

 
Notional
Amount
 
Fair Value
 
Weighted Average
Current Maturity Date for Interest Rate Swaps (1)
 
 
 
Fixed
Pay Rate
(2)
 
Receive 
Rate
(3)
 
Maturity
(Years)
 ≤ 3 years
 
$
865,000

 
$
(6,407
)
 
1.09
%
 
0.32
%
 
2.1
> 3 to ≤ 5 years
 
550,000

 
(11,219
)
 
1.72
%
 
0.32
%
 
3.7
> 5 to ≤ 7 years
 
625,000

 
(43,044
)
 
3.16
%
 
0.31
%
 
6.1
> 7 years
 
250,000

 
(14,591
)
 
2.71
%
 
0.31
%
 
8.2
Total
 
$
2,290,000

 
$
(75,261
)
 
1.98
%
 
0.32
%
 
4.2

46



December 31, 2014
 
 
Notional
Amount
 
Fair Value
 
Weighted Average
Current Maturity Date for Interest Rate Swaps (4)
 
 
 
Fixed
Pay Rate
(2)
 
Receive 
Rate
(3)
 
Maturity
(Years)
 ≤ 3 years
 
$
1,065,000

 
$
(1,635
)
 
0.97
%
 
0.23
%
 
1.6
> 3 to ≤ 5 years
 
850,000

 
(4,441
)
 
1.91
%
 
0.23
%
 
4.2
> 5 to ≤ 7 years
 
1,625,000

 
(38,780
)
 
2.66
%
 
0.23
%
 
6.0
> 7 years
 
475,000

 
(18,782
)
 
2.87
%
 
0.25
%
 
8.2
Total
 
$
4,015,000

 
$
(63,638
)
 
2.08
%
 
0.23
%
 
4.7
————————
(1)
Includes swaps with an aggregate notional of $0.7 billion with deferred start dates averaging 0.8 years from September 30, 2015.
(2) 
Excluding forward starting swaps, the weighted average pay rate was 1.36% and 1.24% as of September 30, 2015 and December 31, 2014, respectively.
(3) 
Weighted average receive rate excludes impact of forward starting interest rate swaps.
(4) 
Includes swaps with an aggregate notional of $2.1 billion with deferred start dates averaging 1.1 years from December 31, 2014.
The following tables present certain information about our interest rate swaption agreements as of September 30, 2015 and December 31, 2014 (dollars in thousands):
September 30, 2015
 
 
Option
 
Underlying Swap
Current Option Expiration Date
 
Cost
 
Fair Value
 
Weighted Average Years to Expiration
 
Notional Amount
 
Pay Rate
 
Weighted Average Term (Years)
 
 
 
 
 
 
≤ 3 months
 
5,359

 
1,439

 
0.2
 
200,000

 
3.12
%
 
9.6
> 3 to ≤ 12 months
 
1,308

 
7

 
0.5
 
100,000

 
4.13
%
 
7.0
> 24 months
 
2,735

 
806

 
2.1
 
100,000

 
3.21
%
 
5.0
Total / weighted average
 
$
9,402

 
$
2,252

 
0.8
 
$
400,000

 
3.40
%
 
7.8
December 31, 2014
 
 
Option
 
Underlying Swap
Current Option Expiration Date
 
Cost
 
Fair Value
 
Weighted Average Years to Expiration
 
Notional Amount
 
Pay Rate
 
Weighted Average Term (Years)
 
 
 
 
 
 
≤ 3 months
 
$
4,013

 
$
1,972

 
0.1
 
$
150,000

 
2.78
%
 
4.3
> 3 to ≤ 12 months
 
3,139

 
1,432

 
0.9
 
200,000

 
3.29
%
 
8.8
>12 to ≤ 24 months
 
1,308

 
207

 
1.3
 
100,000

 
4.13
%
 
7.0
> 24 months
 
2,735

 
1,853

 
2.9
 
100,000

 
3.21
%
 
5.0
Total / weighted average
 
$
11,195

 
$
5,464

 
1.1
 
$
550,000

 
3.29
%
 
6.5

RESULTS OF OPERATIONS

In addition to the results presented in accordance with GAAP, our results of operations discussed herein include certain non-GAAP financial information, including "net spread and dollar roll income" (which includes the periodic interest rate costs of our interest rate swaps, TBA dollar roll income and dividends from REIT equity securities reported in other gains (losses), net in our consolidated statements of operations) and “estimated taxable income” and certain financial metrics derived from non-GAAP information, such as “cost of funds” and “estimated undistributed taxable income.” By providing users of our financial information with such measures in addition to the related GAAP measures, we intend to provide users greater transparency into the information used by our management in its financial and operational decision-making. We believe net spread and dollar roll income is meaningful information to consider as it incorporates the economic costs of financing our investment portfolio inclusive of interest rate swaps used to economically hedge against fluctuations in our borrowing costs and

47


presents our current financial performance without the effects of certain transactions that are not necessarily indicative of our current investment portfolio and operations. We present estimated taxable income and estimated undistributed taxable income, as this information is directly related to the amount of dividends we will be required to distribute over time in order to maintain our REIT qualification status. However, because each of these non-GAAP disclosures are incomplete measures of our financial performance and involve differences from results computed in accordance with GAAP, they should be considered as supplementary to, and not as a substitute for, our results computed in accordance with GAAP. In addition, because not all companies use identical calculations, our presentation of such non-GAAP measures may not be comparable to other similarly titled measures provided by other companies. Furthermore, estimated taxable income can include certain information that is subject to potential adjustments up to the time of filing our income tax returns, which occurs after the end of our fiscal year.




48


The table below presents our consolidated statements of operations during the three and nine months ended September 30, 2015 and 2014 (dollars in thousands, except per share amounts):
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Interest income:
 
 
 
 
 
 
 
Agency securities
$
19,988

 
$
27,208

 
$
75,455

 
$
92,939

Non-agency securities
19,760

 
16,324

 
54,414

 
47,794

Other
67

 
114

 
197

 
247

Interest expense
(7,586
)
 
(6,407
)
 
(22,601
)
 
(21,808
)
Net interest income
32,229

 
37,239

 
107,465

 
119,172

 
 
 
 
 
 
 
 
Servicing:
 
 
 
 
 
 
 
Servicing income
11,576

 
13,081

 
34,768

 
34,034

Servicing expense
(15,580
)
 
(16,213
)
 
(47,149
)
 
(44,861
)
Net servicing loss
(4,004
)
 
(3,132
)
 
(12,381
)
 
(10,827
)
 
 
 
 
 
 
 
 
Other gains (losses):
 
 
 
 
 
 
 
Realized gain (loss) on agency securities, net
175

 
685

 
(5,552
)
 
(8,396
)
Realized gain on non-agency securities, net
8

 
17,403

 
6,405

 
31,795

Realized loss on periodic settlements of interest rate swaps, net
(3,793
)
 
(5,226
)
 
(12,537
)
 
(15,400
)
Realized gain (loss) on other derivatives and securities, net
(27,724
)
 
13,704

 
(43,023
)
 
3,236

Unrealized gain (loss) on agency securities, net
32,583

 
(18,446
)
 
12,877

 
127,447

Unrealized loss on non-agency securities, net
(13,104
)
 
(21,103
)
 
(27,033
)
 
(11,255
)
Unrealized loss on other derivatives and securities, net
(18,654
)
 
(3,303
)
 
(26,388
)
 
(71,608
)
Unrealized loss on mortgage servicing rights
(5,260
)
 
(3,076
)
 
(3,591
)
 
(3,705
)
Impairment of intangible asset
(10,000
)
 

 
(10,000
)
 

Total other gains (losses), net
(45,769
)
 
(19,362
)
 
(108,842
)
 
52,114

 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
Management fees
4,250

 
4,544

 
13,183

 
13,169

General and administrative expenses
1,845

 
1,908

 
5,923

 
5,584

Total expenses
6,095

 
6,452

 
19,106

 
18,753

 
 
 
 
 
 
 
 
Income (loss) before provision for income tax
(23,639
)
 
8,293

 
(32,864
)
 
141,706

Provision for excise and income tax
(373
)
 

 
(42
)
 
(356
)
Net income (loss)
(24,012
)
 
8,293

 
(32,906
)
 
141,350

Dividend on preferred stock
(1,117
)
 
(1,117
)
 
(3,351
)
 
(1,601
)
Net income (loss) available to common shareholders
$
(25,129
)
 
$
7,176

 
$
(36,257
)
 
$
139,749

 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding — basic
50,815

 
51,142

 
51,052

 
51,185

Weighted average number of common shares outstanding — diluted
50,828

 
51,158

 
51,064


51,192

 
 
 
 
 
 
 
 
Net income (loss) per common share — basic and diluted
$
(0.49
)
 
$
0.14

 
$
(0.71
)
 
$
2.73

 
 
 
 
 
 
 
 
Dividend declared per common share
$
0.40

 
$
0.65

 
$
1.40

 
$
1.95


49



Interest Income and Asset Yields
The tables below present the interest income and weighted average yield for our agency and non-agency securities during the three and nine months ended September 30, 2015 and 2014 (dollars in thousands):
 
 
For the Three Months Ended September 30,
 
 
2015
 
2014
 
 
Average Amortized Cost
 
Weighted Average Yield
 
Interest Income
 
Average Amortized Cost
 
Weighted Average Yield
 
Interest Income
Agency RMBS (1)
 
$
3,370,767

 
2.37
%
 
$
19,988

 
$
4,323,399

 
2.52
%
 
$
27,208

Non-agency securities
 
1,429,926

 
5.53
%
 
19,760

 
987,963

 
6.61
%
 
16,324

Total
 
$
4,800,693

 
3.31
%
 
$
39,748

 
$
5,311,362

 
3.28
%
 
$
43,532


 
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
 
Average Amortized Cost
 
Weighted Average Yield
 
Interest Income
 
Average Amortized Cost
 
Weighted Average Yield
 
Interest Income
Agency RMBS (1)
 
$
3,965,416

 
2.54
%
 
$
75,455

 
$
4,919,835

 
2.52
%
 
$
92,939

Non-agency securities
 
1,308,900

 
5.54
%
 
54,414

 
947,449

 
6.73
%
 
47,794

Total
 
$
5,274,316

 
3.28
%
 
$
129,869

 
$
5,867,284

 
3.20
%
 
$
140,733

—————— 
(1)  
Does not include TBA dollar roll income reported in gain (loss) on other derivatives and securities, net in our consolidated statements of operations.
The following is a summary of the estimated impact of changes in the principal elements of interest income during the three and nine months ended September 30, 2015 and 2014 (in thousands):
 
 
For the Three Months Ended September 30, 2015 vs 2014
 
For the Nine Months Ended September 30, 2015 vs 2014
 
 
Increase / (Decrease)
 
Due to Change in Average (1)
 
Increase / (Decrease)
 
Due to Change in Average (1)
 
 
 
Volume
 
Yield
 
 
Volume
 
Yield
Agency RMBS
 
$
(7,220
)
 
$
(5,721
)
 
$
(1,499
)
 
$
(17,484
)
 
$
(18,166
)
 
$
682

Non-agency securities
 
3,436

 
5,418

 
(1,982
)
 
6,620

 
12,283

 
(5,663
)
Total
 
$
(3,784
)
 
$
(303
)
 
$
(3,481
)
 
$
(10,864
)
 
$
(5,883
)
 
$
(4,981
)
—————— 
(1)  
Variances that are the combined effect of volume and yield, but cannot be separately identified, are allocated to the volume and yield variances based on their respective relative amounts.
Interest income on agency RMBS decreased by $(7.2) million during the three months ended September 30, 2015 compared to the three months ended September 30, 2014 and by $(17.5) million during the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014, due mainly to reduced average balances resulting from lower average leverage. Interest income on non-agency securities increased by $3.4 million during the three months ended September 30, 2015 compared to the three months ended September 30, 2014 and by $6.6 million during the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014, due primarily to an increase in average balances, partially offset by lower average yields.
We amortize or accrete premiums and discounts associated with agency RMBS and non-agency securities of high credit quality into interest income over the life of such securities using the effective yield method. The effective yield (or asset yield) on these securities is based on actual CPRs realized for individual securities in our investment portfolio through the reporting date and assumes a CPR over the remaining projected life of our aggregate investment portfolio. We estimate projected CPRs on these securities using a third-party service and market data. We update our estimates on at least a quarterly basis, and more

50



frequently when economic or market conditions warrant. The effective yield on these securities is adjusted retrospectively for differences between actual and projected CPR estimates or for changes in our projected CPR estimates. Our projected CPR estimate for our agency RMBS was 8.6% and 8.2% as of September 30, 2015 and December 31, 2014, respectively. The actual CPR realized for individual agency RMBS in our investment portfolio was approximately 11.0% and 8.9% for the three months ended September 30, 2015 and 2014, respectively, and 9.5% and 7.7% for the nine months ended September 30, 2015 and 2014, respectively.
Interest income from our agency RMBS is net of premium amortization expense of $(8.2) million and $(7.9) million for the three months ended September 30, 2015 and 2014, respectively, and $(22.7) million and $(26.6) million for the nine months ended September 30, 2015 and 2014, respectively. The change in our weighted average CPR estimates resulted in the recognition of "catch up" premium amortization benefit (expense) of approximately $(1.6) million and $(0.8) million for the three months ended September 30, 2015 and 2014, respectively, and $(0.1) million and $(1.9) million for the nine months ended September 30, 2015 and 2014, respectively. The amortized cost basis of our agency RMBS portfolio was 104.9% and 104.4% of par value as of September 30, 2015 and December 31, 2014, respectively. The net unamortized premium balance of our aggregate agency RMBS portfolio was $156.0 million and $184.3 million as of September 30, 2015 and December 31, 2014, respectively.
At the time we purchase non-agency securities that are not of high credit quality, we determine an effective yield based on our estimate of the timing and amount of future cash flows and our cost basis. On at least a quarterly basis, we review the estimated cash flows and make appropriate adjustments with any changes in effective yield recognized prospectively based on the current amortized cost of the investment as adjusted for credit impairment, if any. Our estimates of future cash flows are based on input and analysis received from external sources, internal models and judgment about interest rates, prepayment rates, the timing and amount of credit losses and other factors. Interest income from our non-agency securities includes discount accretion of $9.4 million and $10.2 million for the three months ended September 30, 2015 and 2014, respectively, and $27.1 million and $30.5 million for the nine months ended September 30, 2015 and 2014, respectively. The weighted average cost basis of the non-agency portfolio was 86.4% and 80.9% of par as of September 30, 2015 and December 31, 2014, respectively. The total net discount remaining was $227.3 million and $262.5 million, with $113.7 million and $135.9 million designated as credit reserves as of September 30, 2015 and December 31, 2014, respectively.
Leverage
Our leverage, when adjusted for the net payables and receivables for unsettled securities and our net TBA position, was 4.7x and 4.6x our stockholders’ equity less investments in RCS as of September 30, 2015 and December 31, 2014, respectively. Our measurement of leverage excludes repurchase agreements used to fund short-term investments in U.S. Treasury securities due to the highly liquid and temporary nature of these investments. Our leverage will vary from time to time based on various factors, including our Manager’s opinion of the level of risk of our assets and liabilities, our view of the attractiveness of the return environment, composition of our investment portfolio, our liquidity position, our level of unused borrowing capacity, over-collateralization levels required by lenders when we pledge securities to secure our borrowings and the current market value of our investment portfolio. In addition, certain of our master repurchase agreements and master swap agreements contain a restriction that prohibits our leverage from exceeding certain levels. We do not expect these restrictions to adversely impact our operations.
The table below presents our quarterly average and quarter end repurchase agreement and advances balances outstanding and average leverage ratios for the quarterly periods since September 30, 2014 (dollars in thousands): 
 
 
Repurchase Agreements and Advances (1) (2)
 
Average
Interest
Rate as of Period End (1)
 
Average Leverage During the Period (2)
 
Leverage as of Period End (3)
 
Adjusted Leverage as of Period End (4)
Quarter Ended
 
Average Daily Amount Outstanding
 
Maximum Daily Amount Outstanding
 
Ending Amount Outstanding
 
September 30, 2015
 
$
4,118,008

 
$
4,921,925

 
$
4,067,133

 
0.74
%
 
4.1x
 
4.2x
 
4.7x
June 30, 2015
 
$
4,664,051

 
$
4,994,918

 
$
4,532,751

 
0.66
%
 
4.4x
 
4.2x
 
4.1x
March 31, 2015
 
$
4,994,683

 
$
5,206,437

 
$
4,994,874

 
0.62
%
 
4.6x
 
4.3x
 
4.5x
December 31, 2014
 
$
4,610,643

 
$
4,757,415

 
$
4,717,995

 
0.61
%
 
4.3x
 
4.4x
 
4.6x
September 30, 2014
 
$
4,524,189

 
$
4,778,350

 
$
4,461,278

 
0.58
%
 
4.2x
 
4.1x
 
4.9x
————————
(1) 
Excludes repurchase agreements collateralized by U.S. Treasury securities and includes advances from the Federal Home Loan Bank collateralized by non-agency securities.
(2) 
Average leverage for the period was calculated by dividing our daily weighted average agency and non-agency financing balance by our average month-end stockholders’ equity for the period less investment in RCS.

51



(3) 
Leverage as of period end was calculated by dividing the amount outstanding under our agency and non-agency financing agreements and net payables and receivables for unsettled agency and non-agency securities by our total stockholders’ equity at period end less our investment in RCS.
(4) 
Adjusted leverage as of period end was calculated by dividing the sum of the amounts outstanding under our agency and non-agency financing agreements, the cost basis (or contract price) of our net TBA position and net payables and receivables for unsettled agency and non-agency securities by our total stockholders’ equity at period end less our investment in RCS.
    
Adjusted leverage included in the table above includes the impact of TBA positions, which have the effect of increasing or decreasing our "at risk" leverage. A net long position increases our at risk leverage, while a net short position reduces our at risk leverage. As of September 30, 2015, we had a net long TBA position with both a notional value and underlying cost basis of $0.5 billion.

Interest Expense and Cost of Funds
Interest expense of $7.6 million and $6.4 million for the three months ended September 30, 2015 and 2014, respectively, and $22.6 million and $21.8 million for the nine months ended September 30, 2015 and 2014, respectively, was comprised of interest expense on our repurchase agreements and FHLB advances. We also incurred expense for our net periodic interest settlements related to our interest rate swaps of $3.8 million and $5.2 million for the three months ended September 30, 2015 and 2014, respectively, and $12.5 million and $15.4 million for the nine months ended September 30, 2015 and 2014, respectively, which is included in realized loss on periodic settlements of interest rate swaps, net, on our consolidated statements of operations.

The tables below present our average adjusted cost of funds during the three and nine months ended September 30, 2015 and 2014 (dollars in thousands):
 
 
For the Three Months Ended September 30,
 
 
2015
 
2014
 
 
Average
Balance / Effective Notional
 
Rate
 
Adjusted Cost of Funds (1)
 
Average
Balance / Effective Notional
 
Rate
 
Adjusted Cost of Funds (1)
Repurchase agreements and FHLB advances
 
$
4,118,008

 
0.73%
 
$
7,586

 
$
4,524,189

 
0.56%
 
$
6,407

Interest rate swaps
 
1,521,250

 
0.99%
 
3,793

 
2,065,000

 
1.00%
 
5,226

Total adjusted cost of funds
 
 
 
1.09%
 
$
11,379

 
 
 
1.02%
 
$
11,633

 
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
 
Average
Balance / Effective Notional
 
Rate
 
Adjusted Cost of Funds (1)
 
Average
Balance / Effective Notional
 
Rate
 
Adjusted Cost of Funds (1)
Repurchase agreements and FHLB advances
 
$
4,589,036

 
0.66%
 
$
22,601

 
$
5,117,839

 
0.57%
 
$
21,808

Interest rate swaps
 
1,622,500

 
1.03%
 
12,537

 
2,077,500

 
0.99%
 
15,400

Total adjusted cost of funds
 
 
 
1.02%
 
$
35,138

 
 
 
0.97%
 
$
37,208

————————
(1) 
Our adjusted cost of funds excludes any impacts from other supplemental hedges such as U.S. Treasury securities and swaptions, and the implied financing cost or benefit of our net TBA dollar roll position reported in gain (loss) on other derivatives and securities, net in our consolidated statements of operations.

52



The following is a summary of the impact of changes in the principal elements of our adjusted cost of funds during the three and nine months ended September 30, 2015 and 2014 (in thousands):
 
For the Three Months Ended September 30, 2015 vs 2014
 
For the Nine Months Ended September 30, 2015 vs 2014
 
Increase / (Decrease)
 
Due to Change in Average (1)
 
Increase / (Decrease)
 
Due to Change in Average (1)
 
 
Volume
 
Rate
 
 
Volume
 
Rate
Repurchase agreements and FHLB advances
$
1,179

 
$
(502
)
 
$
1,681

 
$
793

 
$
(1,555
)
 
$
2,348

Interest rate swaps
(1,433
)
 
(1,357
)
 
(76
)
 
(2,863
)
 
(3,550
)
 
687

Total adjusted cost of funds
$
(254
)
 
$
(1,859
)
 
$
1,605

 
$
(2,070
)
 
$
(5,105
)
 
$
3,035

—————— 
(1)  
Variances that are the combined effect of volume and yield, but cannot be separately identified, are allocated to the volume and yield variances based on their respective relative amounts.
The decreases in our adjusted cost of funds of $(0.3) million for the three months ended September 30, 2015 compared to the three months ended September 30, 2014 and $(2.1) million for the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014, were attributable to a combination of lower average financing balances and swap notional amounts, partially offset by an increase in repurchase agreement rates.

Net Servicing Loss
The following table presents the components of servicing income and expense for the three and nine months ended September 30, 2015 and 2014 (dollars in thousands):
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Servicing fee income
 
$
8,312

 
$
9,247

 
$
24,046

 
$
22,572

Incentive, ancillary and other income
 
3,264

 
3,834

 
10,722

 
11,462

Servicing income
 
11,576

 
13,081

 
34,768

 
34,034

 
 
 
 
 
 
 
 
 
Employee compensation and benefit costs
 
7,907

 
8,678

 
22,926

 
25,353

Facility costs
 
2,450

 
3,831

 
7,870

 
10,111

Realization of cash flows from MSR
 
2,642

 
1,728

 
7,875

 
2,830

Other servicing costs
 
2,581

 
1,976

 
8,478

 
6,567

Servicing expense
 
15,580

 
16,213

 
47,149

 
44,861

 
 
 
 
 
 
 
 
 
Net servicing loss
 
$
(4,004
)
 
$
(3,132
)
 
$
(12,381
)
 
$
(10,827
)

As of September 30, 2015, RCS managed a servicing portfolio of approximately 64,000 loans, representing approximately $13 billion in unpaid principal balances. RCS provides full end-to-end services for mortgage servicing solutions, including (i) loan acquisition and boarding, (ii) customer service, collections and loss mitigation, and (iii) foreclosure and real-estate owned services. We have elected to treat our investment in RCS as a TRS, and RCS is therefore subject to corporate income tax on its earnings.

53



Realized and Unrealized Gain (Loss) on Securities, Net
Sales of securities for the three and nine months ended September 30, 2015 and 2014 were largely driven by a reduction in our on-balance sheet agency RMBS portfolio and a rebalancing of the agency and non-agency securities portfolios. These changes in portfolio composition were based upon our Manager's expectations concerning interest rates, Federal government programs, general economic conditions and other factors.
The following table is a summary of our net realized gains and losses on agency RMBS during the three and nine months ended September 30, 2015 and 2014 (dollars in thousands): 
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Proceeds from agency RMBS sold
 
$
536,661

 
$
400,042

 
$
1,772,536

 
$
2,067,118

Increase (decrease) in receivable for agency RMBS sold
 
(141,887
)
 
(77,918
)
 
67,055

 
(570,029
)
Less agency RMBS sold, at cost
 
(394,599
)
 
(321,439
)
 
(1,845,143
)
 
(1,505,485
)
Net realized gain (loss) on sale of agency RMBS
 
$
175

 
$
685

 
$
(5,552
)
 
$
(8,396
)
 
 
 
 
 
 
 
 
 
Gross realized gains on sale of agency RMBS
 
$
2,226

 
$
1,552

 
$
6,190

 
$
9,382

Gross realized losses on sale of agency RMBS
 
(2,051
)
 
(867
)
 
(11,742
)
 
(17,778
)
Net realized gain (loss) on sale of agency RMBS
 
$
175

 
$
685

 
$
(5,552
)
 
$
(8,396
)
The following table is a summary of our net realized gains on non-agency securities during the three and nine months ended September 30, 2015 and 2014 (dollars in thousands): 
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Proceeds from non-agency securities sold
 
$
166,502

 
$
166,204

 
$
385,480

 
$
461,415

Increase in receivable for non-agency securities sold
 

 
10,514

 

 
10,514

Less: non-agency securities sold, at cost
 
(166,494
)
 
(159,315
)
 
(379,075
)
 
(440,134
)
Net realized gain on sale of non-agency securities
 
$
8

 
$
17,403

 
$
6,405

 
$
31,795

 
 
 
 
 
 
 
 
 
Gross realized gain on sale of non-agency securities
 
$
1,769

 
$
18,436

 
$
8,662

 
$
36,731

Gross realized loss on sale of non-agency securities
 
(1,761
)
 
(1,033
)
 
(2,257
)
 
(4,936
)
Net realized gain on sale of non-agency securities
 
$
8

 
$
17,403

 
$
6,405

 
$
31,795


Unrealized net gains of $32.6 million and $12.9 million on agency RMBS for the three and nine months ended September 30, 2015, respectively, and unrealized net losses of $(13.1) million and $(27.0) million on non-agency securities for the three and nine months ended September 30, 2015, respectively, were attributable to the changes in market pricing on the underlying instruments as described above in Trends and Recent Market Impacts, as well as the impact of realized gains and losses on sales of securities.

54



Gain (Loss) on Other Derivatives and Securities, Net
The following table is a summary of our realized and unrealized gain (loss) on other derivatives and securities, net, during the three and nine months ended September 30, 2015 and 2014 (dollars in thousands): 
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Realized loss on periodic settlements of interest rate swaps, net
 
$
(3,793
)
 
$
(5,226
)
 
$
(12,537
)

$
(15,400
)
Realized gain (loss) on other derivatives and securities:
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
(23,540
)
 
$

 
$
(53,114
)

$
68

Interest rate swaptions
 
(1,273
)
 
(719
)
 
(1,793
)

(17,551
)
TBA securities
 
(251
)
 
16,840

 
13,249


22,832

U.S. Treasury securities
 
1,899

 
(222
)
 
10,993


2,536

U.S. Treasury futures
 
(2,156
)
 
(653
)
 
(4,934
)

(4,630
)
U.S. Treasury securities sold short
 
(3,389
)
 
(2,964
)
 
(8,473
)

(8,928
)
REIT equity investments
 

 
1,188

 


8,675

Mortgage options
 

 
234

 
22

 
234

Interest only swaps
 
513

 

 
229



Credit default swaps
 
459

 

 
784

 

Credit default option
 
14

 

 
14

 

Total realized gain (loss) on other derivatives and securities, net
 
$
(27,724
)
 
$
13,704

 
$
(43,023
)

$
3,236

Unrealized loss on other derivatives and securities:
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
(20,279
)
 
$
13,445

 
$
(13,103
)

$
(64,757
)
Interest rate swaptions
 
(1,085
)
 
(514
)
 
(1,419
)

(8,882
)
TBA securities
 
15,242

 
(15,004
)
 
(1,231
)

(3,086
)
U.S. Treasury securities
 
72

 
(145
)
 
(666
)

12,293

U.S. Treasury futures
 
(2,519
)
 
559

 
(773
)

(2,202
)
U.S. Treasury securities sold short
 
(11,729
)
 
(377
)
 
(10,795
)

(5,444
)
REIT equity investments
 

 
(1,375
)
 


502

Mortgage options
 

 
108

 


(32
)
Interest only swaps
 
439

 

 
128



Credit default swaps
 
1,545

 

 
1,471

 

Credit default option
 
(340
)
 

 

 

Total unrealized loss on other derivatives and securities, net
 
$
(18,654
)
 
$
(3,303
)
 
$
(26,388
)

$
(71,608
)

Realized and unrealized net losses on interest rate swaps and swaptions of $(43.8) million and $(2.4) million, respectively, during the three months ended September 30, 2015 were due mainly to termination of $0.5 billion in notional value of swaps during the third quarter of 2015. Realized and unrealized net losses on interest rate swaps and swaptions of $(66.2) million and $(3.2) million, respectively, for the nine months ended September 30, 2015 were due primarily to losses incurred as swap rates fell during the first quarter when average swap notional balances were larger than during the second quarter. Realized and unrealized net gains on TBA securities of $15.0 million during the three months ended September 30, 2015 and $12.0 million during the nine months ended September 30, 2015 were due mainly to the decrease in longer term interest rates during the first and third quarters of 2015. For further details regarding our derivatives and related hedging activity please refer to Notes 3 and 7 to our consolidated financial statements in this Quarterly Report on Form 10-Q.

During the three months ended September 30, 2015, we recorded a $(10.0) million intangible asset impairment charge based on a revised estimated fair value of RCS’ servicing licenses and approvals.  We reduced our estimate of the intangible asset’s fair value as a result of certain financial and economic factors, including anticipated acquisitions of mortgage servicing rights. The fair value of intangible assets of September 30, 2015 was estimated based upon a combination of internal models and third party inputs.


55



Management Fees and General and Administrative Expenses
We pay our Manager a management fee payable monthly in arrears in an amount equal to one twelfth of 1.50% of our month-end GAAP stockholders’ equity, adjusted to exclude the effect of any unrealized gains or losses included in retained earnings as computed in accordance with GAAP. There is no incentive compensation payable to our Manager pursuant to the management agreement. We incurred management fees of $4.3 million and $4.5 million during the three months ended September 30, 2015 and 2014, and $13.2 million during both the nine months ended September 30, 2015 and 2014. The period-over-period decrease for the three months ended September 30, 2015 and 2014 was a function of lower average equity, primarily as a result of realized losses during 2015.
General and administrative expenses were $1.8 million and $1.9 million during the three months ended September 30, 2015 and 2014, respectively, and $5.9 million and $5.6 million during the nine months ended September 30, 2015 and 2014, respectively. Our general and administrative expenses primarily consist of prime brokerage fees, information technology costs, research and data service fees, audit fees, Board of Directors fees and insurance expenses.
Our management fees and general and administrative expenses as a percentage of our average stockholders’ equity on an annualized basis were 2.2% and 2.1% for the three months ended September 30, 2015 and 2014, respectively, and 2.2% for both the nine months ended September 30, 2015 and 2014.
Dividends and Income Taxes

We had estimated taxable income available to common shareholders of $19.2 million and $19.6 million (or $0.38 and $0.38 per common share) for the three months ended September 30, 2015 and 2014, respectively, and $67.7 million and $73.6 million (or $1.33 and $1.44 per common share) for the nine months ended September 30, 2015 and 2014, respectively.

As a REIT, we are required to distribute annually at least 90% of our taxable income to maintain our status as a REIT and all of our taxable income to avoid Federal and state corporate income taxes. We can treat dividends declared by September 15 and paid by December 31 as having been a distribution of our taxable income for our prior tax year ("spill-back provision"). Income as determined under GAAP differs from income as determined under tax rules because of both temporary and permanent differences in income and expense recognition. The primary differences are (i) unrealized gains and losses associated with assets and liabilities marked-to-market in current income for GAAP purposes, but excluded from taxable income until realized or settled, (ii) timing differences in the recognition of certain realized gains and losses, (iii) losses or undistributed income of taxable REIT subsidiaries and (iv) temporary differences related to the amortization of net premiums paid on investments. Furthermore, our estimated taxable income is subject to potential adjustments up to the time of filing our appropriate tax returns, which occurs after the end of our fiscal year.
    

56



The following is a reconciliation of our GAAP net income to our estimated taxable income during the three and nine months ended September 30, 2015 and 2014 (dollars in thousands, except per share amounts).
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015

2014
 
2015
 
2014
Net income (loss)
 
$
(24,012
)
 
$
8,293

 
$
(32,906
)
 
$
141,350

Book to tax differences:
 
 
 
 
 
 
 
 
Unrealized (gains) and losses, net
 
 
 
 
 
 
 
 
Agency RMBS
 
(32,583
)
 
18,446

 
(12,877
)
 
(127,447
)
Non-agency securities
 
13,104

 
21,103

 
27,033

 
11,255

Derivatives, MSR and other securities
 
23,914

 
6,379

 
29,979

 
75,313

Premium amortization, net
 
(1,053
)
 
(3,778
)
 
(10,100
)
 
(9,732
)
Capital losses (gains) in excess of capital gains (losses) (1)
 
1,888

 
(37,359
)
 
(12,478
)
 
(52,440
)
Realized losses, net (1)
 
24,694

 
4,451

 
59,991

 
25,686

Other
 
14,377

 
3,132

 
22,424

 
11,183

Total book to tax difference
 
44,341

 
12,374

 
103,972

 
(66,182
)
Estimated taxable income
 
20,329

 
20,667

 
71,066

 
75,168

Dividend on preferred stock
 
(1,117
)
 
(1,117
)
 
(3,351
)
 
(1,601
)
Estimated taxable income available to common shareholders
 
$
19,212

 
$
19,550

 
$
67,715

 
$
73,567

 
 
 
 

 
 
 
 
Weighted average number of common shares outstanding — basic
 
50,815

 
51,142

 
51,052

 
51,185

Weighted average number of common shares outstanding — diluted
 
50,828

 
51,158

 
51,064

 
51,192

 
 
 
 
 
 
 
 
 
Estimated taxable income per common share - basic and diluted
 
$
0.38

 
$
0.38

 
$
1.33

 
$
1.44

Estimated cumulative undistributed REIT taxable income per common share
 
$
0.05

 
$
0.26

 
$
0.05

 
$
0.26

 
 
 
 
 
 
 
 
 
Beginning cumulative non-deductible capital losses
 
$
130,531

 
$
179,987

 
$
144,897

 
$
195,068

Current period net capital loss (gain)
 
1,888

 
(37,359
)
 
(12,478
)
 
(52,440
)
Ending cumulative non-deductible capital losses
 
$
132,419

 
$
142,628

 
$
132,419

 
$
142,628

Ending cumulative non-deductible capital losses per common share
 
$
2.65

 
$
2.79

 
$
2.65

 
$
2.79

—————— 
(1)  
Estimated taxable income excludes estimated net capital gains (losses) of $(0.04) and $0.24 per common share for the three and nine months ended September 30, 2015, respectively, which will be added to our net capital loss carryforwards from prior periods. Estimated taxable income also excludes losses on terminated interest rate swaps of $(0.46) and $(1.04) per common share, for the three and nine months ended September 30, 2015, respectively, which are deferred and amortized into future ordinary taxable income over the original swap terms.

The decrease in our estimated taxable income per common share is primarily due to lower net spread income.

The following table summarizes dividends declared on our Series A Preferred Stock and common stock for the three and nine months ended September 30, 2015 and 2014:
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Series A Preferred Stock
 
$
0.5078125

 
$
0.5078125

 
$
1.5234375

 
$
0.8068625

Common stock
 
$
0.40

 
$
0.65

 
$
1.40

 
$
1.95


The final tax characterization of our fiscal year 2015 dividends will be determined and reported to stockholders on their annual Form 1099-DIV statement after the end of the year.

57



    
As of September 30, 2015, we had an estimated $2.6 million (or $0.05 per common share) of undistributed taxable income, net of the common stock dividend payable of $20.0 million. We have distributed all of our 2014 taxable income within the allowable time frame, including the available spill-back provision, so that we will not be subject to Federal or state corporate income tax. However, as a REIT, we are still subject to a nondeductible Federal excise tax of 4% to the extent that the sum of (i) 85% of our ordinary taxable income, (ii) 95% of our capital gains and (iii) any undistributed taxable income from the prior year, exceeds our dividends declared in such year and paid by January 31 of the subsequent year. We do not currently expect to incur any excise tax liability for the year ended December 31, 2015.

We acquired 100% of RCS, which is taxable as a corporation under Subchapter C of the Internal Revenue Code, on November 27, 2013, with which we filed a joint TRS election. As of September 30, 2015, RCS had Federal net operating loss ("NOL") carryforwards of approximately $80.6 million, which can be carried forward for up to twenty years. As a result of the change in ownership, the utilization of most of the NOL is subject to limitations imposed by the Internal Revenue Code. The gross deferred tax assets associated with the NOL and other temporary differences as of September 30, 2015 were approximately $38.2 million, with respect to which RCS has provided a full valuation allowance.

We recorded $0.4 million of income tax expense for the three months ended September 30, 2015 related to American Capital Mortgage Investment TRS, LLC, a taxable subsidiary.
Key Statistics
The table below presents key statistics for the three and nine months ended September 30, 2015 and 2014 (dollars in thousands, except per share amounts):
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Ending agency securities, at fair value
 
$
3,356,523

 
$
4,259,763

 
$
3,356,523

 
$
4,259,763

Ending agency securities, at cost
 
$
3,334,238

 
$
4,310,828

 
$
3,334,238

 
$
4,310,828

Ending agency securities, at par
 
$
3,178,229

 
$
4,128,817

 
$
3,178,229

 
$
4,128,817

Average agency securities, at cost
 
$
3,370,767

 
$
4,323,399

 
$
3,965,416

 
$
4,919,835

Average agency securities, at par
 
$
3,213,650

 
$
4,138,378

 
$
3,784,513

 
$
4,712,892

 
 
 
 
 
 
 
 
 
Ending non-agency securities, at fair value
 
$
1,479,586

 
$
1,075,867

 
$
1,479,586

 
$
1,075,867

Ending non-agency securities, at cost
 
$
1,448,908

 
$
1,003,036

 
$
1,448,908

 
$
1,003,036

Ending non-agency securities, at par
 
$
1,676,165

 
$
1,477,251

 
$
1,676,165

 
$
1,477,251

Average non-agency securities, at cost
 
$
1,429,926

 
$
987,963

 
$
1,308,900

 
$
947,449

Average non-agency securities, at par
 
$
1,663,642

 
$
1,493,252

 
$
1,558,331

 
$
1,496,007

 
 
 
 
 
 
 
 
 
Net TBA portfolio - as of period end, at fair value
 
$
543,897

 
$
949,111

 
$
543,897

 
$
949,111

Net TBA portfolio - as of period end, at cost
 
$
533,496

 
$
951,179

 
$
533,496

 
$
951,179

Average net TBA portfolio, at cost
 
$
305,462

 
$
1,095,781

 
$
85,166

 
$
555,357

 
 
 
 
 
 
 
 
 
Average total assets, at fair value
 
$
6,224,595

 
$
6,872,722

 
$
6,632,130

 
$
7,292,900

Average agency and non-agency repurchase agreements and advances
 
$
4,118,008

 
$
4,524,189

 
$
4,589,036

 
$
5,117,839

Average stockholders' equity
 
$
1,099,139

 
$
1,200,644

 
$
1,149,321

 
$
1,162,958


58




 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Average coupon
 
3.15
 %
 
2.93
%
 
3.12
 %
 
2.94
%
Average asset yield
 
3.31
 %
 
3.28
%
 
3.28
 %
 
3.20
%
Average cost of funds (1)
 
1.09
 %
 
1.02
%
 
1.02
 %
 
0.97
%
Average net interest rate spread
 
2.22
 %
 
2.26
%
 
2.26
 %
 
2.23
%
Average net interest rate spread, including estimated dollar roll income (2)
 
2.27
 %
 
2.34
%
 
2.41
 %
 
2.34
%
Average net spread and dollar roll income, excluding catch up amortization
 
2.40
 %
 
2.39
%
 
2.41
 %
 
2.39
%
Average coupon as of period end
 
3.17
 %
 
2.94
%
 
3.17
 %
 
2.94
%
Average asset yield as of period end
 
3.45
 %
 
3.33
%
 
3.45
 %
 
3.33
%
Average cost of funds as of period end
 
1.16
 %
 
1.03
%
 
1.16
 %
 
1.03
%
Average net interest rate spread as of period end
 
2.29
 %
 
2.30
%
 
2.29
 %
 
2.30
%
Average actual CPR for agency securities held during the period
 
11.0
 %
 
8.9
%
 
9.5
 %
 
7.7
%
Average projected life CPR for agency securities as of period end
 
8.6
 %
 
7.6
%
 
8.6
 %
 
7.6
%
 
 
 
 
 
 
 
 
 
Leverage - average during the period (3)
 
4.1x

 
4.2x

 
4.4x

 
4.8x

Leverage - average during the period, including net TBA position
 
4.4x

 
5.2x

 
4.4x

 
5.4x

Leverage - as of period end (4)
 
4.2x

 
4.1x

 
4.2x

 
4.1x

Leverage - as of period end, including net TBA position
 
4.7x

 
4.9x

 
4.7x

 
4.9x

 
 
 
 
 
 
 
 
 
Expenses % of average total assets - annualized
 
0.4
 %
 
0.4
%
 
0.4
 %
 
0.3
%
Expenses % of average stockholders' equity - annualized
 
2.2
 %
 
2.1
%
 
2.2
 %
 
2.2
%
Net book value per common share as of period end
 
$
19.93

 
$
22.24

 
$
19.93

 
$
22.24

Dividends declared per common share
 
$
0.40

 
$
0.65

 
$
1.40

 
$
1.95

Economic return on common equity - annualized
 
(7.1
)%
 
2.8
%
 
(3.6
)%
 
16.9
%
————————  
(1) 
Weighted average cost of funds includes periodic settlements of interest rate swaps.
(2) 
Estimated dollar roll income is net of short TBAs used for hedging purposes. Dollar roll income excludes the impact of other supplemental hedges, and is recognized in gain (loss) on other derivatives and securities, net.
(3) 
Leverage during the period was calculated by dividing the Company's daily weighted average agency and non-agency financing agreements for the period by the Company's average month-ended stockholders' equity for the period less investments in RCS. Leverage excludes U.S. Treasury repurchase agreements.
(4) 
Leverage at period end was calculated by dividing the sum of the amount outstanding under the Company's agency and non-agency financing agreements and the net receivable/payable for unsettled securities at period end by the Company's stockholders' equity at period end less investments in RCS. Leverage excludes U.S. Treasury repurchase agreements.



59



Net Spread and Dollar Roll Income
The table below presents a reconciliation from GAAP net interest income to adjusted net interest income and net spread income during the three and nine months ended September 30, 2015 and 2014 (dollars in thousands, except per share amounts):
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Interest income:
 
 
 
 
 
 
 
 
Agency RMBS
 
$
19,988

 
$
27,208

 
$
75,455

 
$
92,939

Non-agency securities and other
 
19,827

 
16,438

 
54,611

 
48,041

Interest expense
 
(7,586
)
 
(6,407
)
 
(22,601
)
 
(21,808
)
Net interest income
 
32,229

 
37,239

 
107,465

 
119,172

Dividend income from investments in REIT equity securities (1)
 

 

 

 
1,840

Realized loss on periodic settlements of interest rate swaps, net
 
(3,793
)
 
(5,226
)
 
(12,537
)
 
(15,400
)
Adjusted net interest income
 
28,436

 
32,013

 
94,928

 
105,612

Management fees and general and administrative expenses
 
(6,095
)
 
(6,452
)
 
(19,106
)
 
(18,753
)
Net spread income
 
22,341

 
25,561

 
75,822

 
86,859

Dollar roll income
 
3,201

 
10,364

 
5,252

 
16,570

Net spread and dollar roll income
 
25,542

 
35,925

 
81,074

 
103,429

Dividend on preferred stock
 
(1,117
)
 
(1,117
)
 
(3,351
)
 
(1,601
)
Net spread and dollar roll income available to common shareholders
 
$
24,425

 
$
34,808

 
$
77,723

 
$
101,828

 
 
 
 
 
 
 
 
 
Weighted average number of common shares outstanding — basic
 
50,815

 
51,142

 
51,052

 
51,185

Weighted average number of common shares outstanding — diluted
 
50,828

 
51,158

 
51,064

 
51,192

 
 
 
 
 
 
 
 
 
Net spread and dollar roll income per common share- basic and diluted
 
$
0.48

 
$
0.68

 
$
1.52

 
$
2.02

Net spread and dollar roll income, excluding "catch up" amortization per common share- basic and diluted
 
$
0.51

 
$
0.70

 
$
1.52

 
$
1.98

—————— 
(1)  
Dividend income from investments in REIT equity securities is included in realized gain (loss) on other derivatives and securities, net on the consolidated statements of operations.

Net spread and dollar roll income decreased $(0.20) per common share for the three months ended September 30, 2015 compared to the three months ended September 30, 2014 and $(0.50) per common share for the nine months ended September 30, 2015 compared to the nine months ended September 30, 2014 due primarily to a reduction in leverage, including our net TBA position.

We believe that the above non-GAAP financial measures provide information useful to investors because net spread and dollar roll income is a financial metric used by management and investors and estimated taxable income is directly related to the amount of dividends we are required to distribute in order to maintain its REIT tax qualification status.
We also believe that providing investors with our net spread and dollar roll income, estimated taxable income and certain financial metrics derived from such non-GAAP financial information, in addition to the related GAAP measures, gives investors greater transparency to the information used by management in its financial and operational decision-making and that it is meaningful information to consider related to the economic costs of financing our investment portfolio inclusive of interest rate swaps used to economically hedge against fluctuations in our borrowing costs, without the effects of certain transactions that are not necessarily indicative of our current investment portfolio and operations.
However, because such non-GAAP financial information provides incomplete measures of our financial performance and involve differences from results computed in accordance with GAAP, they should be considered supplementary to, and not a substitute for, our results computed in accordance with GAAP. In addition, because not all companies use identical

60



calculations, our presentation of such non-GAAP measures may not be comparable to other similarly-titled measures of other companies.

LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of funds are borrowings under master repurchase agreements, equity offerings, asset sales and monthly principal and interest payments on our investment portfolio. Because the level of our borrowings can be adjusted on a daily basis, the level of cash and cash equivalents carried on our balance sheets is significantly less important than the potential liquidity available under our borrowing arrangements. We currently believe that we have sufficient liquidity and capital resources available for the acquisition of additional investments, repayments on borrowings, maintenance of any margin requirements and the payment of cash dividends as required for our continued qualification as a REIT. To qualify as a REIT, we must distribute annually at least 90% of our taxable income. To the extent that we annually distribute all of our taxable income in a timely manner, we will generally not be subject to Federal and state income taxes. We currently expect to distribute all of our taxable income in a timely manner so that we are not subject to Federal and state income taxes. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital from operations.
Equity Capital

To the extent we raise additional equity capital through follow-on equity offerings, we currently anticipate using cash proceeds from such transactions to purchase additional investment securities, to make scheduled payments of principal and interest on our repurchase agreements and for other general corporate purposes. There can be no assurance, however, that we will be able to raise additional equity capital at any particular time or on any particular terms.

Common Stock Repurchase Program

Our Board of Directors adopted a program that authorizes repurchases of our common stock up to a specified amount. In
October 2015, our Board of Directors extended its authorization through December 31, 2016. Shares of our common stock may be purchased in the open market, including through block purchases, or through privately negotiated transactions, or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The timing, manner, price and amount of any repurchases will be determined at our discretion and the program may be suspended, terminated or modified at any time for any reason. Among other factors, we intend to only consider repurchasing shares of our common stock when the purchase price is less than our estimate of our current net asset value per common share. Generally, when we repurchase our common stock at a discount to our net asset value, the net asset value of our remaining shares of common stock outstanding increases. In addition, we do not intend to repurchase any shares from directors, officers or other affiliates. The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.

During the three and nine months ended September 30, 2015, we repurchased approximately 1.2 million shares of our common stock at an average repurchase price of $15.29 per share, including expenses, totaling $18.1 million. As of September 30, 2015, we had an additional $116.9 million authorized for repurchases of our common stock through December 31, 2016.

Debt Capital

Repurchase Agreements
As part of our investment strategy, we borrow against our agency and non-agency securities pursuant to master repurchase agreements. We expect that our borrowings pursuant to repurchase transactions under such master repurchase agreements generally will have maturities of less than one year. When adjusted for net payables and receivables for unsettled agency and non-agency securities, our leverage ratio was 4.2x and 4.4x the amount of our stockholders’ equity less our investments in RCS as of September 30, 2015 and December 31, 2014, respectively, excluding amounts borrowed under U.S. Treasury repurchase agreements. Our cost of borrowings under master repurchase agreements generally corresponds to LIBOR plus or minus a margin.
To limit our exposure to counterparty credit risk, we diversify our funding across multiple counterparties and by counterparty region. We had repurchase agreements with 32 financial institutions as of September 30, 2015, located throughout North America, Europe and Asia. In addition, less than 5% of our equity was at risk with any one repurchase agreement counterparty, with the top five counterparties representing less than 23% of our equity at risk as of September 30, 2015.

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As of September 30, 2015, borrowings under repurchase agreements of $2.7 billion and $837.8 million, with weighted average remaining days to maturity of 260 days and 23 days, were secured by agency and non-agency securities, respectively.
The table below includes a summary of our repurchase agreement funding and number of counterparties by region as of September 30, 2015. Refer to Note 6 to our consolidated financial statements in this Quarterly Report on Form 10-Q for further details regarding our borrowings under repurchase agreements and weighted average interest rates as of September 30, 2015.
 
 
September 30, 2015
Counterparty Region
 
Number of Counterparties
 
Percentage of Repurchase Agreement Funding
North America
 
18
 
75%
Asia
 
5
 
13%
Europe
 
9
 
12%
Total
 
32
 
100%
Amounts available to be borrowed under our repurchase agreements are dependent upon lender collateral requirements and the lender's determination of the fair value of the securities pledged as collateral, based on recognized pricing sources agreed to by both parties to the agreement. Collateral fair value can fluctuate with changes in interest rates, credit quality and liquidity conditions within the investment banking, mortgage finance and real estate industries. Our counterparties also apply a "haircut" to the fair value of our pledged collateral, which reflects the underlying risk of the specific collateral and protects our counterparties against a decrease in collateral value, but conversely subjects us to counterparty risk and limits the amount we can borrow against our investment securities. Our master repurchase agreements do not specify the haircut, rather haircuts are determined on an individual repurchase transaction basis. Throughout the three and nine months ended September 30, 2015, haircuts on our pledged collateral remained stable and, as of September 30, 2015, our weighted average haircut on agency and non-agency securities held as collateral were approximately 5% and 26%, respectively.
Under our repurchase agreements, we may be required to pledge additional assets to repurchase agreement counterparties in the event the estimated fair value of the existing pledged collateral under such agreements declines and such counterparties demand additional collateral (a margin call), which may take the form of additional securities or cash. Specifically, margin calls would result from a decline in the value of our securities securing our repurchase agreements and prepayments on the mortgages securing such securities. Similarly, if the estimated fair value of our investment securities increases due to changes in interest rates or other factors, counterparties may release collateral back to us. Our repurchase agreements generally provide that the valuations for the securities securing our repurchase agreements are to be obtained from a generally recognized source agreed to by the parties. However, in certain circumstances and under certain of our repurchase agreements, our lenders have the sole discretion to determine the value of the securities securing our repurchase agreements. In such instances, our lenders are required to act in good faith in making determinations of value. Our repurchase agreements generally provide that in the event of a margin call we must provide additional securities or cash on the same business day that a margin call is made if the lender provides us notice prior to the margin notice deadline on such day.
As of September 30, 2015, we had met all margin requirements and had unrestricted cash and cash equivalents of $170.7 million and unpledged securities of approximately $173.6 million, excluding unsettled purchases of securities, available to meet margin calls on our repurchase agreements and derivative instruments as of September 30, 2015.
Although we believe that we will have adequate sources of liquidity available to us through repurchase agreement financing to execute our business strategy, there can be no assurances that repurchase agreement financing will be available to us upon the maturity of our current repurchase agreements to allow us to renew or replace our repurchase agreement financing on favorable terms or at all. If our repurchase agreement lenders default on their obligations to resell the underlying securities back to us at the end of the term, we could incur a loss equal to the difference between the value of the securities and the cash we originally received.
We maintain an interest rate risk management strategy under which we use derivative financial instruments to help manage the adverse impact of interest rates changes on the value of our investment portfolio as well as our cash flows. In particular, we attempt to mitigate the risk of the cost of our short-term variable rate liabilities increasing at a faster rate than the earnings of our long-term assets during a period of rising interest rates. The principal derivative instruments that we use are interest rate swaps, swaptions and short Treasury positions. We may also supplement our hedge portfolio with the use of TBA positions and other instruments.

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Refer to Notes 3 and 7 to our consolidated financial statements in this Quarterly Report on Form 10-Q for further details regarding our outstanding interest rate swaps as of September 30, 2015 and the related activity for the year ended December 31, 2014.

Our derivative agreements typically require that we pledge/receive collateral on such agreements to/from our counterparties in a similar manner as we are required to under our repurchase agreements. Our counterparties, or the clearing exchange in the case of our centrally cleared interest rate swaps, typically have the sole discretion to determine the value of the derivative instruments and the value of the collateral securing such instruments. In the event of a margin call, we must generally provide additional collateral on the same business day.

Similar to repurchase agreements, our use of derivatives exposes us to counterparty credit risk relating to potential losses
that could be recognized in the event that the counterparties to these instruments fail to perform their obligations under the contracts. We minimize this risk by limiting our counterparties to major financial institutions with acceptable credit ratings, by maintaining collateral sufficient to cover the change in market value, and by monitoring positions with individual counterparties.

We did not have an amount at risk with any counterparty related to our non-centrally cleared interest rate swap and swaption agreements greater than 1% of our stockholders’ equity as of both September 30, 2015 and December 31, 2014.

In the case of centrally cleared interest rate swap contracts, we could be exposed to credit risk if the central clearing agency or a clearing member defaults on its respective obligation to perform under the contract; however, the risk is considered minimal due to initial and daily exchange of mark to market margin requirements and the clearinghouse guarantee fund and other resources that are available in the event of a clearing member default.

Federal Home Loan Bank Membership
The FHLBs provide a variety of products and services to their members, including long-term and short-term secured loans, called "advances." FHLB members may use a variety of real estate related assets, including agency MBS, as collateral for such advances. Membership in the FHLB obligates Woodmont to purchase membership stock and activity-based stock in the FHLB, the latter based upon the aggregate amount of advances obtained from the FHLB.
FHLB advances collateralized by agency MBS typically require higher effective "haircuts" than those required under our current repurchase agreements as a result of the slightly higher haircuts implemented by the FHLB coupled with the requirement to acquire activity-based stock in the FHLB concurrently with such borrowings. In addition, the FHLBs determine the fair value of the securities pledged as collateral and retain the right to adjust collateral haircuts during the term of secured borrowings.
In September 2014, the Federal Housing Financing Authority ("FHFA") issued a Notice of Proposed Rulemaking and Request for Comments Involving Proposed Changes to Regulations Concerning Federal Home Loan Bank Membership Criteria (the "Proposed Rule"). If enacted, the Proposed Rule, among other things, would immediately terminate the membership of captive insurance companies that became members of the FHLB system after publication of the Proposed Rule, which would include Woodmont. If Woodmont's membership in the FHLB were terminated, the FHLB would have up to five years to redeem the FHLB stock that Woodmont purchased and owns as the result of its membership and level of FHLB activity. In addition, if such membership were terminated, Woodmont could be required to immediately unwind any outstanding debt advances from the FHLB. It is unclear at this point whether the Proposed Rule will be enacted in its current form. The ultimate content of any rule enacted by FHFA with respect to captive insurance company membership in FHLBs, FHLB advance requirements or standards, or similar matters could have a material impact on Woodmont’s ability to procure funding through the FHLB, which could cause us to experience losses and may have a material adverse effect on our business to the extent of our reliance on FHLB advances.
As of September 30, 2015, Woodmont had $487.9 million in outstanding secured advances, with a weighted average borrowing rate of 0.27%, a weighted average term to maturity of 4.9 years, floating monthly interest rate resets and a one month cancellation feature. These advances were collateralized by $320.8 million and $213.9 million in agency and non-agency securities, respectively, as of September 30, 2015.

TBA Dollar Roll Transactions

We also enter into TBA dollar roll transactions as a means of leveraging (long TBAs) or de-leveraging (short TBAs) our investment portfolio. TBA dollar roll transactions represent a form of off-balance sheet financing and are accounted for as

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derivative instruments in our accompanying consolidated financial statements in this Quarterly Report on Form 10-Q. Inclusive of our net TBA position as of September 30, 2015, our total "at risk" leverage, net of unsettled securities, was 4.7x our stockholders' equity.

Under certain market conditions, it may be uneconomical for us to roll our TBA contracts 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 of a long TBA contract, we would have to fund the total purchase commitment with cash or other financing sources and our liquidity position could be negatively impacted. As of September 30, 2015, we had a net long TBA position with a cost basis and fair value of the securities underlying our net long TBA position each totaling $0.5 billion.

Our TBA dollar roll contracts are also subject to margin requirements governed by the Mortgage-Backed Securities Division ("MBSD") of the Fixed Income Clearing Corporation and by our prime brokerage agreements, which may establish margin levels in excess of the MBSD. Such provisions require that we establish an initial margin based on the notional value of the TBA contract, which is subject to increase if the estimated fair value of our TBA contract or the estimated fair value of our pledged collateral declines. The MBSD has the sole discretion to determine the value of our TBA contracts and of the collateral pledged securing such contracts. In the event of a margin call, we must generally provide additional collateral on the same business day.

Settlement of our net long 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.
Asset Sales and TBA Eligible Securities

We maintain a portfolio of highly liquid agency RMBS. We may sell our agency RMBS through the TBA market by delivering securities into TBA contracts for the sale of securities, subject to "good delivery" provisions promulgated by the Securities Industry and Financial Markets Association ("SIFMA"). We may alternatively sell agency RMBS that have more unique attributes on a specified basis when such securities trade at a premium over generic TBA securities or if the securities are not otherwise eligible for TBA delivery. Since the agency TBA market is the second most liquid market (second to the U.S. Treasury market), maintaining a significant level of agency RMBS eligible for TBA delivery enhances our liquidity profile and provides price support for our TBA eligible securities in a rising interest rate scenario at or above generic TBA prices. As of September 30, 2015, approximately 84% of our agency RMBS portfolio was eligible for TBA delivery.
OFF-BALANCE SHEET ARRANGEMENTS
As of September 30, 2015, we did not maintain any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, or special purpose or variable interest entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, as of September 30, 2015, we had not guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities.
FORWARD-LOOKING STATEMENTS

All statements contained herein that are not historical facts including, but not limited to, statements regarding anticipated activity are forward looking in nature and involve a number of risks and uncertainties. Actual results may differ materially. Among the factors that could cause actual results to differ materially are the following: (i) changes in the market value of our assets; (ii) changes in net interest rate spreads; (iii) changes in the amount or timing of cash flows from our investment portfolio; (iv) risks associated with our hedging activities; (v) availability and terms of financing arrangements; (vi) further actions by the U.S. government to stabilize the economy; (vii) changes in our business or investment strategy; (viii) legislative and regulatory changes (including changes to laws governing the taxation of REITs); (ix) our ability to meet the requirements of a REIT (including income and asset requirements); and (x) our ability to remain exempt from registration under the Investment Company Act of 1940, as amended. For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward looking statements, please see the information under the caption "Risk Factors" described in this Quarterly Report on Form 10-Q. We caution readers not to place undue reliance on any such forward-looking statements, which statements are made pursuant to the Private Securities Litigation Reform Act of 1995, as amended and, as such, speak only as of the date made.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the exposure to loss resulting from changes in market factors such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risks that we are exposed to are interest rate risk, prepayment risk, spread risk, liquidity risk, extension risk, credit risk and inflation risk.
Interest Rate Risk
Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.

Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities, by affecting the spread between our interest-earning assets and interest-bearing liabilities. Changes in the level of interest rates can also affect the rate of prepayments of our securities and the value of the RMBS that constitute our investment portfolio, which affects our net income and ability to realize gains from the sale of these assets and impacts our ability and the amount that we can borrow against these securities.

We may utilize a variety of financial instruments in order to limit the effects of changes in interest rates on our operations. The principal instruments that we use are interest rate swaps and options to enter into interest rate swaps. We also utilize forward contracts for the purchase or sale of agency RMBS on a generic pool, or a TBA contract basis and on a non-generic, specified pool basis, and we utilize U.S. Treasury securities and U.S. Treasury futures contracts, primarily through short sales. We may also purchase or write put or call options on TBA securities and we may invest in other types of mortgage derivatives, such as interest and principal-only securities, and synthetic total return swaps. Derivative instruments may expose us to certain risks, including the risk that losses on a hedge position will reduce the funds available for payments to holders of our common stock and that the losses may exceed the amount we invested in the instruments.
Our profitability and the value of our investment portfolio (including derivatives used for hedging purposes) may be adversely affected during any period as a result of changing interest rates including changes in forward yield curves.

Primary measures of an instrument's price sensitivity to interest rate fluctuations are its duration and convexity. The duration of our investment portfolio changes with interest rates and tends to increase when interest rates rise and decrease when rates fall. The "negative convexity" generally increases the interest rate exposure of our investment portfolio by more than what is measured by duration alone.

We estimate the duration and convexity of our portfolio using both a third-party risk management system and market data. We review the duration estimates from the third-party model and may make adjustments based on our Manager's judgment. These adjustments are intended to, in our Manager's opinion, better reflect the unique characteristics and market trading conventions associated with certain types of securities, such as HARP and lower loan balance securities. These adjustments generally result in shorter durations than what the unadjusted third party model would otherwise produce. Without these adjustments, in rising rate scenarios, the longer unadjusted durations may underestimate price projections on certain securities with slower prepayment characteristics, such as HARP and lower loan balance securities, to a level below those of generic or TBA securities. However, in our Manager's judgment, because these securities are typically deliverable into TBA contracts, the price of these securities is unlikely to drop below the generic or TBA price in rising rate scenarios. The accuracy of the estimated duration of our portfolio and projected agency security prices depends on our Manager's assumptions and judgments. Our Manager may discontinue making these duration adjustments in the future or may choose to make different adjustments. Other models could produce materially different results.
Further, since we do not control the other mortgage REITs that we invest in, we have limited transparency into their underlying investment and hedge portfolios. Therefore, our Manager must make certain assumptions to estimate the duration and convexity of the underlying portfolios and their sensitivity to changes in interest rates. Such estimates do not include the potential impact of other factors which may affect the fair value of our investments in other mortgage REITs, such as stock market volatility. Accordingly, actual results could differ from our estimates.

The table below quantifies the estimated changes in net interest income (including periodic interest costs on our interest rate swaps) and the estimated changes in the fair value of our investment portfolio (including derivatives and other securities used for hedging purposes) and in our net asset value should interest rates go up or down by 50 and 100 basis points, assuming instantaneous parallel shifts in the yield curve, and including the impact of both duration and convexity.

All changes in income and value are measured as percentage changes from the projected net interest income, investment

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portfolio value and net asset value at the base interest rate scenario. The base interest rate scenario assumes interest rates and prepayment projections as of September 30, 2015 and December 31, 2014. We apply a floor of 0% for the down rate scenarios on our interest bearing liabilities and the variable leg of our interest rate swaps, such that any hypothetical interest rate decrease would have a limited positive impact on our funding costs beyond a certain level.

Actual results could differ materially from estimates, especially in the current market environment. To the extent that these estimates or other assumptions do not hold true, which is likely in a period of high price volatility, actual results will likely differ materially from projections and could be larger or smaller than the estimates in the table below. Moreover, if different models were employed in the analysis, materially different projections could result. Lastly, while the table below reflects the estimated impact of interest rate increases and decreases on a static portfolio, we may from time to time sell any of our agency or non-agency securities as a part of our overall management of our investment portfolio.
Interest Rate Sensitivity (1)
 
 
Percentage Change in Projected
Change in Interest Rate
 
Net Interest Income (2)
 
Portfolio Value (3) (4)
 
Net Asset Value (3) (5)
September 30, 2015
 
 
 
 
 
 
+100 basis points
 
(0.6
)%
 
(1.2
)%
 
(6.5
)%
+50 basis points
 
(0.2
)%
 
(0.5
)%
 
(2.7
)%
-50 basis points
 
(0.1
)%
 
0.2
 %
 
1.0
 %
-100 basis points
 
(3.2
)%
 
(0.2
)%
 
(0.8
)%
December 31, 2014
 
 
 
 
 
 
+100 basis points
 
(6.1
)%
 
(1.3
)%
 
(6.9
)%
+50 basis points
 
(3.1
)%
 
(0.6
)%
 
(3.0
)%
-50 basis points
 
2.2
 %
 
0.2
 %
 
1.0
 %
-100 basis points
 
(0.5
)%
 
(0.4
)%
 
(2.0
)%
————————
(1) 
Interest rate sensitivity is derived from models that are dependent on inputs and assumptions provided by third parties as well as by our Manager, assumes there are no changes in mortgage spreads and assumes a static portfolio. Actual results could differ materially from these estimates.
(2) 
Represents the estimated dollar change in net interest income expressed as a percentage of net interest income based on asset yields and cost of funds as of such date. It includes the effect of periodic interest costs on our interest rate swaps, but excludes TBA dollar roll income and costs associated with other supplemental hedges, such as swaptions and U.S. Treasury securities or TBA positions. Estimated dollar change in net interest income does not include the one time impact of retroactive "catch-up" premium amortization benefit/cost due to an increase/decrease in the projected CPR.
(3)     Includes the effect of derivatives and other securities used for hedging purposes.
(4)    Estimated change in portfolio value expressed as a percentage of the total fair value of our investment portfolio.
(5) 
Estimated change in net asset value expressed as a percentage of stockholders' equity.
Prepayment Risk
    
Because residential borrowers have the option to prepay their mortgage loans at par at any time, we face the risk that we
will experience a return of principal on our investments faster than anticipated. Various factors affect the rate at which mortgage prepayments occur, including changes in the level of and directional trends in housing prices, interest rates, general economic conditions, loan age and size, loan-to-value ratio, the location of the property and social and demographic conditions. Additionally, changes to GSE underwriting practices or other governmental programs could also significantly impact prepayment rates or expectations. Also, the pace at which the loans underlying our securities become seriously delinquent or are modified and the timing of GSE repurchases of such loans from our securities can materially impact the rate of prepayments. Generally, prepayments on agency RMBS increase during periods of falling mortgage interest rates and decrease during periods of rising mortgage interest rates. However, this may not always be the case.

We may reinvest principal repayments at a yield that is lower or higher than the yield on the repaid investment, thus affecting our net interest income by altering the average yield on our assets. Premiums or discounts associated with the purchase of agency RMBS and non-agency securities of higher credit quality are amortized or accreted into interest income over the projected lives of the securities, including contractual payments and estimated prepayments using the effective interest method. Our policy for estimating prepayment speeds for calculating the effective yield is to evaluate published prepayment data for similar securities, market consensus and current market conditions. If the actual prepayment experienced differs from

66


our estimate of prepayments, we will be required to make an adjustment to the amortization or accretion of premiums and discounts that would have an impact on future income.
Spread Risk
    
When the market spread between the yield on our RMBS and benchmark interest rates widens, our net book value could decline if the value of our RMBS falls by more than the offsetting fair value increases on our hedging instruments, creating what we refer to as "spread risk" or "basis risk". The spread risk associated with our agency and non-agency securities and the resulting fluctuations in fair value of these securities can occur independent of changes in benchmark interest rates and may relate to other factors impacting the mortgage and fixed income markets, such as actual or anticipated monetary policy actions by the Fed, market liquidity, or changes in required rates of return on different assets. Consequently, while we use interest rate swaps and other supplemental hedges to attempt to protect against moves in interest rates, such instruments typically will not protect our net book value against spread risk.

The table below quantifies the estimated changes in the fair value of our investment portfolio (including derivatives and other securities used for hedging purposes) and in our net asset value should spreads between our mortgage assets and benchmark interest rates go up or down by 10 and 25 basis points for agency securities and 25 and 50 basis points for non-agency securities. These estimated impacts of spread changes are in addition to our sensitivity to interest rate shocks included in the above interest rate sensitivity table. The table below assumes a spread duration of 5.0 years based on interest rates and RMBS prices as of both September 30, 2015 and December 31, 2014. However, our portfolio's sensitivity of spread changes will vary with changes in interest rates and in the size and composition of our investment portfolio. Therefore, actual results could differ materially from our estimates.
RMBS Spread Sensitivity (1)
 
 
Percentage Change in Projected
Change in RMBS Spread: Agency / Non-Agency
 
Portfolio Market Value (2) (3)
 
Net Asset
Value (2) (4)
September 30, 2015
 
 
 
 
-25 / -50 basis points
 
1.5
 %
 
8.2
 %
-10 / -25 basis points
 
0.7
 %
 
3.6
 %
+10 / +25 basis points
 
(0.7
)%
 
(3.6
)%
+25 / +50 basis points
 
(1.5
)%
 
(8.2
)%
December 31, 2014
 
 
 
 
-25 / -50 basis points
 
1.5
 %
 
7.8
 %
-10 / -25 basis points
 
0.6
 %
 
3.3
 %
+10 / +25 basis points
 
(0.6
)%
 
(3.3
)%
+25 / +50 basis points
 
(1.5
)%
 
(7.8
)%
————————
(1) 
Spread sensitivity is derived from models that are dependent on inputs and assumptions provided by third parties as well as by our Manager, and assumes there are no changes in interest rates and a static portfolio. Actual results could differ materially from these estimates.
(2)    Includes the effect of derivatives and other instruments used for hedging purposes.
(3)    Estimated dollar change in portfolio market value expressed as a percentage of the total fair value of our investment portfolio as of such date.
(4) 
Estimated dollar change in net asset value expressed as a percentage of stockholders' equity as of such date.
Liquidity Risk
The primary liquidity risk for us arises from financing long-term assets with shorter-term borrowings. Our assets that are pledged to secure repurchase agreements and FHLB advances are agency and non-agency securities and cash. As of September 30, 2015, we had unrestricted cash and cash equivalents of $170.7 million and unpledged securities of approximately $173.6 million, excluding unsettled purchases of securities, available to meet margin calls on our repurchase agreements, derivative instruments and for other corporate purposes. However, should the value of our securities pledged as collateral or the value of our derivative instruments suddenly decrease, margin calls relating to our repurchase and derivative agreements could increase, causing an adverse change in our liquidity position. Further, there is no assurance that we will always be able to renew (or roll) our repurchase agreements. In addition, our counterparties have the option to increase our haircuts (margin requirements) on the assets we pledge, thereby reducing the amount that can be borrowed against an asset

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even if they agree to renew or roll the repurchase agreement. Significantly higher haircuts can reduce our ability to leverage our portfolio or even force us to sell assets, especially if correlated with asset price declines or faster prepayment rates on our assets.
In addition, we may utilize TBA dollar roll transactions as a means of acquiring and financing purchases of agency RMBS. Under certain economic conditions we may be unable to roll our TBA dollar roll transactions prior to the settlement date and we may have to take physical delivery of the underlying securities and settle our obligations for cash, which could negatively impact our liquidity position, result in defaults or force us to sell assets under adverse conditions.
Extension Risk
The projected weighted-average life and estimated duration (or interest rate sensitivity) of our investments is based on our Manager’s assumptions regarding the rates at which borrowers will prepay or default on the underlying mortgage loans. In general, we use interest rate swaps to help manage our funding cost on our investments in the event that interest rates rise. These swaps allow us to reduce our funding exposure on the notional amount of the swap for a specified period of time by establishing a fixed rate to pay in exchange for receiving a floating rate that generally tracks our financing costs under our repurchase agreements.
However, if prepayment rates decrease in a rising interest rate environment, the average life or duration of our fixed-rate assets generally extends. This could have a negative impact on our results from operations, as our interest rate swap maturities are fixed and will, therefore, cover a smaller percentage of our funding exposure on our mortgage assets to the extent that their average lives increase due to slower prepayments. This situation may also cause the market value of our securities collateralized by fixed rate mortgages to decline by more than otherwise would be the case while most of our hedging instruments (with the exception of short TBA mortgage positions, interest-only securities and certain other supplemental hedging instruments) would not receive any incremental offsetting gains. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur realized losses.
Credit Risk
We are exposed to credit risk related to our non-agency investments, certain derivative transactions, and our collateral held by funding and derivative counterparties. We accept credit exposure at levels we deem prudent as an integral part of our diversified investment strategy. Therefore, we may retain all or a portion of the credit risk on our non-agency investments. We seek to manage this risk through prudent asset selection, pre-acquisition due diligence, post-acquisition performance monitoring, sale of assets where we have identified negative credit trends and the use of various types of credit enhancements. We may also use non-recourse financing, which limits our exposure to credit losses to the specific pool of mortgages subject to the non-recourse financing. Our overall management of credit exposure also includes the use of credit default swaps or other financial derivatives that we believe are appropriate. Additionally, we intend to vary the percentage mix of our non-agency mortgage investments and agency mortgage investments in an effort to actively adjust our credit exposure and to improve the risk/return profile of our investment portfolio. Our credit risk related to certain derivative transactions is largely mitigated through daily adjustments to collateral pledged based on changes in market value and we limit our counterparties to major financial institutions with acceptable credit ratings. There is no guarantee that our efforts to manage credit risk will be successful and we could suffer significant losses if credit performance is worse than our expectations or if economic conditions worsen.
Inflation Risk
Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence our performance more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Further, our consolidated financial statements are prepared in accordance with GAAP and our distributions are determined by our Board of Directors based primarily on our net income as calculated for income tax purposes. In each case, our activities and consolidated balance sheets are measured with reference to historical cost and/or fair market value without considering inflation.


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Item 4. Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act of 1934, as amended (the "Exchange Act") reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of "disclosure controls and procedures" as promulgated under the Exchange Act and the rules and regulations thereunder. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

We, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2015. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There have been no changes in our "internal control over financial reporting" (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the quarter ended September 30, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.  

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings
 
From time to time, we may be involved in various claims and legal actions arising in the ordinary course of business. Neither we, nor any of our consolidated subsidiaries, are currently subject to any material litigation, nor to our knowledge, is any material litigation threatened against us or any consolidated subsidiary.

Item 1A. Risk Factors

There have been no material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults upon Senior Securities

None.
Item 4. Mine Safety Disclosures
Not applicable.

Item 5. Other Information
 
None.


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Item 6. Exhibits
Exhibit No. 
 
Description 
*3.1
 
American Capital Mortgage Investment Corp. Articles of Amendment and Restatement, incorporated herein by reference to Exhibit 3.1 of Form 10-Q for the quarter ended September 30, 2011 (File No. 001-35260), filed November 14, 2011.
 
 
 
3.2
 
American Capital Mortgage Investment Corp. Amended and Restated Bylaws, as amended by Amendments No. 1 and 2, filed herewith.

 
 
 
*3.3
 
Articles Supplementary of 8.125% Series A Cumulative Redeemable Preferred Stock, incorporated herein by reference to Exhibit 3.3 of Form 8-A (File No. 001-35260), filed May 16, 2014.
 
 
 
*4.1
 
Form of Certificate for Common Stock, incorporated herein by reference to Exhibit 4.1 of Amendment No. 3 to Form S-11 (Registration Statement No. 333-173238), filed July 20, 2011.
 
 
 
*4.2
 
Instruments defining the rights of holders of securities: See Article VI of our Articles of Amendment and Restatement, incorporated herein by reference to Exhibit 3.1 of Form 10-Q for the quarter ended September 30, 2011 (File No. 001-35260), filed November 14, 2011.
 
 
 
*4.3
 
Instruments defining the rights of holders of securities: See Article VII of our Amended and Restated Bylaws, as amended by Amendment No. 1, incorporated herein by reference to Exhibit 3.2 of Amendment No. 4 to Form S-11 (Registration Statement No. 333-173238), filed July 29, 2011.
 
 
 
*4.4
 
Form of certificate representing the 8.125% Series A Cumulative Redeemable Preferred Stock, incorporated herein by reference to Exhibit 4.1 of Form 8-A (File No. 001-35260), filed May 16, 2014.
 
 
 
31.1
 
Certification of CEO Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of CFO Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
 
 
 
32
 
Certification of CEO and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101.INS**
 
XBRL Instance Document
 
 
 
101.SCH**
 
XBRL Taxonomy Extension Schema Document
 
 
 
101.CAL**
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
101.LAB**
 
XBRL Taxonomy Extension Labels Linkbase Document
 
 
 
101.PRE**
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 
101.DEF**
 
XBRL Taxonomy Extension Definition Linkbase Document
————————
*    Previously filed
**     This exhibit is being furnished rather than filed, and shall not be deemed incorporated by reference into any filing, in accordance with Item 601 of Regulation S-K

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
American Capital Mortgage Investment Corp.
 
 
By:
 
/s/    MALON WILKUS       
 
 
Malon Wilkus
 
 
Chief Executive Officer
and Chair of the Board
 
Date: November 6, 2015
 





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