PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes to those statements included in Item 1 of this Form 10-Q. The discussion may contain certain forward-looking statements that involve risks and uncertainties. Forward-looking statements are those that are not historical in nature. As a result of many factors, such as those set forth under "Risk Factors" in our most recent Annual Report on Form 10-K, our actual results may differ materially from those anticipated in such forward-looking statements.
We are a specialty finance company that invests in residential mortgage-backed securities ("RMBS") which are issued and guaranteed by a federally chartered corporation or agency ("Agency RMBS"). Our investment strategy focuses on, and our portfolio consists of, two categories of Agency RMBS: (i) traditional pass-through Agency RMBS ("PT RMBS") and (ii) structured Agency RMBS, such as collateralized mortgage obligations ("CMOs"), interest-only securities ("IOs"), inverse interest-only securities ("IIOs") and principal only securities ("POs"), among other types of structured Agency RMBS. We were formed by Bimini in August 2010, commenced operations on November 24, 2010 and completed our initial public offering ("IPO") on February 20, 2013. We are externally managed by Bimini Advisors, a registered investment adviser with the Securities and Exchange Commission (the "SEC").
Our business objective is to provide attractive risk-adjusted total returns over the long term through a combination of capital appreciation and the payment of regular monthly distributions. We intend to achieve this objective by investing in and strategically allocating capital between the two categories of Agency RMBS described above. We seek to generate income from (i) the net interest margin on our leveraged PT RMBS portfolio and the leveraged portion of our structured Agency RMBS portfolio, and (ii) the interest income we generate from the unleveraged portion of our structured Agency RMBS portfolio. We intend to fund our PT RMBS and certain of our structured Agency RMBS through short-term borrowings structured as repurchase agreements. PT RMBS and structured Agency RMBS typically exhibit materially different sensitivities to movements in interest rates. Declines in the value of one portfolio may be offset by appreciation in the other. The percentage of capital that we allocate to our two Agency RMBS asset categories will vary and will be actively managed in an effort to maintain the level of income generated by the combined portfolios, the stability of that income stream and the stability of the value of the combined portfolios. We believe that this strategy will enhance our liquidity, earnings, book value stability and asset selection opportunities in various interest rate environments.
We operate so as to qualify to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). We generally will not be subject to U.S. federal income tax to the extent that we currently distribute all of our REIT taxable income (as defined in the Code) to our stockholders and maintain our REIT qualification.
The Company's common stock trades on the New York Stock Exchange ("NYSE") under the symbol "ORC".
Capital Raising Activities
On July 29, 2016, we entered into an equity distribution agreement (the "July 2016 Equity Distribution Agreement") with two sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $125,000,000 of shares of our common stock in transactions that were deemed to be "at the market" offerings and privately negotiated transactions. We issued a total of 10,174,992 shares under the July 2016 Equity Distribution Agreement for aggregate gross proceeds of $110.0 million, and net proceeds of approximately $108.2 million, net of commissions and fees, prior to its termination.
On February 23, 2017, we entered into another equity distribution agreement, as amended and restated on May 10, 2017, (the "May 2017 Equity Distribution Agreement") with two sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $125,000,000 of shares of our common stock in transactions that were deemed to be "at the market" offerings and privately negotiated transactions. The May 2017 Equity Distribution Agreement replaced the July 2016 Equity Distribution Agreement. We issued a total of 12,299,032 shares under the May 2017 Equity Distribution Agreement for aggregate gross proceeds of $125.0 million, and net proceeds of approximately $122.9 million, net of commissions and fees, prior to its termination.
On August 2, 2017, we entered into another equity distribution agreement (the "August 2017 Equity Distribution Agreement") with two sales agents pursuant to which we may offer and sell, from time to time, up to an aggregate amount of $125,000,000 of shares of our common stock in transactions that are deemed to be "at the market" offerings and privately negotiated transactions. The August 2017 Equity Distribution Agreement replaced the May 2017 Equity Distribution Agreement. Through September 30, 2018, we issued a total of 7,746,052 shares under the August 2017 Equity Distribution Agreement for aggregate gross proceeds of $76.0 million, and net proceeds of approximately $74.7 million, net of commissions and fees.
Stock Repurchase Agreement
On July 29, 2015, the Company's Board of Directors authorized the repurchase of up to 2,000,000 shares of our common stock. The timing, manner, price and amount of any repurchases is determined by the Company in its discretion and is subject to economic and market conditions, stock price, applicable legal requirements and other factors. The authorization does not obligate the Company to acquire any particular amount of common stock and the program may be suspended or discontinued at the Company's discretion without prior notice.
On February 8, 2018, the Board of Directors approved an increase in the stock repurchase program for up to an additional 4,522,822 shares of the Company's common stock.
This stock repurchase program has no termination date.
From the inception of the stock repurchase program through September 30, 2018, we have repurchased a total of 2,285,084 shares at an aggregate cost of approximately $18.5 million, including commissions and fees, for a weighted average price of $8.11 per share. As of September 30, 2018, the remaining authorization under the repurchase program is for up to 4,237,738 shares of the Company's common stock.
Factors that Affect our Results of Operations and Financial Condition
A variety of industry and economic factors may impact our results of operations and financial condition. These factors include:
·
|
the difference between Agency RMBS yields and our funding and hedging costs;
|
·
|
competition for, and supply of, investments in Agency RMBS;
|
·
|
actions taken by the U.S. government, including the presidential administration, the Federal Reserve (the "Fed"), the Federal Open Market Committee (the "FOMC") and the U.S. Treasury;
|
·
|
prepayment rates on mortgages underlying our Agency RMBS, and credit trends insofar as they affect prepayment rates; and
|
·
|
other market developments.
|
In addition, a variety of factors relating to our business may also impact our results of operations and financial condition. These factors include:
·
|
our degree of leverage;
|
·
|
our access to funding and borrowing capacity;
|
·
|
our hedging activities;
|
·
|
the market value of our investments; and
|
·
|
the requirements to qualify as a REIT and the requirements to qualify for a registration exemption under the Investment Company Act.
|
Results of Operations
Described below are the Company's results of operations for the nine and three months ended September 30, 2018, as compared to the Company's results of operations for the nine and three months ended September 30, 2017.
Net (Loss) Income Summary
Net loss for the nine months ended September 30, 2018 was $18.0 million, or $0.34 per share. Net income for the nine months ended September 30, 2017 was $8.0 million, or $0.21 per share. Net loss for the three months ended September 30, 2018 was $3.0 million, or $0.06 per share. Net income for the three months ended September 30, 2017 was $15.2 million, or $0.33 per share. The components of net (loss) income for the nine and three months ended September 30, 2018 and 2017, along with the changes in those components are presented in the table below:
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
Three Months Ended, September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
Interest income
|
|
$
|
117,580
|
|
|
$
|
105,864
|
|
|
$
|
11,716
|
|
|
$
|
39,054
|
|
|
$
|
38,974
|
|
|
$
|
80
|
|
Interest expense
|
|
|
(50,620
|
)
|
|
|
(28,116
|
)
|
|
|
(22,504
|
)
|
|
|
(18,893
|
)
|
|
|
(12,638
|
)
|
|
|
(6,255
|
)
|
Net interest income
|
|
|
66,960
|
|
|
|
77,748
|
|
|
|
(10,788
|
)
|
|
|
20,161
|
|
|
|
26,336
|
|
|
|
(6,175
|
)
|
Losses on RMBS and derivative contracts
|
|
|
(75,939
|
)
|
|
|
(61,578
|
)
|
|
|
(14,361
|
)
|
|
|
(20,150
|
)
|
|
|
(8,254
|
)
|
|
|
(11,896
|
)
|
Net portfolio (deficiency) income
|
|
|
(8,979
|
)
|
|
|
16,170
|
|
|
|
(25,149
|
)
|
|
|
11
|
|
|
|
18,082
|
|
|
|
(18,071
|
)
|
Expenses
|
|
|
(9,009
|
)
|
|
|
(8,181
|
)
|
|
|
(828
|
)
|
|
|
(2,970
|
)
|
|
|
(2,899
|
)
|
|
|
(71
|
)
|
Net (loss) income
|
|
$
|
(17,988
|
)
|
|
$
|
7,989
|
|
|
$
|
(25,977
|
)
|
|
$
|
(2,959
|
)
|
|
$
|
15,183
|
|
|
$
|
(18,142
|
)
|
GAAP and Non-GAAP Reconciliations
In addition to the results presented in accordance with GAAP, our results of operations discussed below include certain non-GAAP financial information, including "Net Earnings Excluding Realized and Unrealized Gains and Losses", "Economic Interest Expense" and "Economic Net Interest Income."
Net Earnings Excluding Realized and Unrealized Gains and Losses
We have elected to account for our Agency RMBS under the fair value option. Securities held under the fair value option are recorded at estimated fair value, with changes in the fair value recorded as unrealized gains or losses through the consolidated statements of operations.
In addition, we have not elected to designate our derivative holdings for hedge accounting treatment under the Financial Accounting Standards Board (the "FASB") Accounting Standards Codification ("ASC") Topic 815,
Derivatives and Hedging
. Changes in fair value of these instruments are presented in a separate line item in the Company's consolidated statements of operations and not included in interest expense. As such, for financial reporting purposes, interest expense and cost of funds are not impacted by the fluctuation in value of the derivative instruments.
Presenting net earnings excluding realized and unrealized gains allows management to: (i) isolate the net interest income and other expenses of the Company over time, free of all mark-to-market adjustments and (ii) assess the effectiveness of our funding and hedging strategies on our capital allocation decisions and our asset allocation performance. Our funding and hedging strategies, capital allocation and asset selection are integral to our risk management strategy, and therefore critical to the management of our portfolio. We believe that the presentation of our net earnings excluding realized and unrealized gains is useful to investors because it provides a means of comparing our results of operations to those of our peers who have not elected the same accounting treatment. Our presentation of net earnings excluding realized and unrealized gains and losses may not be comparable to similarly-titled measures of other companies, who may use different calculations. As a result, net earnings excluding realized and unrealized gains and losses should not be considered as a substitute for our GAAP net income (loss) as a measure of our financial performance or any measure of our liquidity under GAAP. The table below presents a reconciliation of our net income (loss) determined in accordance with GAAP and net earnings excluding realized and unrealized gains.
Net Earnings Excluding Realized and Unrealized Gains and Losses
|
|
(in thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per Share
|
|
|
|
|
|
|
|
|
|
Net Earnings
|
|
|
|
|
|
|
|
|
Net Earnings
|
|
|
|
|
|
|
|
|
|
Excluding
|
|
|
|
|
|
|
|
|
Excluding
|
|
|
|
|
|
|
Realized and
|
|
|
Realized and
|
|
|
|
|
|
Realized and
|
|
|
Realized and
|
|
|
|
Net
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
Net
|
|
|
Unrealized
|
|
|
Unrealized
|
|
|
|
Income
|
|
|
Gains and
|
|
|
Gains and
|
|
|
Income
|
|
|
Gains and
|
|
|
Gains and
|
|
|
|
(GAAP)
|
|
|
Losses
(1)
|
|
|
Losses
|
|
|
(GAAP)
|
|
|
Losses
|
|
|
Losses
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
$
|
(2,959
|
)
|
|
$
|
(20,150
|
)
|
|
$
|
17,191
|
|
|
$
|
(0.06
|
)
|
|
$
|
(0.39
|
)
|
|
$
|
0.33
|
|
June 30, 2018
|
|
|
1,346
|
|
|
|
(17,734
|
)
|
|
|
19,080
|
|
|
|
0.03
|
|
|
|
(0.34
|
)
|
|
|
0.37
|
|
March 31, 2018
|
|
|
(16,377
|
)
|
|
|
(38,055
|
)
|
|
|
21,678
|
|
|
|
(0.31
|
)
|
|
|
(0.72
|
)
|
|
|
0.41
|
|
December 31, 2017
|
|
|
(5,982
|
)
|
|
|
(29,540
|
)
|
|
|
23,558
|
|
|
|
(0.12
|
)
|
|
|
(0.61
|
)
|
|
|
0.49
|
|
September 30, 2017
|
|
|
15,183
|
|
|
|
(8,254
|
)
|
|
|
23,437
|
|
|
|
0.33
|
|
|
|
(0.18
|
)
|
|
|
0.51
|
|
June 30, 2017
|
|
|
(9,643
|
)
|
|
|
(32,597
|
)
|
|
|
22,954
|
|
|
|
(0.26
|
)
|
|
|
(0.88
|
)
|
|
|
0.62
|
|
March 31, 2017
|
|
|
2,449
|
|
|
|
(20,727
|
)
|
|
|
23,176
|
|
|
|
0.07
|
|
|
|
(0.63
|
)
|
|
|
0.70
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
$
|
(17,988
|
)
|
|
$
|
(75,939
|
)
|
|
$
|
57,951
|
|
|
$
|
(0.34
|
)
|
|
$
|
(1.45
|
)
|
|
$
|
1.11
|
|
September 30, 2017
|
|
|
7,989
|
|
|
|
(61,578
|
)
|
|
|
69,567
|
|
|
|
0.21
|
|
|
|
(1.59
|
)
|
|
|
1.80
|
|
(1)
|
Includes realized and unrealized gains (losses) on RMBS and derivative financial instruments, including net interest expense on interest rate swaps
.
|
Economic Interest Expense and Economic Net Interest Income
We use derivative instruments, specifically Eurodollar and Treasury Note ("T-Note") futures contracts, interest rate swaps and swaptions, to hedge a portion of the interest rate risk on repurchase agreements in a rising rate environment.
We have not elected to designate our derivative holdings for hedge accounting treatment under the Financial Accounting Standards Board (the "FASB"), Accounting Standards Codification ("ASC"), Topic 815,
Derivatives and Hedging
. Changes in fair value of these instruments are presented in a separate line item in our consolidated statements of operations and not included in interest expense. As such, for financial reporting purposes, interest expense and cost of funds are not impacted by the fluctuation in value of the derivative instruments.
For the purpose of computing economic net interest income and ratios relating to cost of funds measures, GAAP interest expense has been adjusted to reflect the realized gains or losses on specific derivative instruments that pertain to each period presented. We believe that adjusting our interest expense for the periods presented by the gains or losses on all derivative instruments would not accurately reflect our economic interest expense for these periods. For each period presented, we have combined the effects of the derivative financial instruments in place for the respective period with the actual interest expense incurred on borrowings to reflect total economic interest expense for the applicable period. Interest expense, including the effect of derivative instruments for the period, is referred to as economic interest expense. Net interest income, when calculated to include the effect of derivative instruments for the period, is referred to as economic net interest income. This presentation includes gains or losses on all contracts in effect during the reporting period, covering the current period as well as periods in the future.
We believe that economic interest expense and economic net interest income provide meaningful information to consider, in addition to the respective amounts prepared in accordance with GAAP. The non-GAAP measures help management to evaluate its financial position and performance without the effects of certain transactions and GAAP adjustments that are not necessarily indicative of our current investment portfolio or operations. The unrealized gains or losses on derivative instruments presented in our consolidated statements of operations are not necessarily representative of the total interest rate expense that we will ultimately realize. This is because as interest rates move up or down in the future, the gains or losses we ultimately realize, and which will affect our total interest rate expense in future periods, may differ from the unrealized gains or losses recognized as of the reporting date.
Our presentation of the economic value of our hedging strategy has important limitations. First, other market participants may calculate economic interest expense and economic net interest income differently than the way we calculate them. Second, while we believe that the calculation of the economic value of our hedging strategy described above helps to present our financial position and performance, it may be of limited usefulness as an analytical tool. Therefore, the economic value of our investment strategy should not be viewed in isolation and is not a substitute for interest expense and net interest income computed in accordance with GAAP.
The tables below present a reconciliation of the adjustments to interest expense shown for each period relative to our derivative instruments, and the income statement line item, gains (losses) on derivative instruments, calculated in accordance with GAAP for each quarter during 2018 to date and 2017.
Gains (Losses) on Derivative Instruments
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funding Hedges
|
|
|
|
Recognized in
|
|
|
|
|
|
Attributed to
|
|
|
Attributed to
|
|
|
|
Income
|
|
|
TBA
|
|
|
Current
|
|
|
Future
|
|
|
|
Statement
|
|
|
Securities
|
|
|
Period
|
|
|
Periods
|
|
|
|
(GAAP)
|
|
|
Income
|
|
|
(Non-GAAP)
|
|
|
(Non-GAAP)
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
$
|
12,693
|
|
|
$
|
3,293
|
|
|
$
|
272
|
|
|
$
|
9,128
|
|
June 30, 2018
|
|
|
14,859
|
|
|
|
1,564
|
|
|
|
(852
|
)
|
|
|
14,147
|
|
March 31, 2018
|
|
|
41,994
|
|
|
|
8,407
|
|
|
|
(3,011
|
)
|
|
|
36,598
|
|
December 31, 2017
|
|
|
13,982
|
|
|
|
(2,094
|
)
|
|
|
(3,763
|
)
|
|
|
19,839
|
|
September 30, 2017
|
|
|
(5,470
|
)
|
|
|
(1,459
|
)
|
|
|
(3,761
|
)
|
|
|
(250
|
)
|
June 30, 2017
|
|
|
(19,442
|
)
|
|
|
(2,384
|
)
|
|
|
(3,654
|
)
|
|
|
(13,404
|
)
|
March 31, 2017
|
|
|
(4,419
|
)
|
|
|
-
|
|
|
|
(3,193
|
)
|
|
|
(1,226
|
)
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
$
|
69,547
|
|
|
$
|
13,264
|
|
|
$
|
(3,591
|
)
|
|
$
|
59,873
|
|
September 30, 2017
|
|
|
(29,331
|
)
|
|
|
(3,843
|
)
|
|
|
(10,608
|
)
|
|
|
(14,880
|
)
|
Economic Interest Expense and Economic Net Interest Income
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense on Borrowings
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Losses) on
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Instruments
|
|
|
|
|
|
Net Interest Income
|
|
|
|
|
|
|
GAAP
|
|
|
Attributed
|
|
|
Economic
|
|
|
GAAP
|
|
|
Economic
|
|
|
|
Interest
|
|
|
Interest
|
|
|
to Current
|
|
|
Interest
|
|
|
Net Interest
|
|
|
Net Interest
|
|
|
|
Income
|
|
|
Expense
|
|
|
Period
(1)
|
|
|
Expense
(2)
|
|
|
Income
|
|
|
Income
(3)
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
$
|
39,054
|
|
|
$
|
18,893
|
|
|
$
|
272
|
|
|
$
|
18,621
|
|
|
$
|
20,161
|
|
|
$
|
20,433
|
|
June 30, 2018
|
|
|
38,590
|
|
|
|
16,579
|
|
|
|
(852
|
)
|
|
|
17,431
|
|
|
|
22,011
|
|
|
|
21,159
|
|
March 31, 2018
|
|
|
39,935
|
|
|
|
15,149
|
|
|
|
(3,011
|
)
|
|
|
18,160
|
|
|
|
24,786
|
|
|
|
21,775
|
|
December 31, 2017
|
|
|
40,098
|
|
|
|
13,554
|
|
|
|
(3,763
|
)
|
|
|
17,317
|
|
|
|
26,544
|
|
|
|
22,781
|
|
September 30, 2017
|
|
|
38,974
|
|
|
|
12,638
|
|
|
|
(3,761
|
)
|
|
|
16,399
|
|
|
|
26,336
|
|
|
|
22,575
|
|
June 30, 2017
|
|
|
34,579
|
|
|
|
8,763
|
|
|
|
(3,654
|
)
|
|
|
12,417
|
|
|
|
25,816
|
|
|
|
22,162
|
|
March 31, 2017
|
|
|
32,311
|
|
|
|
6,715
|
|
|
|
(3,193
|
)
|
|
|
9,908
|
|
|
|
25,596
|
|
|
|
22,403
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
$
|
117,580
|
|
|
$
|
50,620
|
|
|
$
|
(3,591
|
)
|
|
$
|
54,212
|
|
|
$
|
66,960
|
|
|
$
|
63,368
|
|
September 30, 2017
|
|
|
105,864
|
|
|
|
28,116
|
|
|
|
(10,608
|
)
|
|
|
38,724
|
|
|
|
77,748
|
|
|
|
67,140
|
|
(1)
|
Reflects the effect of derivative instrument hedges for only the period presented.
|
(2)
|
Calculated by adding the effect of derivative instrument hedges attributed to the period presented to GAAP interest expense.
|
(3)
|
Calculated by adding the effect of derivative instrument hedges attributed to the period presented to GAAP net interest income.
|
During the nine months ended September 30, 2018, we generated $67.0 million of net interest income, consisting of $117.6 million of interest income from RMBS assets offset by $50.6 million of interest expense on borrowings. For the comparable period ended September 30, 2017, we generated $77.7 million of net interest income, consisting of $105.9 million of interest income from RMBS assets offset by $28.1 million of interest expense on borrowings. The $11.7 million increase in interest income and $22.5 million increase in interest expense for the nine months ended September 30, 2018 primarily reflects the growth of our portfolio fueled by our net capital raising activities, combined with increased yields earned on our portfolio and increased costs and amounts of our borrowings.
On an economic basis, our interest expense on borrowings for the nine months ended September 30, 2018 and 2017 was $54.2 million and $38.7 million, respectively, resulting in $63.4 million and $67.1 million of economic net interest income, respectively.
During the three months ended September 30, 2018, we generated $20.2 million of net interest income, consisting of $39.1 million of interest income from RMBS assets offset by $18.9 million of interest expense on borrowings. For the three months ended September 30, 2017, we generated $26.3 million of net interest income, consisting of $39.0 million of interest income from RMBS assets offset by $12.6 million of interest expense on borrowings. As in the nine months ended September 30, 2018, the increased interest income and interest expense for the three months ended September 30, 2018, as compared to the same period in 2017, reflects an increase in the yields on the portfolio and the costs of borrowings.
On an economic basis, our interest expense on repurchase liabilities for the three months ended September 30, 2018 and 2017 was $18.6 million and $16.4 million, respectively, resulting in $20.4 million and $22.6 million of economic net interest income, respectively.
The tables below provide information on our portfolio average balances, interest income, yield on assets, average borrowings, interest expense, cost of funds, net interest income and net interest spread for the nine months ended September 30, 2018 and 2017 and each quarter during 2018 to date and 2017 on both a GAAP and economic basis.
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Yield on
|
|
|
|
|
|
Interest Expense
|
|
|
Average Cost of Funds
|
|
|
|
RMBS
|
|
|
Interest
|
|
|
Average
|
|
|
Average
|
|
|
GAAP
|
|
|
Economic
|
|
|
GAAP
|
|
|
Economic
|
|
|
|
Held
(1)
|
|
|
Income
|
|
|
RMBS
|
|
|
Borrowings
(1)
|
|
|
Basis
|
|
|
Basis
(2)
|
|
|
Basis
|
|
|
Basis
(3)
|
|
Three Months Ended
|
|
September 30, 2018
|
|
$
|
3,601,776
|
|
|
$
|
39,054
|
|
|
|
4.34
|
%
|
|
$
|
3,385,829
|
|
|
$
|
18,893
|
|
|
$
|
18,621
|
|
|
|
2.23
|
%
|
|
|
2.20
|
%
|
June 30, 2018
|
|
|
3,717,690
|
|
|
|
38,590
|
|
|
|
4.15
|
%
|
|
|
3,534,567
|
|
|
|
16,579
|
|
|
|
17,431
|
|
|
|
1.88
|
%
|
|
|
1.97
|
%
|
March 31, 2018
|
|
|
3,745,298
|
|
|
|
39,935
|
|
|
|
4.27
|
%
|
|
|
3,576,533
|
|
|
|
15,149
|
|
|
|
18,160
|
|
|
|
1.69
|
%
|
|
|
2.03
|
%
|
December 31, 2017
|
|
|
3,837,575
|
|
|
|
40,098
|
|
|
|
4.18
|
%
|
|
|
3,621,931
|
|
|
|
13,554
|
|
|
|
17,317
|
|
|
|
1.50
|
%
|
|
|
1.91
|
%
|
September 30, 2017
|
|
|
3,834,083
|
|
|
|
38,974
|
|
|
|
4.07
|
%
|
|
|
3,494,266
|
|
|
|
12,638
|
|
|
|
16,399
|
|
|
|
1.45
|
%
|
|
|
1.88
|
%
|
June 30, 2017
|
|
|
3,499,922
|
|
|
|
34,579
|
|
|
|
3.95
|
%
|
|
|
3,164,532
|
|
|
|
8,763
|
|
|
|
12,417
|
|
|
|
1.11
|
%
|
|
|
1.57
|
%
|
March 31, 2017
|
|
|
3,142,095
|
|
|
|
32,311
|
|
|
|
4.11
|
%
|
|
|
2,922,157
|
|
|
|
6,715
|
|
|
|
9,908
|
|
|
|
0.92
|
%
|
|
|
1.36
|
%
|
Nine Months Ended
|
|
September 30, 2018
|
|
$
|
3,688,255
|
|
|
$
|
117,580
|
|
|
|
4.25
|
%
|
|
$
|
3,498,976
|
|
|
$
|
50,620
|
|
|
$
|
54,212
|
|
|
|
1.93
|
%
|
|
|
2.07
|
%
|
September 30, 2017
|
|
|
3,492,033
|
|
|
|
105,864
|
|
|
|
4.04
|
%
|
|
|
3,193,652
|
|
|
|
28,116
|
|
|
|
38,724
|
|
|
|
1.17
|
%
|
|
|
1.62
|
%
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Interest Income
|
|
|
Net Interest Spread
|
|
|
|
GAAP
|
|
|
Economic
|
|
|
GAAP
|
|
|
Economic
|
|
|
|
Basis
|
|
|
Basis
(2)
|
|
|
Basis
|
|
|
Basis
(4)
|
|
Three Months Ended
|
|
September 30, 2018
|
|
$
|
20,161
|
|
|
$
|
20,433
|
|
|
|
2.11
|
%
|
|
|
2.14
|
%
|
June 30, 2018
|
|
|
22,011
|
|
|
|
21,159
|
|
|
|
2.27
|
%
|
|
|
2.18
|
%
|
March 31, 2018
|
|
|
24,786
|
|
|
|
21,775
|
|
|
|
2.58
|
%
|
|
|
2.24
|
%
|
December 31, 2017
|
|
|
26,544
|
|
|
|
22,781
|
|
|
|
2.68
|
%
|
|
|
2.27
|
%
|
September 30, 2017
|
|
|
26,337
|
|
|
|
22,576
|
|
|
|
2.62
|
%
|
|
|
2.19
|
%
|
June 30, 2017
|
|
|
25,816
|
|
|
|
22,162
|
|
|
|
2.84
|
%
|
|
|
2.38
|
%
|
March 31, 2017
|
|
|
25,596
|
|
|
|
22,403
|
|
|
|
3.19
|
%
|
|
|
2.75
|
%
|
Nine Months Ended
|
|
September 30, 2018
|
|
$
|
66,960
|
|
|
$
|
63,368
|
|
|
|
2.32
|
%
|
|
|
2.18
|
%
|
September 30, 2017
|
|
|
77,748
|
|
|
|
67,142
|
|
|
|
2.87
|
%
|
|
|
2.42
|
%
|
(1)
|
Portfolio yields and costs of borrowings presented in the tables above and the tables on pages 31 and 32 are calculated based on the average balances of the underlying investment portfolio/borrowings balances and are annualized for the periods presented. Average balances for quarterly periods are calculated using two data points, the beginning and ending balances.
|
(2)
|
Economic interest expense and economic net interest income
presented in the table above and the tables on page 32 includes the effect of our derivative instrument hedges for only the periods presented.
|
(3)
|
Represents interest cost of our borrowings and the effect of derivative instrument hedges attributed to the period divided by average RMBS.
|
(4)
|
Economic net interest spread is calculated by subtracting average economic cost of funds from realized yield on average RMBS.
|
Interest Income and Average Asset Yield
Our interest income for the nine months ended September 30, 2018 and 2017 was $117.6 million and $105.9 million, respectively. We had average RMBS holdings of $3,688.3 million and $3,492.0 million for the nine months ended September 30, 2018 and 2017, respectively. The yield on our portfolio was 4.25% and 4.04% for the nine months ended September 30, 2018 and 2017, respectively. For the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017, there was a $11.7 million increase in interest income due to a $196.2 million increase in average RMBS, combined with a 21 basis point ("bps") increase in the yield on average RMBS. The increase in average RMBS during the nine months ended September 30, 2018 reflects the deployment of the proceeds of our net capital raising activities, on a leveraged basis.
Our interest income for the three months ended September 30, 2018 and 2017 was $39.1 million and $39.0 million, respectively. We had average RMBS holdings of $3,601.8 million and $3,834.1 million for the three months ended September 30, 2018 and 2017, respectively. The yield on our portfolio was 4.34% and 4.07% for the three months ended September 30, 2018 and 2017, respectively. For the three months ended September 30, 2018 as compared to the three months ended September 30, 2017, there was a $0.1 million increase in interest income due to a 27 bps increase in the yield on average RMBS, offset by a $232.3 million decrease in average RMBS as we deleveraged our portfolio.
The table below presents the average portfolio size, income and yields of our respective sub-portfolios, consisting of structured RMBS and PT RMBS, for the nine months ended September 30, 2018 to date and 2017, and for each quarter during 2018 and 2017.
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average RMBS Held
|
|
|
Interest Income
|
|
|
Realized Yield on Average RMBS
|
|
|
|
PT
|
|
|
Structured
|
|
|
|
|
|
PT
|
|
|
Structured
|
|
|
|
|
|
PT
|
|
|
Structured
|
|
|
|
|
|
|
RMBS
|
|
|
RMBS
|
|
|
Total
|
|
|
RMBS
|
|
|
RMBS
|
|
|
Total
|
|
|
RMBS
|
|
|
RMBS
|
|
|
Total
|
|
Three Months Ended
|
|
September 30, 2018
|
|
$
|
3,463,325
|
|
|
$
|
138,451
|
|
|
$
|
3,601,776
|
|
|
$
|
36,716
|
|
|
$
|
2,338
|
|
|
$
|
39,054
|
|
|
|
4.24
|
%
|
|
|
6.76
|
%
|
|
|
4.34
|
%
|
June 30, 2018
|
|
|
3,572,540
|
|
|
|
145,150
|
|
|
|
3,717,690
|
|
|
|
36,273
|
|
|
|
2,317
|
|
|
|
38,590
|
|
|
|
4.06
|
%
|
|
|
6.38
|
%
|
|
|
4.15
|
%
|
March 31, 2018
|
|
|
3,610,527
|
|
|
|
134,771
|
|
|
|
3,745,298
|
|
|
|
38,725
|
|
|
|
1,210
|
|
|
|
39,935
|
|
|
|
4.29
|
%
|
|
|
3.59
|
%
|
|
|
4.27
|
%
|
December 31, 2017
|
|
|
3,704,163
|
|
|
|
133,412
|
|
|
|
3,837,575
|
|
|
|
38,927
|
|
|
|
1,171
|
|
|
|
40,098
|
|
|
|
4.20
|
%
|
|
|
3.51
|
%
|
|
|
4.18
|
%
|
September 30, 2017
|
|
|
3,687,533
|
|
|
|
146,550
|
|
|
|
3,834,083
|
|
|
|
38,476
|
|
|
|
498
|
|
|
|
38,974
|
|
|
|
4.17
|
%
|
|
|
1.36
|
%
|
|
|
4.07
|
%
|
June 30, 2017
|
|
|
3,349,042
|
|
|
|
150,880
|
|
|
|
3,499,922
|
|
|
|
32,479
|
|
|
|
2,100
|
|
|
|
34,579
|
|
|
|
3.88
|
%
|
|
|
5.57
|
%
|
|
|
3.95
|
%
|
March 31, 2017
|
|
|
2,990,937
|
|
|
|
151,158
|
|
|
|
3,142,095
|
|
|
|
29,772
|
|
|
|
2,539
|
|
|
|
32,311
|
|
|
|
3.98
|
%
|
|
|
6.72
|
%
|
|
|
4.11
|
%
|
Nine Months Ended
|
|
September 30, 2018
|
|
$
|
3,548,798
|
|
|
$
|
139,457
|
|
|
$
|
3,688,255
|
|
|
$
|
111,714
|
|
|
$
|
5,865
|
|
|
$
|
117,580
|
|
|
|
4.20
|
%
|
|
|
5.61
|
%
|
|
|
4.25
|
%
|
September 30, 2017
|
|
|
3,342,504
|
|
|
|
149,529
|
|
|
|
3,492,033
|
|
|
|
100,727
|
|
|
|
5,137
|
|
|
|
105,864
|
|
|
|
4.02
|
%
|
|
|
4.58
|
%
|
|
|
4.04
|
%
|
Interest Expense and the Cost of Funds
We had average outstanding borrowings of $3,499.0 million and $3,193.7 million and total interest expense of $50.6 million and $28.1 million for the nine months ended September 30, 2018 and 2017, respectively. Our average cost of funds was 1.93% for the nine months ended September 30, 2018, compared to 1.17% for the comparable period in 2017. Contributing to the increase in interest expense was a 76 bps increase in the average cost of funds and a $305.3 million increase in average outstanding borrowings during the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017. The higher cost of funds for the nine months ended September 30, 2018, compared to the same period in 2017, reflects the higher short-term rates as presented in the table below. The increase in average outstanding borrowings reflects the investment, on a leveraged basis, of the proceeds of our net capital raising activities.
Our economic interest expense was $54.2 million and $38.7 million for the nine months ended September 30, 2018 and 2017, respectively. There was a 45 bps increase in the average economic cost of funds to 2.07% for the nine months ended September 30, 2018 from 1.62% for the nine months ended September 30, 2017. The reason for the increase in economic cost of funds is primarily due to the increases in our average outstanding borrowings and the cost of our borrowings noted above.
We had average outstanding borrowings of $3,385.8 million and $3,494.3 million and total interest expense of $18.9 million and $12.6 million for the three months ended September 30, 2018 and 2017, respectively. Our average cost of funds was 2.23% and 1.45% for three months ended September 30, 2018 and 2017, respectively. There was a 78 bps increase in the average cost of funds and a $108.4 million decrease in average outstanding borrowings during the three months ended September 30, 2018, compared to the three months ended September 30, 2017. As in the nine months ended September 30, 2018, the higher cost of funds for the three months ended September 30, 2018, compared to the same period in 2017, reflects higher short-term rates. The decrease in the average outstanding borrowings reflects the deleveraging of the portfolio.
Our economic interest expense was $18.6 million and $16.4 million for the three months ended September 30, 2018 and 2017, respectively. There was a 32 bps increase in the average economic cost of funds to 2.20% for the three months ended September 30, 2018 from 1.88% for the three months ended September 30, 2017. The increase in economic interest expense during the three months ended September 30, 2018 was due to higher average interest rates charged for those borrowings.
Since all of our repurchase agreements are short-term, changes in market rates directly affect our interest expense. Our average cost of funds calculated on a GAAP basis was 6 bps above the average one-month LIBOR and 32 bps below the average six-month LIBOR for the quarter ended September 30, 2018. Our average economic cost of funds was 3 bps above the average one-month LIBOR and 35 bps below the average six-month LIBOR for the quarter ended September 30, 2018. The average term to maturity of the outstanding repurchase agreements decreased to 37 days at September 30, 2018 from 52 days at December 31, 2017.
The tables below present the average balance of borrowings outstanding, interest expense and average cost of funds, and average one-month and six-month LIBOR rates for the nine months ended September 30, 2018 and 2017, and for each quarter in 2018 and 2017 on both a GAAP and economic basis.
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Interest Expense
|
|
|
Average Cost of Funds
|
|
|
|
Balance of
|
|
|
GAAP
|
|
|
Economic
|
|
|
GAAP
|
|
|
Economic
|
|
|
|
Borrowings
|
|
|
Basis
|
|
|
Basis
|
|
|
Basis
|
|
|
Basis
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
$
|
3,385,829
|
|
|
$
|
18,893
|
|
|
$
|
18,621
|
|
|
|
2.23
|
%
|
|
|
2.20
|
%
|
June 30, 2018
|
|
|
3,534,567
|
|
|
|
16,579
|
|
|
|
17,431
|
|
|
|
1.88
|
%
|
|
|
1.97
|
%
|
March 31, 2018
|
|
|
3,576,533
|
|
|
|
15,149
|
|
|
|
18,160
|
|
|
|
1.69
|
%
|
|
|
2.03
|
%
|
December 31, 2017
|
|
|
3,621,931
|
|
|
|
13,554
|
|
|
|
17,317
|
|
|
|
1.50
|
%
|
|
|
1.91
|
%
|
September 30, 2017
|
|
|
3,494,266
|
|
|
|
12,638
|
|
|
|
16,399
|
|
|
|
1.45
|
%
|
|
|
1.88
|
%
|
June 30, 2017
|
|
|
3,164,532
|
|
|
|
8,763
|
|
|
|
12,417
|
|
|
|
1.11
|
%
|
|
|
1.57
|
%
|
March 31, 2017
|
|
|
2,922,157
|
|
|
|
6,715
|
|
|
|
9,908
|
|
|
|
0.92
|
%
|
|
|
1.36
|
%
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
$
|
3,498,976
|
|
|
$
|
50,620
|
|
|
$
|
54,212
|
|
|
|
1.93
|
%
|
|
|
2.07
|
%
|
September 30, 2017
|
|
|
3,193,652
|
|
|
|
28,116
|
|
|
|
38,724
|
|
|
|
1.17
|
%
|
|
|
1.62
|
%
|
|
|
|
|
|
|
|
|
Average GAAP Cost of Funds
|
|
|
Average Economic Cost of Funds
|
|
|
|
|
|
|
|
|
|
Relative to Average
|
|
|
Relative to Average
|
|
|
|
Average LIBOR
|
|
|
One-Month
|
|
|
Six-Month
|
|
|
One-Month
|
|
|
Six-Month
|
|
|
|
One-Month
|
|
|
Six-Month
|
|
|
LIBOR
|
|
|
LIBOR
|
|
|
LIBOR
|
|
|
LIBOR
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
|
2.17
|
%
|
|
|
2.55
|
%
|
|
|
0.06
|
%
|
|
|
(0.32
|
)%
|
|
|
0.03
|
%
|
|
|
(0.35
|
)%
|
June 30, 2018
|
|
|
1.99
|
%
|
|
|
2.48
|
%
|
|
|
(0.11
|
)%
|
|
|
(0.60
|
)%
|
|
|
(0.02
|
)%
|
|
|
(0.51
|
)%
|
March 31, 2018
|
|
|
1.69
|
%
|
|
|
2.11
|
%
|
|
|
0.00
|
%
|
|
|
(0.42
|
)%
|
|
|
0.34
|
%
|
|
|
(0.08
|
)%
|
December 31, 2017
|
|
|
1.36
|
%
|
|
|
1.62
|
%
|
|
|
0.14
|
%
|
|
|
(0.12
|
)%
|
|
|
0.55
|
%
|
|
|
0.29
|
%
|
September 30, 2017
|
|
|
1.20
|
%
|
|
|
1.45
|
%
|
|
|
0.25
|
%
|
|
|
(0.00
|
)%
|
|
|
0.68
|
%
|
|
|
0.43
|
%
|
June 30, 2017
|
|
|
1.05
|
%
|
|
|
1.43
|
%
|
|
|
0.06
|
%
|
|
|
(0.32
|
)%
|
|
|
0.52
|
%
|
|
|
0.14
|
%
|
March 31, 2017
|
|
|
0.82
|
%
|
|
|
1.37
|
%
|
|
|
0.10
|
%
|
|
|
(0.45
|
)%
|
|
|
0.54
|
%
|
|
|
(0.01
|
)%
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
|
1.95
|
%
|
|
|
2.38
|
%
|
|
|
(0.02
|
)%
|
|
|
(0.45
|
)%
|
|
|
0.12
|
%
|
|
|
(0.31
|
)%
|
September 30, 2017
|
|
|
1.03
|
%
|
|
|
1.42
|
%
|
|
|
0.14
|
%
|
|
|
(0.25
|
)%
|
|
|
0.59
|
%
|
|
|
0.20
|
%
|
Gains or Losses
The table below presents our gains or losses for the nine and three months ended September 30, 2018 and 2017.
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
Three Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
Realized (losses) gains on sales of RMBS
|
|
$
|
(23,350
|
)
|
|
$
|
3,354
|
|
|
$
|
(26,704
|
)
|
|
$
|
(2,837
|
)
|
|
$
|
769
|
|
|
$
|
(3,606
|
)
|
Unrealized losses on RMBS
|
|
|
(122,136
|
)
|
|
|
(35,601
|
)
|
|
|
(86,535
|
)
|
|
|
(30,006
|
)
|
|
|
(3,554
|
)
|
|
|
(26,452
|
)
|
Total losses on RMBS
|
|
|
(145,486
|
)
|
|
|
(32,247
|
)
|
|
|
(113,239
|
)
|
|
|
(32,843
|
)
|
|
|
(2,785
|
)
|
|
|
(30,058
|
)
|
Gains (losses) on interest rate futures
|
|
|
34,533
|
|
|
|
(23,145
|
)
|
|
|
57,678
|
|
|
|
6,122
|
|
|
|
(5,843
|
)
|
|
|
11,965
|
|
Gains (losses) on interest rate swaps
|
|
|
17,032
|
|
|
|
(3,170
|
)
|
|
|
20,202
|
|
|
|
2,994
|
|
|
|
1,005
|
|
|
|
1,989
|
|
(Losses) gains on receiver swaptions
|
|
|
(909
|
)
|
|
|
-
|
|
|
|
(909
|
)
|
|
|
(130
|
)
|
|
|
-
|
|
|
|
(130
|
)
|
Gains on payer swaptions
|
|
|
5,627
|
|
|
|
827
|
|
|
|
4,800
|
|
|
|
414
|
|
|
|
827
|
|
|
|
(413
|
)
|
Gains (losses) on TBA securities
|
|
|
13,264
|
|
|
|
(3,843
|
)
|
|
|
17,107
|
|
|
|
3,293
|
|
|
|
(1,459
|
)
|
|
|
4,752
|
|
We invest in RMBS with the intent to earn net income from the realized yield on those assets over their related funding and hedging costs, and not for the purpose of making short term gains from sales. However, we have sold, and may continue to sell, existing assets to acquire new assets, which our management believes might have higher risk-adjusted returns in light of current or anticipated interest rates, federal government programs or general economic conditions or to manage our balance sheet as part of our asset/liability management strategy. During the nine months ended September 30, 2018 and 2017, we received proceeds of $2,762.8 million and $3,891.0 million, respectively, from the sales of RMBS. During the three months ended September 30, 2018 and 2017, we received proceeds of $1,005.2 million and $826.0 million, respectively, from the sales of RMBS.
Realized and unrealized gains and losses on RMBS are driven in part by changes in yields and interest rates, which affect the pricing of the securities in our portfolio. Gains and losses on interest rate futures contracts are affected by changes in implied forward rates during the reporting period.
The table below presents historical interest rate data for each quarter end during 2018 to date and 2017.
|
|
5 Year
|
|
|
10 Year
|
|
|
15 Year
|
|
|
30 Year
|
|
|
Three
|
|
|
|
U.S. Treasury
|
|
|
U.S. Treasury
|
|
|
Fixed-Rate
|
|
|
Fixed-Rate
|
|
|
Month
|
|
|
|
Rate
(1)
|
|
|
Rate
(1)
|
|
|
Mortgage Rate
(2)
|
|
|
Mortgage Rate
(2)
|
|
|
LIBOR
(3)
|
|
September 30, 2018
|
|
|
2.95
|
%
|
|
|
3.06
|
%
|
|
|
4.08
|
%
|
|
|
4.63
|
%
|
|
|
2.40
|
%
|
June 30, 2018
|
|
|
2.73
|
%
|
|
|
2.85
|
%
|
|
|
4.04
|
%
|
|
|
4.57
|
%
|
|
|
2.34
|
%
|
March 31, 2018
|
|
|
2.56
|
%
|
|
|
2.74
|
%
|
|
|
3.91
|
%
|
|
|
4.44
|
%
|
|
|
2.31
|
%
|
December 31, 2017
|
|
|
2.21
|
%
|
|
|
2.40
|
%
|
|
|
3.39
|
%
|
|
|
3.95
|
%
|
|
|
1.61
|
%
|
September 30, 2017
|
|
|
1.93
|
%
|
|
|
2.33
|
%
|
|
|
3.11
|
%
|
|
|
3.81
|
%
|
|
|
1.32
|
%
|
June 30, 2017
|
|
|
1.88
|
%
|
|
|
2.30
|
%
|
|
|
3.17
|
%
|
|
|
3.90
|
%
|
|
|
1.26
|
%
|
March 31, 2017
|
|
|
1.93
|
%
|
|
|
2.40
|
%
|
|
|
3.41
|
%
|
|
|
4.20
|
%
|
|
|
1.13
|
%
|
(1)
|
Historical 5 and 10 Year U.S. Treasury Rates are obtained from quoted end of day prices on the Chicago Board Options Exchange.
|
(2)
|
Historical 30 Year and 15 Year Fixed Rate Mortgage Rates are obtained from Freddie Mac's Primary Mortgage Market Survey.
|
(3)
|
Historical LIBOR is obtained from the Intercontinental Exchange Benchmark Administration Ltd.
|
For the nine and three months ended September 30, 2018, the Company's total operating expenses were approximately $9.0 million and $3.0 million, respectively, compared to approximately $8.2 million and $2.9 million, respectively, for the nine and three months ended September 30, 2017. The table below presents a breakdown of operating expenses for the nine and three months ended September 30, 2018 and 2017.
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
Three Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
|
2018
|
|
|
2017
|
|
|
Change
|
|
Management fees
|
|
$
|
4,800
|
|
|
$
|
4,230
|
|
|
$
|
570
|
|
|
$
|
1,482
|
|
|
$
|
1,528
|
|
|
$
|
(46
|
)
|
Overhead allocation
|
|
|
1,133
|
|
|
|
1,168
|
|
|
|
(35
|
)
|
|
|
391
|
|
|
|
412
|
|
|
|
(21
|
)
|
Accrued incentive compensation
|
|
|
209
|
|
|
|
439
|
|
|
|
(230
|
)
|
|
|
197
|
|
|
|
209
|
|
|
|
(12
|
)
|
Directors fees and liability insurance
|
|
|
734
|
|
|
|
722
|
|
|
|
12
|
|
|
|
234
|
|
|
|
215
|
|
|
|
19
|
|
Audit, legal and other professional fees
|
|
|
632
|
|
|
|
547
|
|
|
|
85
|
|
|
|
170
|
|
|
|
157
|
|
|
|
13
|
|
Direct REIT operating expenses
|
|
|
1,234
|
|
|
|
816
|
|
|
|
418
|
|
|
|
424
|
|
|
|
320
|
|
|
|
104
|
|
Other administrative
|
|
|
267
|
|
|
|
259
|
|
|
|
8
|
|
|
|
72
|
|
|
|
58
|
|
|
|
14
|
|
Total expenses
|
|
$
|
9,009
|
|
|
$
|
8,181
|
|
|
$
|
828
|
|
|
$
|
2,970
|
|
|
$
|
2,899
|
|
|
$
|
71
|
|
We are externally managed and advised by Bimini Advisors, LLC (the "Manager") pursuant to the terms of a management agreement. The management agreement has been renewed through February 20, 2019 and provides for automatic one-year extension options thereafter and is subject to certain termination rights. Under the terms of the management agreement, the Manager is responsible for administering the business activities and day-to-day operations of the Company. The Manager receives a monthly management fee in the amount of:
·
|
One-twelfth of 1.5% of the first $250 million of the Company's equity, as defined in the management agreement,
|
·
|
One-twelfth of 1.25% of the Company's equity that is greater than $250 million and less than or equal to $500 million, and
|
·
|
One-twelfth of 1.00% of the Company's equity that is greater than $500 million.
|
We are obligated to reimburse Bimini Advisors for any direct expenses incurred on its behalf. In addition, beginning July 1, 2014, Bimini Advisors began allocating to us its pro rata portion of certain overhead costs in accordance with the management agreement. Should we terminate the management agreement without cause, we will pay to the Manager a termination fee equal to three times the average annual management fee, as defined in the management agreement, before or on the last day of term of the agreement.
Financial Condition:
Mortgage-Backed Securities
As of September 30, 2018, our RMBS portfolio consisted of $3,514.0 million of Agency RMBS at fair value and had a weighted average coupon on assets of 4.65%. During the nine months ended September 30, 2018, we received principal repayments of $281.0 million compared to $248.5 million for the nine months ended September 30, 2017. The average prepayment speeds for the quarters ended September 30, 2018 and 2017 were 8.6% and 10.3%, respectively.
The following table presents the 3-month constant prepayment rate ("CPR") experienced on our structured and PT RMBS sub-portfolios, on an annualized basis, for the quarterly periods presented. CPR is a method of expressing the prepayment rate for a mortgage pool that assumes that a constant fraction of the remaining principal is prepaid each month or year. Specifically, the CPR in the chart below represents the three month prepayment rate of the securities in the respective asset category. Assets that were not owned for the entire quarter have been excluded from the calculation. The exclusion of certain assets during periods of high trading activity can create a very high, and often volatile, reliance on a small sample of underlying loans.
|
|
|
|
|
Structured
|
|
|
|
|
|
|
PT RMBS
|
|
|
RMBS
|
|
|
Total
|
|
Three Months Ended
|
|
Portfolio (%)
|
|
|
Portfolio (%)
|
|
|
Portfolio (%)
|
|
September 30, 2018
|
|
|
7.5
|
|
|
|
11.5
|
|
|
|
8.6
|
|
June 30, 2018
|
|
|
8.7
|
|
|
|
11.8
|
|
|
|
9.8
|
|
March 31, 2018
|
|
|
6.5
|
|
|
|
11.6
|
|
|
|
7.7
|
|
December 31, 2017
|
|
|
7.0
|
|
|
|
13.6
|
|
|
|
9.1
|
|
September 30, 2017
|
|
|
8.3
|
|
|
|
14.9
|
|
|
|
10.3
|
|
June 30, 2017
|
|
|
7.0
|
|
|
|
12.7
|
|
|
|
9.5
|
|
March 31, 2017
|
|
|
7.5
|
|
|
|
14.3
|
|
|
|
9.9
|
|
The following tables summarize certain characteristics of the Company's PT RMBS and structured RMBS as of September 30, 2018 and December 31, 2017:
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
Weighted
|
|
|
|
|
|
Percentage
|
|
Average
|
|
Average
|
Weighted
|
Weighted
|
|
|
|
of
|
Weighted
|
Maturity
|
|
Coupon
|
Average
|
Average
|
|
|
Fair
|
Entire
|
Average
|
in
|
Longest
|
Reset in
|
Lifetime
|
Periodic
|
Asset Category
|
|
Value
|
Portfolio
|
Coupon
|
Months
|
Maturity
|
Months
|
Cap
|
Cap
|
September 30, 2018
|
|
|
|
|
|
|
|
|
|
Adjustable Rate RMBS
|
$
|
1,437
|
0.0%
|
5.08%
|
194
|
1-Sep-35
|
6.02
|
10.04%
|
2.76%
|
Fixed Rate RMBS
|
|
2,616,916
|
74.5%
|
4.75%
|
282
|
1-Sep-48
|
NA
|
NA
|
NA
|
Fixed Rate CMOs
|
|
760,587
|
21.6%
|
4.62%
|
351
|
15-Oct-44
|
NA
|
NA
|
NA
|
Total Mortgage-backed Pass-through
|
|
3,378,940
|
96.1%
|
4.72%
|
297
|
1-Sep-48
|
NA
|
NA
|
NA
|
Interest-Only Securities
|
|
111,929
|
3.2%
|
4.28%
|
300
|
25-Feb-48
|
NA
|
NA
|
NA
|
Inverse Interest-Only Securities
|
|
23,087
|
0.7%
|
4.86%
|
246
|
15-Apr-47
|
NA
|
4.52%
|
NA
|
Total Structured RMBS
|
|
135,016
|
3.9%
|
4.42%
|
259
|
25-Feb-48
|
NA
|
NA
|
NA
|
Total Mortgage Assets
|
$
|
3,513,956
|
100.0%
|
4.65%
|
289
|
1-Sep-48
|
NA
|
NA
|
NA
|
December 31, 2017
|
|
|
|
|
|
|
|
|
|
Adjustable Rate RMBS
|
$
|
1,754
|
0.0%
|
3.95%
|
206
|
1-Sep-35
|
5.50
|
10.05%
|
2.00%
|
Fixed Rate RMBS
|
|
3,594,533
|
96.0%
|
4.25%
|
338
|
1-Dec-47
|
NA
|
NA
|
NA
|
Hybrid Adjustable Rate RMBS
|
|
27,398
|
0.7%
|
2.59%
|
301
|
1-Aug-43
|
59.77
|
7.59%
|
2.00%
|
Total Mortgage-backed Pass-through
|
|
3,623,685
|
96.7%
|
4.24%
|
338
|
1-Dec-47
|
NA
|
NA
|
NA
|
Interest-Only Securities
|
|
86,918
|
2.3%
|
3.75%
|
262
|
15-Apr-47
|
NA
|
NA
|
NA
|
Inverse Interest-Only Securities
|
|
34,208
|
1.0%
|
4.02%
|
318
|
15-Jul-47
|
NA
|
5.11%
|
NA
|
Total Structured RMBS
|
|
121,126
|
3.3%
|
3.82%
|
278
|
15-Jul-47
|
NA
|
NA
|
NA
|
Total Mortgage Assets
|
$
|
3,744,811
|
100.0%
|
4.23%
|
336
|
1-Dec-47
|
NA
|
NA
|
NA
|
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
|
December 31, 2017
|
|
|
|
|
|
|
Percentage of
|
|
|
|
|
|
Percentage of
|
|
Agency
|
|
Fair Value
|
|
|
Entire Portfolio
|
|
|
Fair Value
|
|
|
Entire Portfolio
|
|
Fannie Mae
|
|
$
|
2,196,959
|
|
|
|
62.5
|
%
|
|
$
|
2,242,213
|
|
|
|
59.9
|
%
|
Freddie Mac
|
|
|
1,312,238
|
|
|
|
37.3
|
%
|
|
|
1,496,615
|
|
|
|
40.0
|
%
|
Ginnie Mae
|
|
|
4,759
|
|
|
|
0.2
|
%
|
|
|
5,983
|
|
|
|
0.1
|
%
|
Total Portfolio
|
|
$
|
3,513,956
|
|
|
|
100.0
|
%
|
|
$
|
3,744,811
|
|
|
|
100.0
|
%
|
|
|
September 30, 2018
|
|
|
December 31, 2017
|
|
Weighted Average Pass-through Purchase Price
|
|
$
|
105.31
|
|
|
$
|
107.52
|
|
Weighted Average Structured Purchase Price
|
|
$
|
14.37
|
|
|
$
|
13.82
|
|
Weighted Average Pass-through Current Price
|
|
$
|
103.20
|
|
|
$
|
106.79
|
|
Weighted Average Structured Current Price
|
|
$
|
14.23
|
|
|
$
|
12.50
|
|
Effective Duration
(1)
|
|
|
3.340
|
|
|
|
2.989
|
|
(1)
|
Effective duration is the approximate percentage change in price for a 100 bps change in rates. An effective duration of 3.340 indicates that an interest rate increase of 1.0% would be expected to cause a 3.340% decrease in the value of the RMBS in the Company's investment portfolio at September 30, 2018. An effective duration of 2.989 indicates that an interest rate increase of 1.0% would be expected to cause a 2.989% decrease in the value of the RMBS in the Company's investment portfolio at December 31, 2017. These figures include the structured securities in the portfolio, but do not include the effect of the Company's funding cost hedges. Effective duration quotes for individual investments are obtained from The Yield Book, Inc.
|
The following table presents a summary of portfolio assets acquired during the nine months ended September 30, 2018 and 2017, including securities purchased during the period that settled after the end of the period, if any.
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2017
|
|
|
|
Total Cost
|
|
|
Average Price
|
|
|
Weighted Average Yield
|
|
|
Total Cost
|
|
|
Average Price
|
|
|
Weighted Average Yield
|
|
Pass-through RMBS
|
|
$
|
2,929,494
|
|
|
$
|
104.20
|
|
|
|
3.34
|
%
|
|
$
|
5,007,614
|
|
|
$
|
108.16
|
|
|
|
2.75
|
%
|
Structured RMBS
|
|
|
28,908
|
|
|
|
21.56
|
|
|
|
5.39
|
%
|
|
|
72,331
|
|
|
|
14.46
|
|
|
|
6.21
|
%
|
As of September 30, 2018, we had established borrowing facilities in the repurchase agreement market with a number of commercial banks and other financial institutions and had borrowings in place with 23 of these counterparties. None of these lenders are affiliated with the Company. These borrowings are secured by the Company's RMBS and cash, and bear interest at prevailing market rates. We believe our established repurchase agreement borrowing facilities provide borrowing capacity in excess of our needs.
As of September 30, 2018, we had obligations outstanding under the repurchase agreements of approximately $3,321.8 million with a net weighted average borrowing cost of 2.30%. The remaining maturity of our outstanding repurchase agreement obligations ranged from 1 to 74 days, with a weighted average remaining maturity of 37 days. Securing the repurchase agreement obligations as of September 30, 2018 are RMBS with an estimated fair value, including accrued interest, of approximately $3,512.5 million and a weighted average maturity of 289 months, and cash pledged to counterparties of approximately $25.8 million. Through October 26, 2018, we have been able to maintain our repurchase facilities with comparable terms to those that existed at September 30, 2018 with maturities through January 14, 2019.
The table below presents information about our period end and average repurchase agreement obligations for each quarter in 2018 and 2017.
($ in thousands)
|
|
|
|
|
|
|
|
|
|
Difference Between Ending
|
|
|
|
Ending
|
|
|
Average
|
|
|
Borrowings and
|
|
|
|
Balance of
|
|
|
Balance of
|
|
|
Average Borrowings
|
|
Three Months Ended
|
|
Borrowings
|
|
|
Borrowings
|
|
|
Amount
|
|
|
Percent
|
|
September 30, 2018
|
|
$
|
3,321,803
|
|
|
$
|
3,385,829
|
|
|
$
|
(64,026
|
)
|
|
|
(1.89
|
)%
|
June 30, 2018
|
|
|
3,449,854
|
|
|
|
3,534,567
|
|
|
|
(84,713
|
)
|
|
|
(2.40
|
)%
|
March 31, 2018
|
|
|
3,619,280
|
|
|
|
3,576,533
|
|
|
|
42,747
|
|
|
|
1.20
|
%
|
December 31, 2017
|
|
|
3,533,786
|
|
|
|
3,621,931
|
|
|
|
(88,145
|
)
|
|
|
(2.43
|
)%
|
September 30, 2017
|
|
|
3,710,077
|
|
|
|
3,494,266
|
|
|
|
215,811
|
|
|
|
6.18
|
%
|
June 30, 2017
|
|
|
3,278,456
|
|
|
|
3,164,532
|
|
|
|
113,924
|
|
|
|
3.60
|
%
|
March 31, 2017
|
|
|
3,050,608
|
|
|
|
2,922,157
|
|
|
|
128,451
|
|
|
|
4.40
|
%
|
Liquidity and Capital Resources
Liquidity is our ability to turn non-cash assets into cash, purchase additional investments, repay principal and interest on borrowings, fund overhead, fulfill margin calls and pay dividends. Our principal immediate sources of liquidity include cash balances, unencumbered assets and borrowings under repurchase agreements. Our borrowing capacity will vary over time as the market value of our interest earning assets varies. Our balance sheet also generates liquidity on an on-going basis through payments of principal and interest we receive on our RMBS portfolio. Management believes that we currently have sufficient liquidity and capital resources available for (a) the acquisition of additional investments consistent with the size and nature of our existing RMBS portfolio, (b) the repayments on borrowings and (c) the payment of dividends to the extent required for our continued qualification as a REIT. We may also generate liquidity from time to time by selling our equity or debt securities in public offerings or private placements.
Because our PT RMBS portfolio consists entirely of government and agency securities, we do not anticipate having difficulty converting our assets to cash should our liquidity needs ever exceed our immediately available sources of cash. Our structured RMBS portfolio also consists entirely of governmental agency securities, although they typically do not trade with comparable bid / ask spreads as PT RMBS. However, we anticipate that we would be able to liquidate such securities readily, even in distressed markets, although we would likely do so at prices below where such securities could be sold in a more stable market. To enhance our liquidity even further, we may pledge a portion of our structured RMBS as part of a repurchase agreement funding, but retain the cash in lieu of acquiring additional assets. In this way we can, at a modest cost, retain higher levels of cash on hand and decrease the likelihood we will have to sell assets in a distressed market in order to raise cash.
Our strategy for hedging our funding costs typically involves taking short positions in interest rate futures, treasury futures, interest rate swaps, interest rate swaptions or other instruments. When the market causes these short positions to decline in value we are required to meet margin calls with cash. This can reduce our liquidity position to the extent other securities in our portfolio move in price in such a way that we do not receive enough cash via margin calls to offset the derivative related margin calls. If this were to occur in sufficient magnitude, the loss of liquidity might force us to reduce the size of the levered portfolio, pledge additional structured securities to raise funds or risk operating the portfolio with less liquidity.
Our master repurchase agreements have no stated expiration, but can be terminated at any time at our option or at the option of the counterparty. However, once a definitive repurchase agreement under a master repurchase agreement has been entered into, it generally may not be terminated by either party. A negotiated termination can occur, but may involve a fee to be paid by the party seeking to terminate the repurchase agreement transaction.
Under our repurchase agreement funding arrangements, we are required to post margin at the initiation of the borrowing. The margin posted represents the haircut, which is a percentage of the market value of the collateral pledged. To the extent the market value of the asset collateralizing the financing transaction declines, the market value of our posted margin will be insufficient and we will be required to post additional collateral. Conversely, if the market value of the asset pledged increases in value, we would be over collateralized and we would be entitled to have excess margin returned to us by the counterparty. Our lenders typically value our pledged securities daily to ensure the adequacy of our margin and make margin calls as needed, as do we. Typically, but not always, the parties agree to a minimum threshold amount for margin calls so as to avoid the need for nuisance margin calls on a daily basis.
Our master repurchase agreements do not specify the haircut; rather haircuts are determined on an individual repurchase transaction basis. Throughout the nine months ended September 30, 2018, haircuts on our pledged collateral remained stable and as of September 30, 2018, our weighted average haircut was approximately 5.3% of the value of our collateral.
As discussed earlier, we invest a portion of our capital in structured Agency RMBS. We do not apply leverage to this portion of our portfolio. The leverage inherent in structured securities replaces the leverage obtained by acquiring PT securities and funding them in the repurchase market. This structured RMBS strategy has been a core element of the Company's overall investment strategy since inception. However, we have and may continue to pledge a portion of our structured RMBS in order to raise our cash levels, but generally will not pledge these securities in order to acquire additional assets.
The following table summarizes the effect on our liquidity and cash flows from contractual obligations for repurchase agreements and interest expense on repurchase agreements.
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations Maturing
|
|
|
|
Within One Year
|
|
|
One to Three Years
|
|
|
Three to Five Years
|
|
|
More than Five Years
|
|
|
Total
|
|
Repurchase agreements
|
|
$
|
3,321,803
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,321,803
|
|
Interest expense on repurchase agreements
(1)
|
|
|
12,272
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
12,272
|
|
Totals
|
|
$
|
3,334,075
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,334,075
|
|
(1)
|
Interest expense on repurchase agreements is based on current interest rates as of September 30, 2018 and the remaining term of the liabilities existing at that date.
|
In future periods, we expect to continue to finance our activities in a manner that is consistent with our current operations through repurchase agreements. As of September 30, 2018, we had cash and cash equivalents of $164.4 million. We generated cash flows of $397.2 million from principal and interest payments on our RMBS and had average repurchase agreements outstanding of $3,499.0 million during the nine months ended September 30, 2018.
Stockholders' Equity
On July 29, 2016, we entered into an equity distribution agreement (the "July 2016 Equity Distribution Agreement") with two sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $125,000,000 of shares of our common stock in transactions that were deemed to be "at the market" offerings and privately negotiated transactions. We issued a total of 10,174,992 shares under the July 2016 Equity Distribution Agreement for aggregate gross proceeds of $110.0 million, and net proceeds of approximately $108.2 million, net of commissions and fees, prior to its termination.
On February 23, 2017, we entered into another equity distribution agreement, as amended and restated on May 10, 2017, (the "May 2017 Equity Distribution Agreement") with two sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate amount of $125,000,000 of shares of our common stock in transactions that were deemed to be "at the market" offerings and privately negotiated transactions. The May 2017 Equity Distribution Agreement replaced the July 2016 Equity Distribution Agreement. We issued a total of 12,299,032 shares under the May 2017 Equity Distribution Agreement for aggregate gross proceeds of $125.0 million, and net proceeds of approximately $122.9 million, net of commissions and fees, prior to its termination.
On August 2, 2017, we entered into another equity distribution agreement (the "August 2017 Equity Distribution Agreement") with two sales agents pursuant to which we may offer and sell, from time to time, up to an aggregate amount of $125,000,000 of shares of our common stock in transactions that are deemed to be "at the market" offerings and privately negotiated transactions. The August 2017 Equity Distribution Agreement replaced the May 2017 Equity Distribution Agreement. Through September 30, 2018, we issued a total of 7,746,052 shares under the August 2017 Equity Distribution Agreement for aggregate gross proceeds of $76.0 million, and net proceeds of approximately $74.7 million, net of commissions and fees.
Outlook
The economy of the United States grew by over 4% during the second quarter of 2018 and likely grew by 3% or more during the third quarter. Economic growth that handily exceeds what most economists estimate as the sustainable growth rate of the economy may generate price pressure in the economy. Inflation, running below the target level of the Federal Reserve (the "Fed") for most of the past several years, reached the Fed's 2% target level during the third quarter. On October 5, 2018, the Bureau of Labor Statistics reported the U3 unemployment rate reached 3.7% in September, the lowest level since December 1969. The unemployment rate appears to be headed lower given the strength of job gains year to date.
During the second quarter, the interest rate and equity markets appeared to be driven by external factors more than the performance of the economy. The specter of a trade war, or wars, with our various trading partners was a constant source of concern to market participants. The Trump administration did not appear to be making any progress with our trading partners even as it announced new tariffs on several occasions. A regime change in Italy also impacted the markets as a new threat to the stability of the European Union appeared to emerge. The new Italian government coalition threatened to leave the European Union and bring back the Lire during the campaign leading up to its victory in late May. The economic data reported over the course of the second quarter was consistently strong, but the markets reacted more to these external factors. This changed during the third quarter. Several factors led to this change.
The Trump administration finally had a breakthrough on the trade front when it reached an agreement in principle with Mexico. By the end of September, the Trump administration also reached an agreement with Canada, thus averting the demise of NAFTA that was widely feared. The new agreement, the United States Mexico Canada Agreement, or "USMCA" as it will be called, will now move through the ratification process over the next six months or so. These developments seemed to calm the markets and demonstrate that the Trump administration could reach agreements with our trading partners. Tensions with China over trade have not subsided and new tariffs were implemented during the quarter. However, the tariffs were set at 10%, versus the 25% level the market feared, and will not go into effect until January 2019. The tariffs on $50 billion of goods imported from China each year threatened by the Trump administration earlier this year did go into effect during the quarter, but the impact of these tariffs is not expected to be material.
Developments in Italy are on-going, but the threat of Italy leaving the European Union appears to be gone for now. What remains to be resolved is Italy's compliance, or lack thereof, with the various budget and deficit guidelines of the European Union and European Central Bank. There is also the threat of a ratings downgrade later this month, a potential source of an adverse market reaction.
The difference between the second quarter and the third is the market now takes its direction from the economy versus the external developments described above. The trade wars are not perceived to be the threat they once were, or their effect will likely be less than feared. Developments in Italy are not as bad as feared. Finally, the economy continued to appear very strong in the third quarter, and the Fed has acknowledged as much through its public comments. On September 7, 2018, the Bureau of Labor Statistics released the August employment data, and the average hourly earnings number exceeded market expectations and triggered a sell-off in the rates market. The ten-year U.S Treasury note rates eventually broke out of the trading range in place since late May of 2.80% - 3.00% and began moving steadily higher. In fact, the 10-year U.S. Treasury rate closed higher 22 times during the 30-day period from August 24, 2018 through October 5, 2018. This was the first time that the 10-year U.S Treasury rate increased this many times in a 30-day period since 1984, when rates were close to 14%. These increases caused the yield on the 10-year U.S. Treasury rate to increase by over 40 basis points in just 30 days, setting a new year-to-date high yield, as did the 30-year U.S. Treasury (increasing 42 basis points during the same period). In fact, many short-term U.S. Treasury rates are at their highest level since the financial crisis began.
At its quarterly meeting that concluded on September 26, 2018, the Fed acknowledged the economy was strong and the summary of economic projections reflected their optimism. The so-called "dot plot", or summary of committee member forecasts for the Federal Funds rate, reflected expectations for one more rate hike in 2018, three in 2019 and possibly one more hike in 2020.
The Agency RMBS market was impacted by several factors during the quarter. The performance drivers were the movement in interest rates, the continued decline in the Fed's reinvestments of its monthly pay-downs – which hit its cap in mid-October, and the relative attractiveness of the asset class. As interest rates moved steadily higher starting in late August, prepayment expectations were not materially affected. This is because refinancing activity had already been on a steady decline and the MBA's refinance index was at multi-year lows. As the cap on the Fed's reinvestment of its pay-downs hit in mid-October, which limits re-investments of monthly pay-downs only to the extent they exceed $20 billion per month, an important source of demand for the Agency RMBS asset class is essentially gone. However, the rise in rates over the course of the period, and in fact the last two years, mitigated this problem as the supply of Agency RMBS declined. The third driver of performance was the attractiveness of the asset class on a relative return basis with other asset classes. However, recent production of Agency RMBS has frequently had characteristics that negatively impact the anticipated total returns of the securities. In this case the spread between the weighted average coupon of the underlying mortgage loans and the net rate received by the investor is quite high. This leads to higher prepayment activity for the given coupon versus more typical spreads. Also, average loan balances appear higher than what market participants are accustomed to and average FICO scores are higher as well. All three of these factors tend to increase prepayment expectations and negatively impact expected returns for the securities. This has negatively impacted the relative attractiveness of the Agency RMBS asset class and has manifested itself in the relative performance versus investment and sub-investment grade corporate securities, various non-Agency RMBS, commercial mortgage backed securities and asset-backed securities. The spread of the 30-year, current coupon Agency RMBS has traded between 70 and 74 basis points above the 10-year U.S. Treasury during the quarter but has traded as high as 78 basis points in October. For the quarter the Bloomberg Agency MBS index had a slightly negative return of -0.12%, a year-to-date return through the end of the third quarter of -1.07% and a negative -0.52% return so far in the fourth quarter. When interest rates broke through previous year-to-date high levels in early October, Agency RMBS performed poorly as investors feared the duration extension of the securities and sold them, a phenomenon referred to as convexity related selling.
Recent Regulatory Developments
On January 12, 2016, the FHFA issued RIN 2590-AA39, Members of Federal Home Loan Banks (the "Final Rule"). The Final Rule, among other things, expressly excludes captive insurance companies, such as our wholly-owned captive insurance subsidiary, Orchid Island Casualty, LLC ("Orchid Island Casualty"), from being eligible for membership in the Federal Home Loan Bank ("FHLB") system. Under the Final Rule, there was a one-year transition period from the effective date of February 19, 2016 within which the FHLBs were required to wind down their relationships with any captive insurance companies that had been admitted to membership on or after September 12, 2014, including Orchid Island Casualty ("Post-NPR Captives"). The Final Rule also precludes the FHLBs from making any new advances or extending existing advances to Post-NPR Captives. In addition, upon the termination of membership, the FHLBs were required to liquidate all outstanding advances to Post-NPR Captives, settle all other business transactions, and repurchase or redeem all FHLB stock held by the terminated Post-NPR Captive in accordance with the Final Rule. Therefore, Orchid Island Casualty, along with all other Post-NPR Captives, was required to completely wind down all business relationships with the FHLB, including the repayment of all outstanding advances, prior to or simultaneously with the termination of Orchid Island Casualty's membership with the FHLB.
The adopting release for the Final Rule expressly invited Congress to address the treatment of Post-NPR Captives with respect to membership in the FHLB. In October 2015, Reps. Blaine Luetkemeyer (R-Mo.), Denny Heck (D-Wash.), Patrick McHenry (R-N.C.) and John Carney (D-Del.) introduced H.R. 3808, a bill that would have preemptively prevented the FHFA from adopting the Final Rule in such a way that would foreclose membership in the FHLB to captive insurance companies. There can be no way of predicting if any subsequent legislation addressing the status of Post-NPR Captives with respect to the FHLB will be proposed in either house of Congress, the likelihood of passage of any such legislation, and the ultimate effects, if any, on the availability of short-term, low-cost funding provided by the FHLBs to Post-NPR Captives subsequent to the enactment of any such legislation.
The scope and nature of the actions the U.S. government or the Fed will ultimately undertake are unknown and will continue to evolve. Although the Trump administration has made statements of its intentions to reform housing finance and tax policy, many of these potential policy changes will require congressional action. In addition, the Fed has made statements regarding additional increases to the Federal Funds Rate in 2018 and beyond.
In September 2017, the FOMC announced that it would implement a balance sheet normalization policy by gradually decreasing the Fed's reinvestment of U.S. Treasuries and Agency RMBS. More specifically, principal payments received by the Fed will be reinvested only to the extent they exceed gradually rising caps until the FOMC determines that the Fed is holding no more securities than necessary to implement monetary policy efficiently and effectively. In October 2017, the FOMC commenced this balance sheet normalization program. In October of 2018, the Fed reached its terminal cap of $20 billion per month. Going forward, the Fed will only purchase Agency RMBS to the extent paydowns on the Fed's holdings exceed $20 billion in any given month.
On January 30, 2018, legislation was introduced in the United States Senate that would permit captive insurance companies that were FHLB members prior to January 19, 2016 to restore or continue their membership in the FHLB. In June 2017, legislation was introduced in the United States House of Representatives that would permit a captive insurance company that was admitted to the FHLB prior to September 12, 2014 to continue its membership in the FHLB. The Company joined the FHLBC after September 12, 2014, so the House version of the legislation would not permit the Company to rejoin the FHLBC. It is still uncertain whether legislation on FHLB membership will be adopted, and if so, whether it would permit us to rejoin the FHLB.
Effect on Us
Regulatory developments, movements in interest rates and prepayment rates affect us in many ways, including the following:
Effects on our Assets
A change in or elimination of the guarantee structure of Agency RMBS may increase our costs (if, for example, guarantee fees increase) or require us to change our investment strategy altogether. For example, the elimination of the guarantee structure of Agency RMBS may cause us to change our investment strategy to focus on non-Agency RMBS, which in turn would require us to significantly increase our monitoring of the credit risks of our investments in addition to interest rate and prepayment risks.
Lower long-term interest rates can affect the value of our Agency RMBS in a number of ways. If prepayment rates are relatively low (due, in part, to the refinancing problems described above), lower long-term interest rates can increase the value of higher-coupon Agency RMBS. This is because investors typically place a premium on assets with yields that are higher than market yields. Although lower long-term interest rates may increase asset values in our portfolio, we may not be able to invest new funds in similarly-yielding assets.
If prepayment levels increase, the value of our Agency RMBS affected by such prepayments may decline. This is because a principal prepayment accelerates the effective term of an Agency RMBS, which would shorten the period during which an investor would receive above-market returns (assuming the yield on the prepaid asset is higher than market yields). Also, prepayment proceeds may not be able to be reinvested in similar-yielding assets. Agency RMBS backed by mortgages with high interest rates are more susceptible to prepayment risk because holders of those mortgages are most likely to refinance to a lower rate. IOs and IIOs, however, may be the types of Agency RMBS most sensitive to increased prepayment rates. Because the holder of an IO or IIO receives no principal payments, the values of IOs and IIOs are entirely dependent on the existence of a principal balance on the underlying mortgages. If the principal balance is eliminated due to prepayment, IOs and IIOs essentially become worthless. Although increased prepayment rates can negatively affect the value of our IOs and IIOs, they have the opposite effect on POs. Because POs act like zero-coupon bonds, meaning they are purchased at a discount to their par value and have an effective interest rate based on the discount and the term of the underlying loan, an increase in prepayment rates would reduce the effective term of our POs and accelerate the yields earned on those assets, which would increase our net income.
Higher long-term rates can also affect the value of our Agency RMBS. As long-term rates rise, rates available to borrowers also rise. This tends to cause prepayment activity to slow and extend the expected average life of mortgage cash flows. As the expected average life of the mortgage cash flows increases, coupled with higher discount rates, the value of Agency RMBS declines. Some of the instruments the Company uses to hedge our Agency RMBS assets, such as Euro Dollar futures, swaps, interest rate futures and swaptions, are stable average life instruments. This means that to the extent we use such instruments to hedge our Agency RMBS assets, our hedges may not adequately protect us from price declines, and therefore may negatively impact our book value. It is for this reason we use interest only securities in our portfolio. As interest rates rise, the expected average life of these securities increases, causing generally positive price movements as the number and size of the cash flows increase the longer the underlying mortgages remain outstanding. This makes interest only securities desirable hedge instruments for pass-through Agency RMBS.
As the economy has rebounded from the financial crisis, the Fed has taken steps to remove the considerable accommodation that was employed to combat the crisis. At the conclusion of its meeting in September 2017, the Fed announced it would implement caps on the amount of Agency RMBS assets it would allow to run off, or not be re-invested, starting in October 2017. Previously the Fed would re-invest all of the principal repayments it received each month on the Agency RMBS assets it had acquired during its quantitative easing programs. By capping the amount they would allow to run off each month, the Fed was effectively limiting the amount it would re-invest. Per the Fed's September 2017 announcement, the cap reached $20 billion per month in October of 2018. At the time of the Fed's announcement in September 2017, its monthly re-investments were approximately $20 billion per month as well, so this implied the Fed would stop, or nearly stop, re-investing its monthly pay-downs beyond October of 2018. The purchases each month by the Fed have been a significant source of demand in the Agency RMBS market and as it is reduced slowly over the course of 2018 and essentially eliminated beyond October of 2018, the removal of this source of demand could negatively impact Agency RMBS prices. The extent this negatively impacts the Agency RMBS market will be a function of the level of supply each month – as the supply/demand balance affects the price of any asset – and whether or not another source of demand emerges to replace the Fed.
Because we base our investment decisions on risk management principles rather than anticipated movements in interest rates, in a volatile interest rate environment we may allocate more capital to structured Agency RMBS with shorter durations, such as short-term fixed and floating rate CMOs. We believe these securities have a lower sensitivity to changes in long-term interest rates than other asset classes. We may attempt to mitigate our exposure to changes in long-term interest rates by investing in IOs and IIOs, which typically have different sensitivities to changes in long-term interest rates than PT RMBS, particularly PT RMBS backed by fixed-rate mortgages.
If Fannie Mae and Freddie Mac were to modify or end their repurchase programs, our investment portfolio could be negatively impacted.
Effects on our borrowing costs
We leverage our PT RMBS portfolio and a portion of our structured Agency RMBS with principal balances through the use of short-term repurchase agreement transactions. The interest rates on our debt are determined by market levels of both the Federal Funds Rate and LIBOR. An increase in the Federal Funds Rate or LIBOR would increase our borrowing costs, which could affect our interest rate spread if there is no corresponding increase in the interest we earn on our assets. This would be most prevalent with respect to our Agency RMBS backed by fixed rate mortgage loans because the interest rate on a fixed-rate mortgage loan does not change even though market rates may change.
In order to protect our net interest margin against increases in short-term interest rates, we may enter into interest rate swaps, which effectively convert our floating-rate repurchase agreement debt to fixed-rate debt, or utilize other hedging instruments such as Eurodollar and T-Note futures contracts or interest rate swaptions.
Summary
By most estimates the U.S. economy had fully recovered from the financial crisis of 2008 when the Trump administration passed the Tax Cuts and Jobs Act of 2017 and the Bipartisan Budget Act of 2018, which added a significant source of fiscal stimulation to the economy. As expected, growth has accelerated, reaching 4% annualized in the second quarter of 2018 and likely over 3% in the third quarter. The economic data has in many cases reached multi-year or, in some cases, multi-decade levels. The economy appears to have considerable momentum as it enters the fourth quarter. Up until the third quarter, it appeared the markets had a muted reaction to these developments, being driven by external factors like the threat of a trade war escalation and/or developments in Italy and various emerging markets. During the third quarter, the Trump administration finally had a break-through on the trade front and is close to finalizing a revised NAFTA agreement with Mexico and Canada, to be named the USMCA. The markets took this as a sign that the Trump administration was capable of agreements with its major trading partners and the threat of a material trade war disrupting the domestic economy faded. The Fed raised the Federal Funds rate at its September meeting and indicated it expects to continue its gradual pace of rate hikes into 2020.
The Agency RMBS market generated a slight negative return of - 0.12% as interest rates increased significantly during the third quarter of 2018. Year-to-date through the end of the third quarter of 2018, the Agency RMBS market has generated a -1.07% return. The returns in the preceding sentences are as reported by the Bloomberg Agency MBS index. Given the extent by which interest rates had risen through the end of the third quarter, this was a commendable performance. However, when interest rates broke through previous year-to-date high levels in early October, Agency RMBS performed poorly as investors feared the duration extension of the securities and sold them, a phenomenon often referred to as convexity related selling. The return of the Bloomberg Agency MBS index in the fourth quarter to date is -0.52.
For the past several years, a significant source of demand for Agency RMBS, the Fed, through reinvestment of its monthly pay-downs, essentially exited the market starting mid-October. Going forward, the relative performance of the asset class will be driven by demand from banks and money managers, historically core investors in the asset class, and the relative attractiveness of the asset class.
Critical Accounting Policies
Our condensed consolidated financial statements are prepared in accordance with GAAP. GAAP requires our management to make some complex and subjective decisions and assessments. Our most critical accounting policies involve decisions and assessments which could significantly affect reported assets, liabilities, revenues and expenses. There have been no changes to our critical accounting policies as discussed in our annual report on Form 10-K for the year ended December 31, 2017.
Capital Expenditures
At September 30, 2018, we had no material commitments for capital expenditures.
Off-Balance Sheet Arrangements
At September 30, 2018, we did not have any off-balance sheet arrangements.
Dividends
In addition to other requirements that must be satisfied to qualify as a REIT, we must pay annual dividends to our stockholders of at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gains. REIT taxable income (loss) is computed in accordance with the Code, and can be greater than or less than our financial statement net income (loss) computed in accordance with GAAP. These book to tax differences primarily relate to the recognition of interest income on RMBS, unrealized gains and losses on RMBS, and the amortization of losses on derivative instruments that are treated as funding hedges for tax purposes.
We intend to pay regular monthly dividends to our stockholders and have declared the following dividends since the completion of our IPO.
(in thousands, except per share amounts)
|
|
Year
|
|
Per Share Amount
|
|
|
Total
|
|
2013
|
|
$
|
1.395
|
|
|
$
|
4,662
|
|
2014
|
|
|
2.160
|
|
|
|
22,643
|
|
2015
|
|
|
1.920
|
|
|
|
38,748
|
|
2016
|
|
|
1.680
|
|
|
|
41,388
|
|
2017
|
|
|
1.680
|
|
|
|
70,717
|
|
2018 - YTD
(1)
|
|
|
0.910
|
|
|
|
47,817
|
|
Totals
|
|
$
|
9.745
|
|
|
$
|
225,975
|
|
(1)
|
On October 17, 2018, the Company declared a dividend of $0.08 per share to be paid on November 9, 2018. The effect of this dividend is included in the table above but is not reflected in the Company's financial statements as of September 30, 2018.
|
Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our consolidated financial statements are prepared in accordance with GAAP and our distributions will be determined by our Board of Directors consistent with our obligation to distribute to our stockholders at least 90% of our REIT taxable income on an annual basis in order to maintain our REIT qualification; in each case, our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation.
Jumpstart Our Business Startups Act of 2012
We are an "emerging growth company" as defined in the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"). The JOBS Act permits emerging growth companies to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We have elected to "opt out" of this provision and, as a result, we will be required to comply with new or revised accounting standards as required when they are adopted. The decision to opt out of the extended transition period under the JOBS Act is irrevocable.
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 and counterparty credit 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, ability to realize gains from the sale of these assets and ability to borrow
,
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 futures contracts and options to enter into interest rate swaps. These instruments are intended to serve as a hedge against future interest rate increases on our repurchase agreement borrowings. Hedging techniques are partly based on assumed levels of prepayments of our Agency RMBS. If prepayments are slower or faster than assumed, the life of the Agency RMBS will be longer or shorter, which would reduce the effectiveness of any hedging strategies we may use and may cause losses on such transactions. Hedging strategies involving the use of derivative securities are highly complex and may produce volatile returns. Hedging techniques are also limited by the rules relating to REIT qualification. In order to preserve our REIT status, we may be forced to terminate a hedging transaction at a time when the transaction is most needed.
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 the forward yield curve.
Our portfolio of PT RMBS is typically comprised of adjustable-rate RMBS ("ARMs"), fixed-rate RMBS and hybrid adjustable-rate RMBS. We generally seek to acquire low duration assets that offer high levels of protection from mortgage prepayments provided they are reasonably priced by the market. Although the duration of an individual asset can change as a result of changes in interest rates, we strive to maintain a hedged PT RMBS portfolio with an effective duration of less than 2.0. The stated contractual final maturity of the mortgage loans underlying our portfolio of PT RMBS generally ranges up to 30 years. However, the effect of prepayments of the underlying mortgage loans tends to shorten the resulting cash flows from our investments substantially. Prepayments occur for various reasons, including refinancing of underlying mortgages and loan payoffs in connection with home sales.
The duration of our IO and IIO portfolios will vary greatly depending on the structural features of the securities. While prepayment activity will always affect the cash flows associated with the securities, the interest only nature of IOs may cause their durations to become extremely negative when prepayments are high, and less negative when prepayments are low. Prepayments affect the durations of IIOs similarly, but the floating rate nature of the coupon of IIOs (which is inversely related to the level of one month LIBOR) causes their price movements, and model duration, to be affected by changes in both prepayments and one month LIBOR, both current and anticipated levels. As a result, the duration of IIO securities will also vary greatly.
Prepayments on the loans underlying our RMBS can alter the timing of the cash flows from the underlying loans to us. As a result, we gauge the interest rate sensitivity of our assets by measuring their effective duration. While modified duration measures the price sensitivity of a bond to movements in interest rates, effective duration captures both the movement in interest rates and the fact that cash flows to a mortgage related security are altered when interest rates move. Accordingly, when the contract interest rate on a mortgage loan is substantially above prevailing interest rates in the market, the effective duration of securities collateralized by such loans can be quite low because of expected prepayments.
We face the risk that the market value of our PT RMBS assets will increase or decrease at different rates than that of our structured RMBS or liabilities, including our hedging instruments. Accordingly, we assess our interest rate risk by estimating the duration of our assets and the duration of our liabilities. We generally calculate duration using various third party models. However, empirical results and various third party models may produce different duration numbers for the same securities.
The following sensitivity analysis shows the estimated impact on the fair value of our interest rate-sensitive investments and hedge positions as of September 30, 2018 and December 31, 2017, assuming rates instantaneously fall 200 bps, fall 100 bps, fall 50 bps, rise 50 bps, rise 100 bps and rise 200 bps, adjusted to reflect the impact of convexity, which is the measure of the sensitivity of our hedge positions and Agency RMBS' effective duration to movements in interest rates.
All changes in value in the table below are measured as percentage changes from the investment 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, 2018 and December 31, 2017. We apply a floor of 0% for the down rate scenarios on our interest bearing liabilities and hedge positions, 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 securities as a part of our overall management of our investment portfolio.
Interest Rate Sensitivity
(1)
|
|
|
|
Portfolio
|
|
|
|
|
|
|
Market
|
|
|
Book
|
|
Change in Interest Rate
|
|
Value
(2)(3)
|
|
|
Value
(2)(4)
|
|
As of September 30, 2018
|
|
|
|
|
|
|
-200 Basis Points
|
|
|
(1.65
|
)%
|
|
|
(14.73
|
)%
|
-100 Basis Points
|
|
|
(0.42
|
)%
|
|
|
(3.75
|
)%
|
-50 Basis Points
|
|
|
(0.03
|
)%
|
|
|
(0.24
|
)%
|
+50 Basis Points
|
|
|
0.04
|
%
|
|
|
0.34
|
%
|
+100 Basis Points
|
|
|
(0.06
|
)%
|
|
|
(0.51
|
)%
|
+200 Basis Points
|
|
|
(0.96
|
)%
|
|
|
(8.57
|
)%
|
As of December 31, 2017
|
|
|
|
|
|
|
|
|
-200 Basis Points
|
|
|
(0.94
|
)%
|
|
|
(7.62
|
)%
|
-100 Basis Points
|
|
|
(0.32
|
)%
|
|
|
(2.63
|
)%
|
-50 Basis Points
|
|
|
(0.21
|
)%
|
|
|
(1.73
|
)%
|
+50 Basis Points
|
|
|
(0.59
|
)%
|
|
|
(4.82
|
)%
|
+100 Basis Points
|
|
|
(1.61
|
)%
|
|
|
(13.05
|
)%
|
+200 Basis Points
|
|
|
(4.67
|
)%
|
|
|
(37.84
|
)%
|
(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, and assumes there are no changes in mortgage spreads and assumes a static portfolio. Actual results could differ materially from these estimates.
|
(2)
|
Includes the effect of derivatives and other securities used for hedging purposes.
|
(3)
|
Estimated dollar change in investment portfolio value expressed as a percent of the total fair value of our investment portfolio as of such date.
|
(4)
|
Estimated dollar change in portfolio value expressed as a percent of stockholders' equity as of such date.
|
In addition to changes in interest rates, other factors impact the fair value of our interest rate-sensitive investments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, in the event of changes in actual interest rates, the change in the fair value of our assets would likely differ from that shown above and such difference might be material and adverse to our stockholders.
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 government sponsored entity underwriting practices or other governmental programs could also significantly impact prepayment rates or expectations. 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.
Spread Risk
When the market spread widens between the yield on our Agency RMBS and benchmark interest rates, our net book value could decline if the value of our Agency RMBS falls by more than the offsetting fair value increases on our hedging instruments tied to the underlying benchmark interest rates. We refer to this as "spread risk" or "basis risk." The spread risk associated with our mortgage assets 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 futures contracts and interest rate swaps and swaptions to attempt to protect against moves in interest rates, such instruments typically will not protect our net book value against spread risk.
Liquidity Risk
The primary liquidity risk for us arises from financing long-term assets with shorter-term borrowings through repurchase agreements. Our assets that are pledged to secure repurchase agreements are Agency RMBS and cash. As of September 30, 2018, we had unrestricted cash and cash equivalents of $164.4 million and unpledged securities of approximately $15.2 million (not including securities pledged to us) available to meet margin calls on our repurchase agreements and derivative contracts, and for other corporate purposes. However, should the value of our Agency RMBS 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 against repurchase agreements, thereby reducing the amount that can be borrowed against an asset 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.
Extension Risk
The projected weighted average life and the duration (or interest rate sensitivity) of our investments is based on our Manager's assumptions regarding the rate at which the borrowers will prepay the underlying mortgage loans. In general, we use futures contracts and interest rate swaps and swaptions to help manage our funding cost on our investments in the event that interest rates rise. These hedging instruments allow us to reduce our funding exposure on the notional amount of the instrument for a specified period of time.
However, if prepayment rates decrease in a rising interest rate environment, the average life or duration of our fixed-rate assets or the fixed-rate portion of the ARMs or other assets generally extends. This could have a negative impact on our results from operations, as our hedging instrument expirations 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 agency securities collateralized by fixed rate mortgages or hybrid ARMs to decline by more than otherwise would be the case, while most of our 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.
Counterparty Credit Risk
We are exposed to counterparty credit risk relating to potential losses that could be recognized in the event that the counterparties to our repurchase agreements and derivative contracts fail to perform their obligations under such agreements. The amount of assets we pledge as collateral in accordance with our agreements varies over time based on the market value and notional amount of such assets as well as the value of our derivative contracts. In the event of a default by a counterparty, we may not receive payments provided for under the terms of our agreements and may have difficulty obtaining our assets pledged as collateral under such agreements. 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. However, there is no guarantee our efforts to manage counterparty credit risk will be successful and we could suffer significant losses if unsuccessful.