Edgar Filing: Invesco Mortgage Capital Inc.

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FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 001-34385

INVESCO MORTGAGE CAPITAL INC.

(Exact Name of Registrant as Specified in Its Charter)


Maryland		26-2749336
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

1555 Peachtree Street, N.E., Suite 1800 Atlanta, Georgia		30309
(Address of Principal Executive Offices)		(Zip Code)

(404) 892-0896

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of May 8, 2013, there were 135,210,824 outstanding shares of common stock of Invesco Mortgage Capital Inc.

INVESCO MORTGAGE CAPITAL INC.

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		Page

PART I FINANCIAL INFORMATION			1

Item 1.	Consolidated Financial Statements		1

	Consolidated Balance Sheets as of March 31, 2013 (unaudited) and December 31, 2012		1

	Unaudited Consolidated Statements of Operations for the three months ended March 31, 2013 and 2012		2

	Unaudited Consolidated Statement of Comprehensive Income (Loss) for the three months ended March 31, 2013 and 2012		3

	Unaudited Consolidated Statement of Equity for the three months ended March 31, 2013		4

	Unaudited Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and 2012		5

	Notes to Consolidated Financial Statements		6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		31

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		49

Item 4.	Controls and Procedures		51

PART II OTHER INFORMATION			52

Item 1.	Legal Proceedings		52

Item 1A.	Risk Factors		52

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		52

Item 3.	Defaults Upon Senior Securities		52

Item 4.	Mine Safety Disclosures		52

Item 5.	Other Information		52

Item 6.	Exhibits		54

PART I

ITEM 1. FINANCIAL STATEMENTS

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS


$ in thousands, except per share amounts	As of
	March 31, 2013		December 31, 2012
	(Unaudited)
ASSETS

Mortgage-backed securities, at fair value		21,248,432		18,470,563
Residential loans, held-for-investment		405,541		—
Cash and cash equivalents		274,538		286,474
Investment related receivable		34,155		41,429
Investments in unconsolidated ventures, at fair value		35,456		35,301
Accrued interest receivable		72,863		62,977
Derivative assets, at fair value		8,026		6,469
Deferred securitization and financing costs		13,464		—
Other investments		10,000		10,000
Other assets		1,482		1,547

Total assets (1)		22,103,957		18,914,760


LIABILITIES AND EQUITY
Liabilities:
Repurchase agreements		17,873,256		15,720,460
Asset-backed securities issued		374,196		—
Exchangeable senior notes		400,000		—
Derivative liability, at fair value		420,439		436,440
Dividends and distributions payable		91,049		79,165
Investment related payable		305		63,715
Accrued interest payable		17,189		15,275
Accounts payable and accrued expenses		1,109		877
Due to affiliate		10,956		9,308

Total liabilities (1)		19,188,499		16,325,240


Equity:
Preferred Stock: par value $0.01 per share; 50,000,000 shares authorized, 7.75% series A cumulative redeemable, $25 liquidation preference, 5,600,000 issued and outstanding at March 31, 2013 and December 31, 2012, respectively		135,356		135,362
Common Stock: par value $0.01 per share; 450,000,000 shares authorized, 134,477,190 and 116,195,500 shares issued and outstanding, at March 31, 2013 and December 31, 2012, respectively		1,345		1,162
Additional paid in capital		2,697,177		2,316,290
Accumulated other comprehensive income		35,248		86,436
Retained earnings		15,430		18,848

Total shareholders’ equity		2,884,556		2,558,098
Non-controlling interest		30,902		31,422

Total equity		2,915,458		2,589,520


Total liabilities and equity		22,103,957		18,914,760

(1)

Our consolidated balance sheets include assets of a consolidated variable interest entity (‘VIE’) that can only be used to settle obligations of this VIE and liabilities of the VIE for which creditors do not have recourse to the primary beneficiary (IAS Asset I LLC, an indirect subsidiary of Invesco Mortgage Capital, Inc.). At March 31, 2013 and December 31, 2012 assets of the consolidated VIE totaled $408,291 and $0 respectively, and liabilities of the consolidated VIE totaled $375,261 and $0 respectively. See Note 3 for further discussion.

The accompanying notes are an integral part of these consolidated financial statements.

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three Months Ended March 31,
$ in thousands, except per share data	2013			2012

Interest Income
Mortgage-backed securities		160,344			141,960
Residential loans		137			—

Total interest income		160,481			141,960

Interest Expense
Repurchase agreements		66,328			55,285
Exchangeable senior note		1,160			—
Asset-back securities issued		79			—

Total interest expense		67,567			55,285

Net interest income		92,914			86,675


Other Income
Gain on sale of investments		6,712			6,045
Equity in earnings and fair value change in unconsolidated ventures		1,590			1,009
Unrealized loss on interest rate swaps and swaptions		(2,003	)		(509	)
Realized and unrealized credit default swap income		351			657

Total other income		6,650			7,202


Expenses
Management fee – related party		10,354			8,639
General and administrative		1,543			1,130

Total Expenses		11,987			9,769

Net income		87,667			84,108

Net income attributable to non-controlling interest		962			1,026

Net income attributable to Invesco Mortgage Capital Inc.		86,705			83,082

Dividends to preferred shareholders		2,713			—

Net income attributable to common shareholders		83,992			83,082


Earnings per share:
Net income attributable to common shareholders
(basic)		0.65			0.72

(diluted)		0.64			0.72

Dividends declared per common share		0.65			0.65

The accompanying notes are an integral part of these consolidated financial statements.

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)


	Three Months Ended March 31,
$ in thousands, except per share data	2013			2012

Net income		87,667			84,108

Other comprehensive income (loss)
Unrealized gain (loss) on mortgage-back securities
Change in fair value		(55,124	)		205,904
Reclassification adjustments for (gains) loss included in gain on sale of investments		(15,012	)		3,169

Unrealized gain (loss) on mortgage-backed securities, net		(70,136	)		209,073
Unrealized gain (loss) on derivatives
Change in fair value		(17,171	)		(18,331	)
Reclassification adjustments for loss included in unrealized gain (loss) on interest swap and swaptions		35,562			35,420

Unrealized gains on derivatives, net		18,391			17,089
Other comprehensive income (loss)		(51,745	)		226,162

Comprehensive income		35,922			310,270
Less: Comprehensive loss attributable to non-controlling interest		(405	)		(3,784	)
Less: Dividends to preferred shareholders		(2,713	)		—

Comprehensive income attributable to common shareholders		32,804			306,486

The accompanying notes are an integral part of these consolidated statements.

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EQUITY

For the three months ended March 31, 2013

(Unaudited)


						Attributable to Common Shareholders
$ in thousands, except per share amounts	Preferred Stock					Common Stock				Additional Paid in Capital		Accumulated Other Comprehensive Income (loss)			Retained Earnings			Total Shareholders’ Equity			Non- Controlling Interest			Total Equity
$ in thousands, except per share amounts	Shares		Amount			Shares		Amount		Additional Paid in Capital		Accumulated Other Comprehensive Income (loss)			Retained Earnings			Total Shareholders’ Equity			Non- Controlling Interest			Total Equity
Balance at January 1, 2013		5,600,000		135,362			116,195,500		1,162		2,316,290		86,436			18,848			2,558,098			31,422			2,589,520

Net income		—		—			—		—		—		—			86,705			86,705			962			87,667
Other comprehensive loss		—		—			—		—		—		(51,188	)		—			(51,188	)		(557	)		(51,745	)
Proceeds from issuance of common stock, net of offering costs		—		—			18,274,223		183		380,789		—			—			380,972			—			380,972
Proceeds from issuance of preferred stock, net of offering costs		—		(6	)		—		—		—		—			—			(6	)		—			(6	)
Stock awards		—		—			7,467		—		—		—			—			—			—			—
Common stock dividends		—		—			—		—		—		—			(87,410	)		(87,410	)		—			(87,410	)
Common unit dividends		—		—			—		—		—		—			—			—			(926	)		(926	)
Preferred stock dividends		—		—			—		—		—		—			(2,713	)		(2,713	)		—			(2,713	)
Amortization of equity-based compensation		—		—			—		—		98		—			—			98			1			99

Balance at March 31, 2013		5,600,000		135,356			134,477,190		1,345		2,697,177		35,248			15,430			2,884,556			30,902			2,915,458

The accompanying notes are an integral part of this consolidated financial statement.

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


$ in thousands	Three Months Ended March 31,
	2013			2012
Cash Flows from Operating Activities
Net income		87,667			84,108
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of mortgage-backed securities premiums and discounts, net		46,173			25,402
Amortization of residential loan premiums		4			—
Unrealized loss on interest swap and swaptions		2,003			509
Unrealized loss on credit default swap		223			168
Gain on sale of mortgage-backed securities		(6,712	)		(6,045	)
Equity in earnings and fair value change in unconsolidated ventures		(1,590	)		(1,009	)
Amortization of equity-based compensation		99			77
Amortization of deferred securitization and financing costs		128			—
Changes in operating assets and liabilities:
Increase in accrued interest receivable		(9,886	)		(2,009	)
Decrease in other assets		14			150
Increase (decrease) in accrued interest payable		1,914			(293	)
Increase (decrease) in due to affiliate		1,444			(57	)
Increase in accounts payable and accrued expenses		122			281

Net cash provided by operating activities		121,603			101,282


Cash Flows from Investing Activities
Purchase of mortgage-backed securities		(4,671,035	)		(2,005,516	)
Distributions from investment in unconsolidated ventures, net		122			17,615
Principal payments from mortgage-backed securities		742,108			540,608
Investment related receivable		—			(274	)
Proceeds from sale of mortgage-backed securities		986,334			570,409
Payment of premiums for interest rate swaptions		(1,395	)		—
Purchase of residential loans		(405,262	)		—

Net cash used in investing activities		(3,349,128	)		(877,158	)


Cash Flows from Financing Activities
Proceeds from issuance of common stock		381,276			(36	)
Proceeds from issuance of preferred stock		(6	)		—
Restricted cash		—			57,082
Proceeds from repurchase agreements		48,870,103			33,933,342
Principal repayments of repurchase agreements		(46,717,307	)		(33,180,000	)
Proceeds from issuance of exchangeable senior notes		400,000			—
Proceeds from issuance of asset-backed-securities		374,218			—
Payments of deferred costs		(13,530	)		—
Payments of dividends and distributions		(79,165	)		(75,933	)

Net cash provided by financing activities		3,215,589			734,455


Net change in cash		(11,936	)		(41,421	)
Cash, beginning of period		286,474			197,224

Cash and cash equivalents, end of period		274,538			155,803


Supplement Disclosure of Cash Flow Information
Interest paid		65,546			55,577


Non-cash Investing and Financing Activities Information
Net change in unrealized gain on mortgage-backed securities and derivatives		(51,745	)		226,163

Net change in unconsolidated ventures		1,313			—

Net change in restricted cash		—			1,346

Dividends and distributions declared not paid		91,049			75,939

Payable for mortgage-backed securities purchased		(55,149	)		(279,399	)

The accompanying notes are an integral part of these consolidated financial statements.

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1 – Organization and Business Operations

Invesco Mortgage Capital Inc. (the “Company”) is a Maryland corporation focused on investing in, financing and managing residential and commercial mortgage-backed securities and mortgage loans. The Company invests in residential mortgage-backed securities (“RMBS”) for which a U.S. Government Agency such as the Government National Mortgage Association (“Ginnie Mae”), the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”) guarantees payments of principal and interest on the securities (collectively “Agency RMBS”). The Company’s Agency RMBS investments include mortgage pass-through securities and collateralized mortgage obligations (“CMOs”). The Company also invests in RMBS that are not issued or guaranteed by a U.S. government Agency (“non-Agency RMBS”), commercial mortgage-backed securities (“CMBS”), and residential and commercial mortgage loans. The Company is externally managed and advised by Invesco Advisers, Inc. (the “Manager”), a registered investment adviser and an indirect, wholly-owned subsidiary of Invesco Ltd. (“Invesco”), a global investment management company.

The Company conducts its business through IAS Operating Partnership LP (the “Operating Partnership”) as its sole general partner. As of March 31, 2013, the Company owned 99.0% of the Operating Partnership and Invesco Investments (Bermuda) Ltd., a direct, wholly-owned subsidiary of Invesco, owned the remaining 1.0%.

The Company finances its Agency RMBS, non-Agency RMBS and CMBS investments through short-term borrowings structured as repurchase agreements. The Company has secured commitments with a number of repurchase agreement counterparties. The Company finances its residential loans through the issuance of asset-backed securities. The Company has, in the past, contributed capital to the Invesco Mortgage Recovery Feeder Fund L.P. managed by the Company’s Manager (“Invesco IMRF Fund”) that received financing under the U.S. government’s Public Private Investment Program (“PPIP”). In March 2012, Invesco IMRF Fund returned substantially all of its proceeds and repaid all financing under the PPIP. The Company is awaiting final distribution from the Invesco IMRF Fund. In addition, the Company may use other sources of financing including committed borrowing facilities and other private financing.

The Company elected to be taxed as a real estate investment trust (“REIT”) for U.S. federal income tax purposes under the provisions of the Internal Revenue Code of 1986, as amended (“Code”), commencing with the Company’s taxable year ended December 31, 2009. To maintain the Company’s REIT qualification, the Company is generally required to distribute at least 90% of its taxable income to its shareholders annually.

Note 2 – Summary of Significant Accounting Policies

Basis of Quarterly Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, promulgated by the Securities and Exchange Commission (the “SEC”). In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial position and the results of operations of the Company for the interim periods presented have been included. Certain disclosures included in the Company’s annual report on Form 10-K are not required to be included on an interim basis in the company’s quarterly reports on Forms 10-Q. The Company has condensed or omitted these disclosures. The interim consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2012 which was filed with the SEC on March 1, 2013. The results of operations for the period ended March 31, 2013 are not necessarily indicative of the results to be expected for the full year or any other future period.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, its subsidiaries and a variable interest entity (“VIE”) in which the Company is the primary beneficiary. The underlying loans owned by the VIE are shown under residential loans on our consolidated balance sheet. The asset-backed securities (“ABS”) issued to third parties by the VIE are shown under asset-backed securities issued. In our consolidated statements of income, we record interest income on the residential loans owned by the VIE and interest expense on the ABS issued by the VIE. All intercompany balances and transactions have been eliminated.

Variable Interest Entity

A VIE is an entity that lacks one or more of the characteristics of a voting interest entity. A VIE is defined as an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. The determination of whether an entity is a VIE includes both a qualitative and quantitative analysis. The Company reassesses its initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events. The entity that consolidates a VIE is known as its primary beneficiary, and is generally the entity with (i) the power to direct the activities that most significantly impact the VIE’s economic performance, and (ii) the right to receive benefits from the VIE or the obligation to absorb losses of the VIE that could be significant to the VIE. For VIEs that do not have substantial ongoing activities, the power to direct the activities that most significantly impact the VIE’s economic performance may be determined by an entity’s involvement with the design of the VIE.

Use of Estimates

The accounting and reporting policies of the Company conform to U.S. GAAP. The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Examples of estimates include, but are not limited to, estimates of the fair values of financial instruments, interest income on mortgage-backed securities (“MBS”) and other-than-temporary impairment charges. Actual results may differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid investments that have original or remaining maturity dates of three months or less when purchased to be cash equivalents. At March 31, 2013, the Company had cash and cash equivalents, including amounts restricted, in excess of the FDIC deposit insurance limit of $250,000 per institution. The Company mitigates its risk of loss by actively monitoring the counterparties.

Restricted Cash

Restricted cash represents the Company’s cash held by its counterparties as collateral against the Company’s swaps and repurchase agreements. Restricted cash is not available for general corporate purposes but may be applied against amounts due to counterparties under the Company’s swap and repurchase agreements, or returned to the Company when the collateral requirements are exceeded or at the maturity of the swap or repurchase agreement.

Underwriting Commissions and Offering Costs

Underwriting commissions and direct costs incurred in connection with the Company’s initial public offering (“IPO”) and subsequent stock offerings are reflected as a reduction of additional paid-in-capital.

Deferred Costs

Included in deferred costs are costs associated with the issuance of beneficial interest by a consolidated VIE incurred by the Company and costs incurred in connection with the issuance of its exchangeable senior notes. These costs may include underwriting, rating agency, legal, accounting and other fees. These deferred costs are

amortized as an adjustment to interest expense using the effective interest method, based upon actual repayments of the associated beneficial interest issued to third parties and over the stated legal maturity of the exchangeable senior notes.

Repurchase Agreements

The Company finances its Agency RMBS, non-Agency RMBS and CMBS investment portfolio through the use of repurchase agreements. Repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, including accrued interest, as specified in the respective agreements.

In instances where the Company acquires Agency RMBS, non-Agency RMBS or CMBS through repurchase agreements with the same counterparty from whom such assets were purchased, the Company accounts for the purchase commitment and repurchase agreement on a net basis and records a forward commitment to purchase such assets as a derivative instrument if the transaction does not comply with the criteria for gross presentation. All of the following criteria must be met for gross presentation in the circumstance where the repurchase assets are financed with the same counterparty:

•

the initial transfer of and repurchase financing cannot be contractually contingent;

•

the repurchase financing entered into between the parties provides full recourse to the transferee and the repurchase price is fixed;

•

the financial asset has an active market and the transfer is executed at market rates; and

•

the repurchase agreement and financial asset do not mature simultaneously.

If the transaction complies with the criteria for gross presentation, the Company records the assets and the related financing on a gross basis on its consolidated balance sheet, and the corresponding interest income and interest expense in its statements of operations. Such forward commitments are recorded at fair value with subsequent changes in fair value recognized in income. Additionally, the Company records the cash portion of its investment in Agency RMBS and non-Agency RMBS as a mortgage related receivable from the counterparty on its consolidated balance sheet. See recent accounting pronouncements not yet adopted.

Asset-Backed Debt Securities

Asset-backed debt securities (“ABS”) are recorded at principal balance net of unamortized premiums or discounts.

Fair Value Measurements

The Company discloses the fair value of its financial instruments according to a fair value hierarchy (Levels 1, 2, and 3, as defined). In accordance with U.S. GAAP, the Company is required to provide enhanced disclosures regarding instruments in the Level 3 category (which require significant management judgment), including a separate reconciliation of the beginning and ending balances for each major category of assets and liabilities.

Additionally, U.S. GAAP permits entities to choose to measure many financial instruments and certain other items at fair value (the “fair value option”). Unrealized gains and losses on items for which the fair value option has been elected are irrevocably recognized in earnings at each subsequent reporting date.

The Company elected the fair value option for its investments in unconsolidated ventures. The Company has the one-time option to elect fair value for these financial assets on the election date. The changes in the fair value of these instruments are recorded in equity in earnings and fair value change in unconsolidated ventures in the consolidated statements of operations.

For assets representing available-for-sale investment securities any change in fair value is reported through consolidated other comprehensive income (loss) with the exception of impairment losses, which are recorded in the consolidated statement of operations.

Securities

The Company designates securities as held-to-maturity, available-for-sale, or trading depending on its ability and intent to hold such securities to maturity. Trading and securities available-for-sale are reported at fair value, while securities held-to-maturity are reported at amortized cost. Although the Company generally intends to hold most of its RMBS and CMBS until maturity, the Company may, from time to time, sell any of its RMBS or CMBS as part of its overall management of its investment portfolio and classifies its RMBS and CMBS as available-for-sale securities.

All securities classified as available-for-sale are reported at fair value, based on market prices from third-party sources, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity. When applicable, included with available-for-sale securities are forward purchase commitments on to-be-announced securities (“TBA”). The Company records TBA purchases on the trade date and the corresponding payable is recorded as an outstanding liability as a payable for investments purchased until the settlement date of the transaction. This payable is presented in the “Investment related payable” line item on the consolidated balance sheet.

The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. The determination of whether a security is other-than-temporarily impaired involves judgments and assumptions based on subjective and objective factors. Consideration is given to (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of recovery in fair value of the security, and (iii) the Company’s intent and ability to retain its investment in the security for a period of time sufficient to allow for any anticipated recovery in fair value.

For debt securities, the amount of the other-than-temporary impairment related to a credit loss or impairments on securities that the Company has the intent or for which it is more likely than not that the Company will need to sell before recovery are recognized in earnings and reflected as a reduction in the cost basis of the security. The amount of the other-than-temporary impairment on debt securities related to other factors is recorded consistent with changes in the fair value of all other available-for-sale securities as a component of consolidated shareholders’ equity in other comprehensive income or loss with no change to the cost basis of the security.

Residential Loans Held-For-Investment

Loans held-for-investment include securitized residential mortgage loans held by a VIE in which we hold a controlling interest and which is included in our consolidated balance sheets, and are carried at cost, net of unamortized premiums. The Company expects that it will be required to continue to consolidate the VIE in which such loans are held and generally does not have the authority to sell the residential loans held in the VIE. Loans held-for-sale are recorded in the consolidated balance sheet at the lower of their amortized cost adjusted for any allowance for loan losses or fair value. If the fair value of an individual loan or pool of loans held-for-sale is lower than its amortized cost basis, the difference is reported in earnings. An allowance for loan losses will be recognized only if past and current events indicate it is probable that all amounts due will not be collected according to the terms of the loan agreement.

Interest Income Recognition

Securities

Interest income on available-for-sale MBS, which includes accretion of discounts and amortization of premiums on such MBS, is recognized over the life of the investment using the effective interest method. Management estimates, at the time of purchase, the future expected cash flows and determines the effective interest rate based on these estimated cash flows and the Company’s purchase price. As needed, these estimated cash flows are updated and a revised yield is computed based on the current amortized cost of the investment. In estimating these cash flows, there are a number of assumptions that are subject to uncertainties and contingencies, including the rate and timing of principal payments (prepayments, repurchases, defaults and liquidations), the pass through or coupon rate and interest rate fluctuations. In addition, management must use its judgment to estimate interest payment shortfalls due to delinquencies on the underlying mortgage loans. These uncertainties and contingencies are difficult to predict and are subject to future events that may impact management’s estimates and its interest income. Security transactions are recorded on the trade date. Realized gains and losses from security transactions are determined based upon the specific identification method and recorded as gain (loss) on sale of available-for-sale securities in the consolidated statement of operations.

Residential Loans

Interest income from the Company’s residential loans is recognized on an accrual basis with the related premiums being amortized into interest income using the effective interest method over the weighted average life of these loans. As needed, these estimated cash flows are updated and a revised yield is computed based on the current amortized cost of the investment. In estimating these cash flows, there are a number of assumptions that are subject to estimation, including the interest rate and timing of principal payments (prepayments, repurchases, defaults and liquidations), the timing and amount of expected credit losses, and other factors. Coupon interest is recognized as revenue when earned and deemed collectible or until a loan becomes more than 90 days past due or has been individually impaired, at which point the loan is placed on nonaccrual status. Interest previously accrued for loans that have become greater than 90 days past due or individually impaired is reserved for in the allowance for loan losses. Residential loans delinquent more than 90 days or in foreclosure are characterized as delinquent. Cash principal and interest that is advanced from servicers subsequent to a loan becoming greater than 90 days past due or individually impaired is used to reduce the outstanding loan principal balance. When a delinquent loan previously placed on nonaccrual status has cured, meaning all delinquent principal and interest have been remitted by the borrower, the loan is placed back on accrual status. Alternately, nonaccrual loans may be placed back on accrual status if restructured and after the loan is considered re-performing. A restructured loan is considered re-performing when the loan has been current for at least 12 months.

Investments in Unconsolidated Ventures

The Company has investments in unconsolidated ventures. In circumstances where the Company has a non-controlling interest but is deemed to be able to exert significant influence over the affairs of the enterprise, the Company utilizes the equity method of accounting. Under the equity method of accounting, the initial investment is increased each period for additional capital contributions and a proportionate share of the entity’s earnings and decreased for cash distributions and a proportionate share of the entity’s losses.

The Company elected the fair value option for its investments in unconsolidated ventures. The election was made upon initial recognition in the financial statements. The Company has elected the fair value option for the purpose of enhancing the transparency of its financial condition. The Company measures the fair value on the basis of the net asset value per share of the investments.

Dividends and Distributions Payable

Dividends and distributions payable represent dividends declared at the consolidated balance sheet date which are payable to common shareholders, preferred shareholders and distributions declared at the consolidated balance sheet date which are payable to non-controlling interest common unit holders of the Operating Partnership, respectively.

Earnings per Share

The Company calculates basic earnings per share by dividing net income attributable to common shareholders for the period by weighted-average shares of the Company’s common stock outstanding for that period. Diluted earnings per share takes into account the effect of dilutive instruments, such as units of limited partnership interest in the Operating Partnership (“OP Units”), and unvested restricted stock, but use the average share price for the period in determining the number of incremental shares that are to be added to the weighted-average number of shares outstanding.

Comprehensive Income (Loss)

Comprehensive income (loss) is comprised of net income, as presented in the consolidated statements of operations, adjusted for changes in unrealized gains or losses on available for sale securities and changes in the fair value of derivatives accounted for as cash flow hedges.

Accounting for Derivative Financial Instruments

U.S. GAAP provides disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (i) how and why an entity uses derivative instruments; (ii) how derivative instruments and related hedged items are accounted for; and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. U.S. GAAP requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

The Company records all derivatives on the consolidated balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts, such as credit default swaps, that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting under U.S. GAAP.

Income Taxes

The Company elected to be taxed as a REIT, commencing with the Company’s taxable year ended December 31, 2009. Accordingly, the Company will generally not be subject to U.S. federal and applicable state and local corporate income tax to the extent that the Company makes qualifying distributions to its common shareholders, and provided the Company satisfies on a continuing basis, through actual investment and operating results, the REIT requirements including certain asset, income, distribution and stock ownership tests. If the Company fails to qualify as a REIT, and does not qualify for certain statutory relief provisions, it will be subject to U.S. federal, state and local income taxes and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year in which the Company lost its REIT qualification. Accordingly, the Company’s failure to qualify as a REIT could have a material adverse impact on its results of operations and amounts available for distribution to its shareholders.

A REIT’s dividend paid deduction for qualifying dividends to the Company’s shareholders is computed using its taxable income as opposed to net income reported on the consolidated financial statements. Taxable income, generally, will differ from net income because the determination of taxable income is based on tax regulations and not financial accounting principles.

The Company may elect to treat certain of its future subsidiaries as taxable REIT subsidiaries (“TRS”). In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate-related business. A TRS is subject to U.S. federal, state and local corporate income taxes.

If a TRS generates net income, the TRS can declare dividends to the Company which will be included in its taxable income and necessitate a distribution to its shareholders. Conversely, if the Company retains earnings at a

TRS level, no distribution is required and the Company can increase book equity of the consolidated entity. The Company has no adjustments regarding its tax accounting treatment of any uncertainties. The Company expects to recognize interest and penalties related to uncertain tax positions, if any, as income tax expense, which will be included in general and administrative expense.

Share-Based Compensation

The Company has adopted an equity incentive plan under which its independent directors, as part of their compensation for serving as directors, are eligible to receive quarterly restricted stock awards. In addition, the Company may compensate the officers and employees of the Manager and its affiliates under this plan pursuant to the management agreement.

Share-based compensation arrangements include share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Compensation costs relating to share-based payment transactions are recognized in the consolidated financial statements, based on the fair value of the equity or liability instruments issued on the date of grant, for awards to the Company’s independent directors. Compensation related to stock awards to officers and employees of the Manager and its affiliates are recorded at the estimated fair value of the award during the vesting period. The Company makes an upward or downward adjustment to compensation expense for the difference in the fair value at the date of grant and the date the award was earned.

Dividend Reinvestment Plan

The Company has implemented a dividend reinvestment and stock purchase plan (the “DRSPP”). Under the terms of the Plan, shareholders who participate in the Plan may purchase shares of common stock directly from the Company. Plan participants may also automatically reinvest all or a portion of their dividends for additional shares of common stock.

Reclassifications

The presentation of certain prior period reported amounts has been reclassified to be consistent with the current presentation. Such reclassifications had no impact on net income or equity attributable to common shareholders.

Recent Accounting Pronouncements

In January 2013, the FASB issued Accounting Standard Update 2013-01, “Clarifying the Scope of Disclosure about Offsetting Assets and Liabilities” (“ASU 2013-01”). ASU 2013-01 Clarified Accounting Standard Update 2011-11, “Disclosures about Offsetting Assets and Liabilities” which was issued in December 2011. Entities will be required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transaction subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on a basis of US GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards (IFRS). The guidance was effective for periods beginning on or after January 1, 2013, and interim periods within those annual periods. Refer to Note 9 – “Offsetting Assets and Liabilities”.

In February 2013, the FASB issued Accounting Standards Update 2013-02, “Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income” (“ASU 2013-02”), which adds new disclosure requirements for items reclassified out of accumulated other comprehensive income. ASU 2013-02 does not amend any existing requirements for reporting net income or other comprehensive income in the financial statements and is effective prospectively for reporting periods beginning after December 15, 2012. ASU 2013-02 increased our disclosures related to items reclassified out of accumulated other comprehensive income, but did not have an significant effect on our consolidated financial statements.

Recent Accounting Pronouncements Not Yet Adopted

None.

Note 3 – Variable Interest Entity

During March 2013, we purchased through our indirect subsidiary a controlling interest in a securitization trust which we determined to be a VIE. The VIE holds a pool of 488 residential mortgage loans having an initial aggregate principal balance of $389.9 million and it issued a series of asset-backed securities (“ABS”) having an aggregate original principal amount of $389.9 payable from the cash flow generated by the pool of residential mortgage loans. Our interest in the VIE consists of several classes of such ABS having an aggregate original principal balance of $28.5 million, which are either subordinate in payment priority, pay interest only, or are payable from certain designated cash flows from the loans.

In determining if the securitized trust should be consolidated, the Company evaluated whether it was a VIE and, if so, whether the Company’s direct involvement in the VIE reflects a controlling financial interest that would result in the Company being deemed the primary beneficiary. The Company concluded that its interest in the securitized trust purchased in March 2013, was a VIE because it included the power to direct the activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or right to receive benefits that are potentially significant to the VIE. Accordingly, for financial statement reporting purposes, the Company consolidated the underlying assets and liabilities of the securitization trust at their fair value and, as such, no gain or loss was recorded upon consolidation. The securitization is a non-recourse financing of the residential mortgage loans held-for-investment. The senior securities issued by the securitization trust and not purchased by the Company, which were sold to unaffiliated third parties, are presented in the consolidated balance sheet as “Asset-back securities issued”.

The Company is not contractually required and has not provided any additional financial support to the VIE for the period ended March 31, 2013. The following table presents a summary of the assets and liabilities of the VIE. Intercompany balances have been eliminated for purposes of this presentation.


$ in thousand	March 31, 2013		December 31, 2012
Residential loans, held for investment		405,541		—
Accrued interest receivable		1,224		—
Deferred costs		1,526		—

Total assets		408,291		—


Accrued interest payable		1,065		—
Asset-backed securities issued		374,196		—

Total liabilities		375,261		—

Note 4 – Mortgage-Backed Securities

All of the Company’s MBS are classified as available-for-sale and, as such, are reported at fair value, which is determined by obtaining valuations from an independent source. If the fair value of a security is not available from a dealer or third-party pricing service, or such data appears unreliable, the Company may estimate the fair value of the security using a variety of methods including other pricing services, repurchase agreement pricing, discounted cash flow analysis, matrix pricing, option adjusted spread models and other fundamental analysis of observable market factors. At March 31, 2013 and December 31, 2012, all of the Company’s MBS values were based on values obtained from third-party pricing services. The following tables present certain information about the Company’s investment portfolio at March 31, 2013 and December 31, 2012.


March 31, 2013
$ in thousands	Principal Balance		Unamortized Premium (Discount)			Amortized Cost		Unrealized Gain/ (Loss), net		Fair Value		Net Weighted Average Coupon ⁽¹⁾			Period- end Weighted Average Yield ⁽²⁾			Quarterly Weighted Average Yield ⁽³⁾




Agency RMBS:
15 year fixed-rate		1,927,848		102,811			2,030,659		58,848		2,089,507		4.06	%		2.29	%		2.19	%
30 year fixed-rate		11,302,383		752,598			12,054,981		116,840		12,171,821		4.00	%		2.83	%		2.84	%
ARM		70,163		2,139			72,302		1,753		74,055		3.34	%		2.02	%		2.13	%
Hybrid ARM		461,439		10,529			471,968		14,329		486,297		3.16	%		2.23	%		2.33	%

Total Agency pass-through		13,761,833		868,077			14,629,910		191,770		14,821,680		3.98	%		2.73	%		2.72	%


Agency-CMO⁽⁴⁾		1,395,266		(894,925	)		500,341		2,738		503,079		2.86	%		2.46	%		1.46	%
Non-Agency RMBS⁽⁵⁾		3,812,636		(350,396	)		3,462,240		93,063		3,555,303		4.18	%		4.30	%		4.63	%
CMBS		2,679,653		(477,301	)		2,202,352		166,018		2,368,370		4.41	%		4.77	%		4.75	%

Total		21,649,388		(854,545	)		20,794,843		453,589		21,248,432		4.00	%		3.20	%		3.21	%

(1)	Net weighted average coupon as of March 31, 2013 (“WAC”) is presented net of servicing and other fees.

(2)	Average yield based on amortized costs as of March 31, 2013 and incorporates future prepayment and loss assumptions.

(3)	Average yield based on average amortized costs for the three months ended March 31, 2013 and incorporates future prepayment and loss assumptions.

(4)	Included in the Agency-CMO are interest-only securities which represent 15.1% of the balance based on fair value.

(5)	The non-Agency RMBS held by the Company is 72.7% variable rate, 22.7% fixed rate, and 4.6% floating rate based on fair value.


December 31, 2012
	Principal Balance		Unamortized Premium (Discount)			Amortized Cost		Unrealized Gain/ (Loss), net		Fair Value		Net Weighted Average Coupon ⁽¹⁾			Period- end Weighted Average Yield ⁽²⁾			Quarterly Weighted Average Yield ⁽³⁾
$ in thousands
$ in thousands
Agency RMBS:
15 year fixed-rate		1,964,999		102,058			2,067,057		63,839		2,130,896		4.09	%		2.37	%		2.37	%
30 year fixed-rate		9,168,196		601,592			9,769,788		238,949		10,008,737		4.21	%		2.89	%		2.88	%
ARM		109,937		3,464			113,401		2,365		115,766		3.15	%		2.06	%		2.02	%
Hybrid ARM		556,790		13,493			570,283		16,885		587,168		3.19	%		2.18	%		2.22	%

Total Agency pass-through		11,799,922		720,607			12,520,529		322,038		12,842,567		4.13	%		2.77	%		2.75	%


Agency-CMO⁽⁴⁾		1,322,043		(819,530	)		502,513		1,926		504,439		2.89	%		2.35	%		1.51	%
Non-Agency RMBS⁽⁵⁾		3,339,683		(308,885	)		3,030,798		48,238		3,079,036		4.20	%		4.61	%		4.80	%
CMBS		1,868,928		24,070			1,892,998		151,523		2,044,521		5.27	%		4.96	%		4.82	%

Total		18,330,576		(383,738	)		17,946,838		523,725		18,470,563		4.17	%		3.30	%		3.27	%

(1)	Net weighted average coupon as of December 31, 2012 (“WAC”) is presented net of servicing and other fees.

(2)	Average yield based on amortized cost as of December 31, 2012 incorporates future prepayment and loss assumptions.

(3)	Average yield based on average amortized cost for the three months ended December 31, 2012 incorporates future prepayment and loss assumptions.

(4)	Included in Agency-CMO are interest-only securities which represent 14.1% of the balance based on fair value.

(5)	The non-Agency RMBS held by the Company is 79.2% variable rate, 15.5% fixed rate, and 5.3% floating rate based on fair value.

The following table summarizes our non-Agency RMBS portfolio by asset type as of March 31, 2013 and December 31, 2012, respectively:


$ in thousands	March 31, 2013		% of Non-Agency			December 31, 2012		% of Non-Agency
Re-REMIC Senior		1,765,156		49.6	%		1,844,209		59.9	%
Prime		1,151,170		32.4	%		754,161		24.5	%
Alt-A		627,736		17.7	%		468,181		15.2	%
Subprime		11,241		0.3	%		12,485		0.4	%

Total Non-Agency		3,555,303		100.0	%		3,079,036		100.0	%

The following table summarizes certain characteristics of our senior Re-REMIC Holdings as of March 31, 2013 and December 31, 2012:


	Percentage of Re-REMIC Holdings at Fair Value
Re-REMIC Subordination⁽¹⁾	March 31, 2013			December 31, 2012
0-10		3.0	%		2.1	%
10-20		3.2	%		3.2	%
20-30		15.0	%		15.0	%
30-40		26.7	%		27.0	%
40-50		39.7	%		40.4	%
50-60		7.8	%		7.6	%
60-70		4.6	%		4.7	%

Total		100.0	%		100.0	%

(1)

Subordination refers to the credit enhancement provided to the senior Re-REMIC tranche by the junior Re-REMIC tranche or tranches in a resecuritization. This figure reflects the percentage of the balance of the underlying security represented by the junior tranche or tranches at the time of resecuritization. Generally, principal losses on the underlying security in excess of the subordination amount would result in principal losses on the senior Re-REMIC tranche.

The components of the carrying value of the Company’s investment portfolio at March 31, 2013 and December 31, 2012 are presented below:


$ in thousands	March 31, 2013			December 31, 2012
Principal balance		21,649,388			18,330,576
Unamortized premium		949,516			788,716
Unamortized discount		(1,804,061	)		(1,172,454	)
Gross unrealized gains		545,324			563,093
Gross unrealized losses		(91,735	)		(39,368	)

Fair value		21,248,432			18,470,563

The following table summarizes certain characteristics of the Company’s investment portfolio, at fair value, according to estimated weighted average life classifications as of March 31, 2013 and December 31, 2012:


$ in thousands	March 31, 2013		December 31, 2012
Less than one year		73,492		70,044
Greater than one year and less than five years		9,717,411		13,146,577
Greater than or equal to five years		11,457,529		5,253,942

Total		21,248,432		18,470,563

The following tables present the gross unrealized losses and estimated fair value of the Company’s MBS by length of time that such securities have been in a continuous unrealized loss position at March 31, 2013 and December 31, 2012, respectively:


March 31, 2013	Less than 12 Months					12 Months or More					Total
$ in thousands	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
$ in thousands	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Agency RMBS:
15 year fixed-rate		140,809		(341	)		13,606		(220	)		154,415		(561	)
30 year fixed-rate		6,199,401		(63,711	)		91,756		(413	)		6,291,157		(64,124	)

Total Agency pass-through		6,340,210		(64,052	)		105,362		(633	)		6,445,572		(64,685	)


Agency-CMO		39,552		(7,948	)		9,631		(2,446	)		49,183		(10,394	)
Non-Agency RMBS		576,687		(5,226	)		369,642		(8,021	)		946,329		(13,247	)
CMBS		355,612		(2,711	)		17,300		(698	)		372,912		(3,409	)

Total		7,312,061		(79,937	)		501,935		(11,798	)		7,813,996		(91,735	)


December 31, 2012	Less than 12 Months					12 Months or More					Total
$ in thousands	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
$ in thousands	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Agency RMBS:
15 year fixed-rate		31,269		(279	)		—		—			31,269		(279	)
30 year fixed-rate		1,763,113		(6,469	)		78,640		(832	)		1,841,753		(7,301	)

Total Agency pass-through		1,794,382		(6,748	)		78,640		(832	)		1,873,022		(7,580	)


Agency-CMO		31,719		(7,796	)		10,770		(2,812	)		42,489		(10,608	)
Non-Agency RMBS		516,744		(6,005	)		490,503		(12,895	)		1,007,247		(18,900	)
CMBS		187,349		(1,267	)		52,813		(1,013	)		240,162		(2,280	)

Total		2,530,194		(21,816	)		632,726		(17,552	)		3,162,920		(39,368	)

Gross unrealized losses on the Company’s Agency RMBS were $64.6 million at March 31, 2013. Due to the inherent credit quality of Agency RMBS, the Company determined that at March 31, 2013, any unrealized losses on its Agency RMBS portfolio are temporary.

Gross unrealized losses on the Company’s MBS-CMO, non-Agency RMBS, and CMBS were $27.1 million at March 31, 2013. The Company does not consider these unrealized losses to be credit related, but rather due to non-credit related factors such as interest rate spreads, prepayment speeds, and market fluctuations. These investment securities are included in the Company’s assessment for other-than-temporary impairment on at least a quarterly basis.

The following table presents the impact of the Company’s MBS on its accumulated other comprehensive income for the three months ended March 31, 2013 and 2012.


$ in thousands	Three Months ended March 31, 2013			Three Months ended March 31, 2012
$ in thousands	Three Months ended March 31, 2013			Three Months ended March 31, 2012
Accumulated other comprehensive income from investment securities:
Unrealized gain (loss) on MBS at beginning of period		523,725			(1,218	)
Unrealized gain (loss) on MBS, net		(70,136	)		209,073

Balance at the end of period		453,589			207,855

During the three months ended March 31, 2013 and 2012, the Company reclassified $15.0 million of net unrealized gains and $3.2 million of net unrealized gains, respectively from other comprehensive income into gain (loss) on sale of investments as a result of the Company selling certain investments.

The Company assesses its investment securities for other-than-temporary impairment on at least a quarterly basis. When the fair value of an investment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated as either “temporary” or “other-than-temporary.” In deciding whether a security is other-than-temporarily impaired, the Company considers several factors, including the nature of the investment, the severity and duration of the impairment, the cause of the impairment, and the Company’s intent that it is more likely than not that the Company can hold the security until recovery of its cost basis.

The Company did not have other-than-temporary impairments for the three months ended March 31, 2013 and 2012.

The following table presents components of interest income on the Company’s MBS portfolio for the three months ended March 31, 2013 and 2012.


For the three months ended March 31, 2013				Net (Premium Amortization)/Discount Accretion
$ in thousands	Coupon Interest						Interest Income
$ in thousands	Coupon Interest						Interest Income
Agency		143,414			(45,114	)		98,300
Non-Agency		36,411			1,141			37,552
CMBS		26,650			(2,200	)		24,450
Other		42			—			42

Total		206,517			(46,173	)		160,344


For the three months ended March 31, 2012
$ in thousands	Coupon Interest			Net (Premium Amortization)/Discount Accretion			Interest Income
Agency		122,314			(31,497	)		90,817
Non-Agency		28,283			5,928			34,211
CMBS		16,810			168			16,978
Other		(46	)		—			(46	)

Total		167,361			(25,401	)		141,960

Note 5 – Residential Loans Held-for-Investment

The following table details the carrying value for residential loans held-for-investment at March 31, 2013. These loans are held by the VIE that the Company consolidates. At March 31, 2013 there was no allowance for loan loss.


$ in thousands	March 31, 2013		December 31, 2012
Principal balance		389,886		—
Unamortized premium, net		15,655		—

Recorded investment		405,541		—

Carrying value		405,541		—

The following table displays residential loans held-for-investment at March 31, 2013 organized by year of origination.


$ in thousands	2013			2012			2011			2010			2009			Total
Portfolio Characteristics:
Number of Loans		114			373			—			—			1			488
Current Principal Balance		89,336			300,215			—			—			335			389,886
Net Weighted Average Coupon Rate		3.7	%		3.8	%		0.0	%		0.0	%		4.0	%		3.8	%
Weighted Average Maturity (years)		30			30			—			—			30			30

Current Performance:
Current		89,336			300,215			—			—			335			389,886
30 Day Delinquent		—			—			—			—			—			—
60 Days Delinquent		—			—			—			—			—			—
90+ Days Delinquent		—			—			—			—			—			—
Bankruptcy/Foreclosure		—			—			—			—			—			—

Total		89,336			300,215			—			—			335			389,886

The following table presents the five largest geographic concentrations of the Company’s residential loans at March 31, 2013 based on principal balance:


State	Percent
California		49.9	%
Virginia		7.3	%
Massachusetts		7.3	%
Maryland		5.7	%
New York		5.2	%
Other states (none greater than 4%)		24.6	%

Total		100.0	%

Future minimum annual principal payments under the residential loans, held for investments at March 31, 2013:


$ in thousands Scheduled Principal	March 31, 2013
$ in thousands Scheduled Principal	March 31, 2013
Within one year		6,923
One to three years		14,651
Three to five years		15,794
Greater than or equal to five years		352,518

Total		389,886

Note 6 – Investments in Unconsolidated Ventures

The Company’s non-controlling, unconsolidated ownership interests in these unconsolidated entities are accounted for under the equity method. Capital contributions, distributions, profits and losses of the entities are allocated in accordance with the terms of the entities’ operating agreements. Such allocations may differ from the stated percentage interests, if any, as a result of preferred returns and allocation formulas as described in such agreements. The Company has made the fair value election for its investments in all unconsolidated ventures. The fair value measurement for the investments in unconsolidated ventures is based on the net asset value per share of the investment, or its equivalent.

Invesco Mortgage Recovery Feeder Fund, L.P. and Invesco Mortgage Recovery Loans AIV, L.P.

The Company invested in certain non-Agency RMBS, CMBS and residential and commercial mortgage loans by contributing equity capital to the Invesco IMRF Fund that received financing under the PPIP. In March 2012, Invesco IMRF Fund returned substantially all of its proceeds and repaid all financing under the PPIP. The Company is awaiting final distribution from the Invesco IMRF Fund. In addition, the Manager identified a whole loan transaction for the Company, which resulted in the Company’s admission into an alternative investment vehicle, the Invesco Mortgage Recovery Loans AIV, L.P. (“AIV”). The Company’s initial commitment in the Invesco IMRF Fund and AIV was $25.0 million. During 2009 and 2010, the Invesco IMRF Fund and AIV accepted additional subscriptions and the Company increased its overall commitment to $100.0 million, which effectively increased the Company’s initial ownership interest in the Invesco IMRF Fund and AIV. As of March 31, 2010, the Invesco IMRF Fund stopped accepting investment subscriptions and was deemed closed. The Company made its first contributions to the Invesco IMRF Fund in October 2009. The Company is committed to fund $17.1 million in aggregate of additional capital at March 31, 2013 for the Invesco IMRF Fund and AIV. The Company realized approximately $345,000 (2012: $353,000) of equity in earnings for the three months ended March 31, 2013 related to these investments. The Company also realized $148,000 of unrealized gain (2012: $151,000 of unrealized gain) from these investments for the three months ended March 31, 2013.

IMRF Loan Portfolio Member LLC

On September 30, 2011, the Company invested in a portfolio of commercial mortgage loans by contributing $16.9 million, net of distributions, of equity capital to IMRF Loan Portfolio Member LLC (“IMRF”), a limited liability company managed by AIV. The Company has fully funded its commitment to IMRF. The Company realized loss of approximately $105,000 (2012: $354,000 realized gain) of equity in earnings and $1.2 million (2012: $152,000) of unrealized appreciation from these investments for the three months ended March 31, 2013.

Note 7 – Borrowings

The Company has entered into repurchase agreements and an exchangeable senior note to finance the majority of its portfolio of investments. The following table summarizes certain characteristics of the Company’s borrowings at March 31, 2013 and December 31, 2012:


$ in thousands	March 31, 2013							December 31, 2012
	Amount Outstanding		Weighted Average Interest Rate			Weighted Average Remaining Maturity (days)		Amount Outstanding		Weighted Average Interest Rate			Weighted Average Remaining Maturity (days)
Agency RMBS		13,545,701		0.40	%		15		11,713,565		0.48	%		16
Non-Agency RMBS		2,520,515		1.62	%		32		2,450,960		1.75	%		23
CMBS		1,807,040		1.47	%		20		1,555,935		1.51	%		18
Exchangeable Senior Notes		400,000		5.00	%		1,810		—		—	%		—

Total		18,273,256		0.78	%		57		15,720,460		0.78	%		17

Repurchase Agreements

The repurchase agreements bear interest at a contractually agreed rate. The repurchase obligations mature and typically reinvest every thirty days to one year. Repurchase agreements are being accounted for as secured borrowings since the Company maintains effective control of the financed assets. Under the repurchase agreements, the respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets would require the Company to provide additional collateral or fund margin calls. In addition, the repurchase agreements are subject to certain financial covenants. The Company is in compliance with these covenants at March 31, 2013.

The following tables summarize certain characteristics of the Company’s repurchase agreements at March 31, 2013 and December 31, 2012:


March 31, 2013 $ in thousands Repurchase Agreement Counterparties	Amount Outstanding		Percent of Total Amount Outstanding			Company MBS Held as Collateral


Credit Suisse Securities (USA) LLC		1,831,940		10.3	%		2,202,780
Wells Fargo Securities, LLC		1,305,871		7.4	%		1,486,179
Morgan Stanley & Co. Incorporated		1,272,375		7.1	%		1,402,549
South Street Securities LLC		1,240,081		6.9	%		1,310,504
Banc of America Securities LLC		1,133,073		6.3	%		1,243,914
CitiGroup Global Markets Inc.		1,075,152		6.0	%		1,205,885
JP Morgan Securities Inc.		1,058,856		5.9	%		1,229,961
HSBC Securities (USA) Inc		821,462		4.6	%		844,932
Mitsubishi UFJ Securities (USA), Inc.		796,459		4.5	%		845,807
Goldman, Sachs & Co.		791,102		4.4	%		850,149
ING Financial Market LLC		789,174		4.4	%		849,337
Pierpont Securities LLC		733,558		4.1	%		776,635
Scotia Capital		708,691		4.0	%		757,824
Nomura Securities International, Inc.		655,765		3.7	%		706,838
Industrial and Commercial Bank of China Financial Services LLC		591,073		3.3	%		638,829
Royal Bank of Canada		569,645		3.2	%		655,196
Daiwa Capital Markets America Inc		500,169		2.8	%		528,777
BNP Paribas Securities Corp.		480,641		2.7	%		521,513
Deutsche Bank Securities Inc.		473,326		2.6	%		546,869
RBS Securities Inc.		421,280		2.4	%		516,442
Barclays Capital Inc.		270,704		1.5	%		297,938
Mizuho Securities USA Inc.		138,798		0.8	%		160,327
KGS-Alpha Capital Markets, L.P.		78,521		0.4	%		83,873
Cantor Fitzgerald & Co.		77,824		0.4	%		84,038
Guggenheim Liquidity Services, LLC		38,166		0.2	%		40,083
TD Securities		19,550		0.1	%		24,633

Total		17,873,256		100.0	%		19,811,812


December 31, 2012 $ in thousands Repurchase Agreement Counterparties	Amount Outstanding		Percent of Total Amount Outstanding			Company MBS Held as Collateral


Credit Suisse Securities (USA) LLC		1,600,331		10.2	%		1,919,676
Morgan Stanley & Co. Incorporated		1,275,616		8.1	%		1,397,846
Nomura Securities International, Inc.		1,240,231		7.9	%		1,350,901
Mitsubishi UFJ Securities (USA), Inc.		941,671		6.0	%		990,057
Wells Fargo Securities, LLC		941,556		6.0	%		1,079,194
HSBC Securities (USA) Inc		883,726		5.6	%		918,551
South Street Securities LLC		819,524		5.2	%		871,963


CitiGroup Global Markets Inc.	780,020	5.0	%	882,517
Banc of America Securities LLC	728,609	4.6	%	838,216
Scotia Capital	708,750	4.5	%	744,692
Industrial and Commercial Bank of China Financial Services LLC	634,928	4.0	%	690,783
Deutsche Bank Securities Inc.	587,919	3.7	%	666,472
ING Financial Market LLC	573,116	3.6	%	622,944
JP Morgan Securities Inc.	561,426	3.6	%	697,602
Royal Bank of Canada	560,828	3.6	%	641,079
BNP Paribas Securities Corp.	488,375	3.1	%	516,770
Goldman, Sachs & Co.	468,806	3.0	%	509,660
Daiwa Capital Markets America Inc	456,098	2.9	%	479,354
Pierpont Securities LLC	437,095	2.8	%	463,466
Barclays Capital Inc.	350,688	2.3	%	372,708
RBS Securities Inc.	348,741	2.2	%	427,183
Mizuho Securities USA Inc.	101,962	0.6	%	122,836
Cantor Fitzgerald & Co.	80,466	0.5	%	86,961
KGS-Alpha Capital Markets, L.P.	79,052	0.5	%	86,241
Guggenheim Liquidity Services, LLC	43,245	0.3	%	45,437
TD Securities	27,681	0.2	%	33,129

Total	15,720,460	100.0	%	17,456,238

Company MBS held by counterparties as security for repurchase agreements was $19.8 billion and $17.5 billion at March 31, 2013 and December 31, 2012, respectively. This represents a collateral ratio (Company MBS Held as Collateral/Amount Outstanding) of 111% and 111% for each period.

No cash collateral was held by the counterparties at March 31, 2013 and December 31, 2012. The cash collateral was replaced by Agency RMBS.

Asset-Backed Securities Issued

In March 2013, the Company purchased a controlling interest in a securitization trust which it determined to be a VIE. The securitization trust securitized residential mortgage loans with an aggregate principal balance of $389.9 million, and issued $389.9 million aggregate principal amount of ABS, of which $361.4 million were sold to unaffiliated third parties and the balance was purchased by the Company. As a result, the ABS issued by the securitization trust is recorded as a non-recourse liability in the Company’s consolidated balance sheet.

The carrying value of the ABS is based on its amortized cost, which is equal to the remaining principal balance net of unamortized premiums or discounts. The following table provides summary information of the carrying value of the ABS issued, along with other relevant information, at March 31, 2013.


$ in thousands	ABS Outstanding			Residential loans Held as Collateral
$ in thousands	ABS Outstanding			Residential loans Held as Collateral
Principal balance		361,424			389,886
Interest-only securities		10,797			—
Unamortized premium		2,622			15,655
Unamortized discount		(647	)		—

Carrying value		374,196			405,541


Range of weighted average interest rates		1.0% - 2.5%
Number of series		2

The following table presents the estimated principal repayment schedule of the Company’s ABS at March 31, 2013, based on expected cash flows of the residential mortgage loans, as adjusted for projected losses on such loans.


$ in thousands Contractual maturity	March 31, 2013
$ in thousands Contractual maturity	March 31, 2013
Within One Year		63,862
One to Three Years		98,259
Three to Five Years		68,623
Greater Than or Equal to Five Years		130,680

Total		361,424

The maturity of the Company’s ABS is dependent upon cash flows received from the underlying residential mortgage loans. The estimate of their repayment is based on estimated principal payments on the underlying loans. This estimate may differ from actual amounts to the extent prepayments and/or loan losses vary. See Note 5 for a more detailed discussion of the residential loans collateralizing asset-backed debt securities

Exchangeable Senior Notes

On March 12, 2013, a wholly owned subsidiary of the Company, issued $350.0 million in aggregate principal amount of Exchangeable Senior Notes (the “Notes”) due 2018. Subsequently, on March 15, 2013, upon the exercise in full by the initial purchasers of such notes of their option to purchase additional notes, the wholly owned subsidiary issued $50.0 million in aggregate principal amount of the Notes, for a total of $400.0 million in aggregate principal amount of the Notes. The total net proceeds to the Company after deducting financing expenses was $387.9 million.

The terms of the Notes are governed by an indenture, dated as of March 12, 2013 (the “Indenture”), by and among the wholly-owned subsidiary, as issuer, the Company, as guarantor, and The Bank of New York Mellon Trust Company, N.A., as trustee (the “Trustee”). The Notes bear interest at 5.00% per annum, payable semi-annually in arrears on March 15 and September 15 of each year, beginning September 15, 2013. The Notes may be exchanged for shares of the Company’s common stock at the applicable exchange rate at any time prior to the close of business on the second scheduled trading day prior to the maturity date. The initial exchange rate for each $1,000 aggregate principal amount of the Notes is 42.0893 shares of the Company’s common stock, equivalent to an exchange price of approximately $23.76 per share. The Notes, including the guaranty, and the shares of common stock of the Company issuable upon exchange of the Notes have not been registered under the Securities Act of 1933. Accrued interest payable on the notes is approximately $1.1 million as of March 31, 2013.

Note 8 – Derivatives and Hedging Activities

Risk Management Objective of Using Derivatives

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its investments, debt funding, and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s investments and borrowings.

The Company also utilizes credit derivatives such as credit default swaps (“CDS”) to provide credit event protection based on a financial index or specific security in exchange for receiving a fixed-rate fee or premium over the term of the contract. These instruments enable the Company to synthetically assume the credit risk of a reference security, portfolio of securities or index of securities. The counterparty pays a premium to the Company and the Company agrees to make a payment to compensate the counterparty for losses upon the occurrence of a specified credit event.

Although contract-specific, credit events generally include bankruptcy, failure to pay, restructuring, obligation acceleration, obligation default, or repudiation/moratorium. Upon the occurrence of a defined credit event, the difference between the value of the reference obligation and the CDS’s notional amount is recorded as a realized loss in the statement of operations.

Our only CDS contract was entered into on December 30, 2010. We sold protection against losses on a specific pool of non-Agency RMBS in the event they exceed a specified loss limit of 25% of the balance of the non-Agency RMBS on the trade date. The maximum exposure is the remaining unpaid principal balance of the underlying RMBS in excess of the specified loss threshold. In exchange, we are paid a stated fixed rate fee of 3%. The remaining notional amount of the CDS at March 31, 2013 is $72.1 million (2012: $103.3 million), and we estimated the fair market value of the CDS to be approximately $1.3 million (2012: $1.2 million) at March 31, 2013. As of March 31, 2013, we have not made any payments related to the CDS contract.

At March 31, 2013 and December 31, 2012, the open CDS sold by the Company is summarized as follows:


$ in thousand	March 31, 2013		December 31, 2012
Fair value amount		1,296		1,519
Notional amount		72,123		79,806
Maximum potential amount of future undiscounted payments		72,123		79,806
Recourse provisions with third parties		—		—
Collateral held by counterparty		11,126		12,371

Cash Flow Hedges of Interest Rate Risk

The Company has purchased interest rate swaptions to help mitigate the potential impact of increases or decreases in interest rates on the performance of a portion of the Company’s investment portfolio (referred to as “convexity risk”). The interest rate swaptions provide the Company the option to enter into interest rate swap agreements for a predetermined notional amount, stated term and pay and receive interest rates in the future. The premium paid for interest rate swaptions is reported as an asset in the Company’s consolidated balance sheets. The premium is valued at an amount equal to the fair value of the swaption that would have the effect of closing the position adjusted for nonperformance risk, if any. The difference between the premium and the fair value of the swaption is reported in unrealized gain (loss) on interest rate swaps and swaptions, net in the Company’s consolidated statement of operations. If a swaption expires unexercised, the loss on the swaption would be equal to the premium paid. If we sell or exercise a swaption, the realized gain or loss on the swaption would be equal to the difference between the cash or the fair value of the underlying interest rate swap received and the premium paid. For the three months ended March 31, 2013, the Company had $2.0 million of unrealized losses, which represents the change in fair value of our interest rate swaptions that are recognized directly in earnings.

During the three months ended March 31, 2013, the Company recorded $1,000 (2012: $509,000) of unrealized swap losses in earnings as hedge ineffectiveness attributable primarily to differences in the reset dates on the Company’s swaps versus the refinancing dates of certain of its repurchase agreements.


$ in thousands	Option								Underlying Swap
Swaptions	Expiration		Cost		Fair Value		Average Months to Expiration		Notional Amount		Average Fixed Pay Rate			Average Receive rate		Average Term (Years)


Payer		< 6 Months		2,140		—		0.37		200,000		1.85	%		3M Libor		5.01
Payer		> 6 Months		8,068		4,342		7.85		800,000		2.87	%		3M Libor		10.02

				10,208		4,342		6.36		1,000,000		2.66	%				9.01

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest is accrued and paid on the Company’s repurchase agreements. During the next twelve months, the Company estimates that an additional $161.7 million will be reclassified as an increase to interest expense.

The Company is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of 129 months.

As of March 31, 2013, the Company had the following interest rate derivatives outstanding, which were designated as cash flow hedges of interest rate risk:


$ in thousands Counterparty		Notional		Maturity Date		Fixed Interest Rate in Contract
$ in thousands Counterparty		Notional		Maturity Date		Fixed Interest Rate in Contract
The Bank of New York Mellon			100,000		5/24/2013		1.83	%
The Bank of New York Mellon			200,000		6/15/2013		1.73	%
SunTrust Bank			100,000		7/15/2014		2.79	%
Deutsche Bank AG			200,000		1/15/2015		1.08	%
Deutsche Bank AG			250,000		2/15/2015		1.14	%
Credit Suisse International			100,000		2/24/2015		3.26	%
Credit Suisse International			100,000		3/24/2015		2.76	%
Wells Fargo Bank, N.A.			100,000		7/15/2015		2.85	%
Wells Fargo Bank, N.A.			50,000		7/15/2015		2.44	%
Morgan Stanley Capital Services, LLC			300,000		1/24/2016		2.12	%
The Bank of New York Mellon			300,000		1/24/2016		2.13	%
Morgan Stanley Capital Services, LLC			300,000		4/5/2016		2.48	%
Citibank, N.A.			300,000		4/15/2016		1.67	%
Credit Suisse International			500,000		4/15/2016		2.27	%
The Bank of New York Mellon			500,000		4/15/2016		2.24	%
JPMorgan Chase Bank, N.A.			500,000		5/15/2016		2.31	%
Goldman Sachs Bank USA			500,000		5/24/2016		2.34	%
Goldman Sachs Bank USA			250,000		6/15/2016		2.67	%
Wells Fargo Bank, N.A.			250,000		6/15/2016		2.67	%
JPMorgan Chase Bank, N.A.			500,000		6/24/2016		2.51	%
Citibank, N.A.			500,000		10/15/2016		1.93	%
Deutsche Bank AG			150,000		2/5/2018		2.90	%
ING Capital Markets LLC	(5)		350,000		2/24/2018		0.95	%
Morgan Stanley Capital Services, LLC			100,000		4/5/2018		3.10	%
JPMorgan Chase Bank, N.A.			200,000		5/15/2018		2.93	%
UBS AG			500,000		5/24/2018		1.10	%
The Royal Bank of Scotland Plc			500,000		9/5/2018		1.04	%
Wells Fargo Bank, N.A.			200,000		3/15/2021		3.14	%
Citibank, N.A.			200,000		5/25/2021		2.83	%
The Royal Bank of Scotland Plc	(7)		400,000		3/15/2023		2.39	%
UBS AG	(6)		400,000		3/15/2023		2.51	%
HSBC Bank USA, National Association			250,000		6/5/2023		1.91	%
HSBC Bank USA, National Association	(1)		250,000		7/5/2023		1.97	%
The Royal Bank of Scotland Plc	(2)		500,000		8/15/2023		1.98	%
UBS AG	(4)		250,000		11/15/2023		2.23	%
HSBC Bank USA, National Association	(3)		500,000		12/15/2023		2.20	%

Total			10,650,000				2.11	%

(1)	Forward start date of July 2013

(2)	Forward start date of August 2013

(3)	Forward start date of December 2013

(4)	Forward start date of November 2013

(5)	Forward start date of February 2013

(6)	Forward start date of March 2015

(7)	Forward start date of March 2015

At March 31, 2013, the Company’s counterparties held no cash margin deposits and approximately $475.9 million in Agency RMBS as collateral against its swap contracts. In addition, a counterparty posted Agency RMBS of approximately $1.9 million as collateral with the Company. Cash margin, if any, is classified as restricted cash and the Agency RMBS collateral is included in the total mortgage-backed securities on the Company’s consolidated balance sheet.

Tabular Disclosure of the Effect of Derivative Instruments on the Consolidated Balance Sheet

The table below presents the fair value of the Company’s derivative financial instruments, as well as their classification on the consolidated balance sheet as of March 31, 2013 and December 31, 2012.

$ in thousands

Asset Derivatives

Liability Derivatives

As of March 31, 2013

As of December 31, 2012

As of March 31, 2013

As of December 31, 2012

Balance
Sheet

Fair Value

Balance
Sheet

Fair Value

Balance
Sheet

Fair Value

Balance
Sheet

Fair Value

Interest rate
swap asset

2,388

Interest rate
swap asset

—

Interest rate
swap
liability

420,439

Interest rate
swap
liability

436,440

CDS

1,296

CDS

1,519

Swaption

4,342

Swaption

4,950

Tabular Disclosure of the Effect of Derivative Instruments on the Income Statement

The table below presents the effect of the Company’s derivative financial instruments on the statement of operations for the three months ended March 31, 2013 and 2012.

Three months ended March 31, 2013

$ in thousands

Derivative type for

cash flow hedge

Amount of loss recognized
in OCI on derivative
(effective portion)

Location of loss
reclassified from
accumulated
OCI into
income (effective
portion)

Amount of loss
reclassified from
accumulated OCI into
income (effective
portion)

Location of loss
recognized in income on
derivative

(ineffective

portion)

Amount of loss
recognized in income
on derivative
(ineffective portion)

Interest Rate Swap

17,171

Interest Expense

35,562

Unrealized loss on interest rate swaps and swaptions

Three months ended March 31, 2012

$ in thousands

Derivative type

for cash flow hedge

Amount of loss recognized
in OCI on derivative
(effective portion)

Location of loss
reclassified from
accumulated
OCI into
income (effective
portion)

Amount of loss
reclassified from
accumulated OCI into
income (effective
portion)

Location of loss
recognized in income on
derivative

(ineffective

portion)

Amount of loss
recognized in income
on derivative
(ineffective portion

Interest Rate Swap

18,331

Interest Expense

35,420

Unrealized gain (loss) on interest rate swaps and swaptions

509


Derivative not designated as hedging instrument	Location of unrealized gain recognized in income on derivative	Amount of gain (loss) recognized in income on derivative
		Three months ended March 31, 2013			Three months ended March 31, 2012
CDS Contract	Realized and unrealized credit default swap income		(223	)		(168	)
	Unrealized gain (loss) on interest rate swaps and swaptions		(2,003	)

Credit-risk-related Contingent Features

The Company has agreements with each of its derivative counterparties. Some of those agreements contain a provision where if the Company defaults on any of its indebtedness, including default whereby repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.

The Company’s agreements with certain of its derivative counterparties provide that if the Company’s net asset value declines by certain percentages over specified time periods, then the Company could be declared in default on its derivative obligations with that counterparty. The Company’s agreements with certain of its derivative counterparties provide that if the Company’s shareholders’ equity declines by certain percentages over specified time periods, then the Company could be declared in default on its derivative obligations with that counterparty.

The Company’s agreements with certain of its derivative counterparties provide that if the Company fails to maintain a minimum shareholders’ equity or market value of $100 million and $80 million, respectively, then the Company could be declared in default on its derivative obligations with that counterparty.

As of March 31, 2013, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for non-performance risk, related to these agreements was $419.5 million. The

Company has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $475.9 million of Agency RMBS as of March 31, 2013. If the Company had breached any of these provisions at March 31, 2013, it could have been required to settle its obligations under the agreements at their termination value.

The Company was in compliance with all of the financial provisions of these agreements through March 31, 2013.

Note 9 – Offsetting Assets and Liabilities

The following tables present information about certain assets and liabilities that are subject to master netting agreements (or similar agreements) and can potentially be offset on the Company’s consolidated balance sheet at March 31, 2013 and December 31, 2012.


Offsetting of Derivative Assets As of March 31, 2013

							Gross Amounts Not Offset in the Statement of Consolidated Balance Sheet
$ in thousands Description	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Consolidated Balance Sheet		Net Amounts of Assets presented in the Consolidated Balance Sheet		Financial Instruments			Cash Collateral Received		Net Amount

Derivatives		8,026		—		8,026		(8,026	)		—		—


Total		8,026		—		8,026		(8,026	)		—		—


Offsetting of Derivative Liabilities and Repurchase agreements As of March 31, 2013

							Gross Amounts Not Offset in the Consolidated Balance Sheet
$ in thousands Description	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Consolidated Balance Sheet		Net Amounts of Liabilities presented in the Consolidated Balance Sheet		Financial Instruments			Cash Collateral Posted		Net Amount

Derivatives		420,439		—		420,439		(420,439	)		—		—

Repurchase Agreements		17,873,256				17,873,256		(17,873,256	)				—

		18,293,695		—		18,293,695		(18,293,695	)		—		—


Offsetting of Derivative Assets As of December 31, 2012

							Gross Amounts Not Offset in the Consolidated Balance Sheet
$ in thousands Description	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Consolidated Balance Sheet		Net Amounts of Assets presented in the Consolidated Balance Sheet		Financial Instruments			Cash Collateral Received		Net Amount

Derivatives		6,469		—		6,469		(6,469	)		—		—


Total		6,469		—		6,469		(6,469	)		—		—


Offsetting of Derivative Liabilities and Repurchase agreements As of December 31, 2012

							Gross Amounts Not Offset in the Consolidated Balance Sheet
$ in thousands Description	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Consolidated Balance Sheet		Net Amounts of Liabilities presented in the Consolidated Balance Sheet		Financial Instruments			Cash Collateral Posted		Net Amount

Derivatives		436,440		—		436,440		(436,440	)		—		—

Repurchase Agreements		15,720,460		—		15,720,460		(15,720,460	)				—


		16,156,900		—		16,156,900		(16,156,900	)		—		—

In the Company’s consolidated balance sheets, all balances associated with the repurchase agreement and derivatives transactions are presented on a gross basis.

Certain of the Company’s repurchase agreement and derivative transactions are governed by underlying agreements that generally provide for a right of setoff in the event of default or in the event of a bankruptcy of either party to the transaction. For one repurchase agreement counterparty, the underlying agreements provide for an unconditional right of setoff.

Note 10 – Financial Instruments

U.S. GAAP defines fair value, provides a consistent framework for measuring fair value under U.S. GAAP and Accounting Standards Codification (“ASC”) Topic 820 expands fair value financial statement disclosure requirements. ASC Topic 820 does not require any new fair value measurements and only applies to accounting pronouncements that already require or permit fair value measures, except for standards that relate to share-based payments.

Valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels are defined as follows:

•

Level 1 Inputs – Quoted prices for identical instruments in active markets.

•

Level 2 Inputs – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

•

Level 3 Inputs – Instruments with primarily unobservable value drivers.

The fair values on a recurring basis of the Company’s MBS and interest rate hedges based on the level of inputs at March 31, 2013 and December 31, 2012 are summarized below:


	March 31, 2013
	Fair Value Measurements Using:						Total at Fair Value
$ in thousands	Level 1		Level 2		Level 3		Total at Fair Value
Assets
Mortgage-backed securities(1)		—		21,248,432		—		21,248,432
Investments in unconsolidated ventures		—		—		35,456		35,456
Derivatives		—		6,730		1,296		8,026

Total		—		21,255,162		36,752		21,291,914


Liabilities
Derivatives		—		420,439		—		420,439

Total		—		420,439		—		420,439


	December 31, 2012 Fair Value Measurements Using:						Total at Fair Value
$ in thousands	Level 1		Level 2		Level 3		Total at Fair Value
Assets
Mortgage-backed securities(1)		—		18,470,563		—		18,470,563
Investments in unconsolidated ventures		—		—		35,301		35,301
Derivatives		—		4,950		1,519		6,469

Total		—		18,475,513		36,820		18,512,333


Liabilities
Derivatives		—		436,440		—		436,440

Total		—		436,440		—		436,440

(1)	For more detail about the fair value of our MBS and type of securities, see Note 4 in the consolidated financial statements.

The following table presents additional information about the Company’s investments in unconsolidated ventures which are measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:


$ in thousands	March 31, 2013			December 31, 2012
Beginning balance		35,301			68,793
Purchases		—			4,218
Sales and settlements		(1,435	)		(44,879	)
Total net gains / (losses) included in net income
Realized gains/(losses), net		239			6,813
Unrealized gains/(losses), net		1,351			356
Unrealized gain/(losses), net included in other comprehensive income		—			—

Ending balance		35,456			35,301

The following table presents additional information about the Company’s CDS contract which is measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value:


$ in thousands	March 31, 2013			December 31, 2012
Beginning balance		1,519			1,339
Purchases		—			—
Sales and settlements		—			—
Total net gains / (losses) included in net income
Realized gains/(losses), net		—			—
Unrealized gains/(losses), net		(223	)		180
Unrealized gain/(losses), net included in other comprehensive income		—			—

Ending balance		1,296			1,519

The following table summarizes quantitative information about Level 3 fair value measurements:


$ in thousands	Fair Value at March 31, 2013		Valuation Technique	Unobservable Input	Range	Weighted Average
CDS Contract		1,296	Discounted cash flow	Swap Rate			2.39	%
				Discount Rate			0.53	%
				Credit Spread			0.81	%
				Constant Prepayment Rate	1.0% - 20.0%		4.97	%
				Constant Default Rate	0.6% - 100.0%		4.94	%
				Loss Severity	15.3% - 82.1%		47.43	%

The significant unobservable inputs used in the fair value measurement of the CDS contract are the swap rate, discount rate, credit spread, constant prepayment rate, constant default rate, and loss severity in the event of default. These inputs change according to market conditions and security performance expectations. Significant increases (decreases) in swap rate, discount rate, credit spread, constant prepayment rate, constant default rate or loss severity in isolation would result in a lower (higher) fair value measurement. Generally, a change in the assumption used for the constant default rate would likely be accompanied by a directionally similar change in the assumptions used for swap rate, credit spread and loss severity and a directionally opposite change in the assumption used for discount rate and constant prepayment rate. If the inputs had not changed during the quarter, the fair value of the CDS contract would have been $52,000 more than the actual fair value at March 31, 2013.

The following table presents the carrying value and estimated fair value of our financial instruments that are not carried at fair value on the consolidated balance sheet, at March 31, 2013 and December 31, 2012:


	March 31, 2013				December 31, 2012
$ in thousands	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Financial Assets
Residential loans, held-for-investment		405,541		405,541		—		—
Other investments		10,000		10,000		10,000		10,000

Total		415,541		415,541		10,000		10,000


Financial Liabilities
Repurchase agreements		17,873,256		17,882,595		15,720,460		15,730,387
Asset-backed-securities		374,196		374,196		—		—
Exchangeable senior notes		400,000		402,492		—		—

Total		18,647,452		18,659,283		15,720,460		15,730,387

The following describes the Company’s methods for estimating the fair value for financial instruments.

•

The fair value of the residential loans, held-for-investment is a Level 3 fair value measurement, based on an expected present value technique. This method discounts future estimated cash flows using rates the Company determined best reflect current market interest rates that would be offered for loans with similar characteristics and credit quality.

•

In December 2012, the Company acquired a $10.0 million debt security from a repurchase lending counterparty that matures October 31, 2016. The debt security pays interest quarterly at the rate of 4.0% above the three-month LIBOR rate. The debt security is included in “Other Investments” and its fair value is a Level 3 fair value measurement based on an expected present value technique. This method discounts future estimated cash flows using rates the Company determined best reflect current market interest rates that would be offered for securities with similar characteristics and credit quality.

•

The fair value of the repurchase agreements is a Level 3 fair value measurement, based on an expected present value technique. This method discounts future estimated cash flows using rates the Company determined best reflect current market interest rates that would be offered for repurchase agreements with similar characteristics and credit quality.

•

The fair value of the asset-backed-securities issued is a Level 3 fair value measurement based on an expected present value technique. This method discounts future estimated cash flows using rates the Company determined best reflect current market interest rates that would be offered for securities with similar characteristics and credit quality.

•

The fair value of the exchangeable senior notes issued is a Level 2 fair value measurement based on obtaining valuations from an independent source. The value was based on a value obtained from a third-party pricing service.

Note 11 – Related Party Transactions

The Company is externally managed and advised by the Manager. Pursuant to the terms of the management agreement, the Manager and its affiliates provide the Company with its management team, including its officers, along with appropriate support personnel. Each of the Company’s officers is an employee of Invesco or one of Invesco’s affiliates. The Company does not have any employees. With the exception of the Company’s Chief Financial Officer and Controller, the Manager is not obligated to dedicate any of its employees exclusively to the Company, nor are the Manager or its employees obligated to dedicate any specific portion of its or their time to the Company’s business. The Manager is at all times subject to the supervision and oversight of the Company’s Board of Directors and has only such functions and authority as the Company delegates to it.

Management Fee

The Company pays the Manager a management fee equal to 1.50% of the Company’s shareholders’ equity per annum, which is calculated and payable quarterly in arrears. For purposes of calculating the management fee,

shareholders’ equity is equal to the sum of the net proceeds from all issuances of equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus retained earnings at the end of the most recently completed calendar quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less any amount paid to repurchase common stock since inception, and excluding any unrealized gains, losses or other items that do not affect realized net income (regardless of whether such items are included in other comprehensive income or loss, or in net income). This amount will be adjusted to exclude one-time events pursuant to changes in U.S. GAAP, and certain non-cash items after discussions between the Manager and the Company’s independent directors and approval by a majority of the Company’s independent directors.

The Manager has agreed to reduce (but not below zero) the management fee payable by the Company under the management agreement with respect to any equity investment managed by the Manager. The fee reduction occurs at the equity investment level.

For the three months ended March 31, 2013, the Company incurred management fees of $10.4 million (2012: $8.6 million), of which $10.4 million (2012: $8.6 million), was accrued but has not been paid.

Expense Reimbursement

Pursuant to the management agreement, the Company is required to reimburse the Manager for operating expenses related to the Company incurred by the Manager, including directors and officers insurance, accounting services, auditing and tax services, filing fees, and miscellaneous general and administrative costs. The Company’s reimbursement obligation is not subject to any dollar limitation.

The Company incurred costs, originally paid by Invesco, of approximately $1.2 million for the three months ended March 31, 2013 (2012:$592,000). Approximately $934,000 (2012: $550,000) was either prepaid or expensed for the three months ended March 31, 2013. Approximately $234,000 (2012: $42,000) was charged against equity as a cost of raising capital for the three months ended March 31, 2013.

Termination Fee

A termination fee is due to the Manager upon termination of the management agreement by the Company equal to three times the sum of the average annual management fee earned by the Manager during the 24-month period prior to such termination, calculated as of the end of the most recently completed fiscal quarter.

Note 12 – Shareholders’ Equity

Securities Convertible into Shares of Common Stock

The limited partner who holds units of the Operating Partnership (“OP Units”) has the right to cause the Operating Partnership to redeem their OP Units for cash equal to the market value of an equivalent number of shares of common stock, or at the Company’s option, the Company may purchase their OP Units by issuing one share of common stock for each OP Unit redeemed. The Company has also adopted an equity incentive plan which includes the ability of the Company to grant securities convertible into the Company’s common stock to the independent directors and the executive officers of the Company and the personnel of the Manager and its affiliates.

Exchangeable Senior Notes

On March 12, 2013, a wholly owned subsidiary of the Company issued $350.0 million in aggregate principal amount of Exchangeable Senior Notes (the “Notes”) due 2018. Subsequently, on March 15, 2013, upon the exercise in full by the initial purchasers of such notes of their option to purchase additional notes, the wholly- owned subsidiary issued $50.0 million in aggregate principal amount of the Notes, for a total of $400.0 million in aggregate principal amount of the Notes. The total net proceeds to the Company after deducting financing expenses was $387.9 million. The Notes may be exchanged for shares of the Company’s common stock at the applicable exchange rate at any time prior to the close of business on the second scheduled trading day prior to the maturity date. The initial exchange rate for each $1,000 aggregate principal amount of the Notes is 42.0893 shares of the Company’s common stock, equivalent to an exchange price of approximately $23.76 per share.

Registration Rights

The Company entered into a registration rights agreement with regard to the common stock and OP Units owned by the Manager and Invesco Investments (Bermuda) Ltd., respectively, upon completion of the Company’s IPO and any shares of common stock that the Manager may elect to receive under the management agreement or otherwise. Pursuant to the registration rights agreement, the Company has granted to the Manager and Invesco Investments (Bermuda) Ltd., (i) unlimited demand registration rights to have the shares purchased by the Manager or granted to it in the future and the shares that the Company may issue upon redemption of the OP Units purchased by Invesco Investments (Bermuda) Ltd. registered for resale, and (ii) in certain circumstances, the right to “piggy-back” these shares in registration statements the Company might file in connection with any future public offering so long as the Company retains the Manager under the management agreement.

Common Stock Public Offerings

On January 28, 2013, the Company completed a public offering of 15,000,000 shares of our common stock and an issuance of an additional 2,250,000 shares of common stock pursuant to the underwriters’ full exercise of their over-allotment option at $21.00 per share, resulting in net proceeds of approximately $359.0 million, after deducting underwriting discounts and estimated offering costs.

During the three months ended March 31, 2013, the Company issued 1,024,223 shares of common stock at an average price of $21.61 under the DRSPP with total proceeds to the Company of approximately $22.0 million, net of issuance costs of $130,000.

Preferred Stock Public Offering

Holders of the Company’s Series A Preferred Stock are entitled to receive dividends at an annual rate of 7.75% of the liquidation preference of $25 per share or $1.9375 per share per annum. These dividends are cumulative and payable quarterly in arrears. The shares are not convertible into or exchangeable for any other property or any other securities of the Company at the election of the holders. However, the Company, at its option after July 26, 2017, may redeem the shares at a redemption price of $25.00, plus any accrued unpaid distributions through the date of the redemption.

Share-Based Compensation

The Company established the 2009 Equity Incentive Plan for grants of restricted common stock and other equity based awards to the independent directors and the executive officers of the Company and personnel of the Manager and its affiliates (the “Incentive Plan”). Under the Incentive Plan, a total of 1,000,000 shares of common stock are currently reserved for issuance. Unless terminated earlier, the Incentive Plan will terminate in 2019, but will continue to govern the unexpired awards. The Company recognized compensation expense of approximately $38,000 for the three months ended March 31, 2013 (2012: $38,000). During the three months ended March 31, 2013, the Company issued 1,770 shares (2012: 2,208 shares), of restricted stock pursuant to the Incentive Plan to the Company’s non-executive directors. The fair market value of the shares granted was determined using the closing stock market price on the date of the grant.

The Company recognized compensation expense of approximately $62,000 for the three months ended March 31, 2013 (2012: $40,000) related to awards to officers and employees of the Manager and its affiliates which is reimbursed by the Manager under the management agreement.

During March 2013, the Company issued 5,697 shares of common stock (net of tax withholding) in exchange for 8,783 restricted stock units that vested under the 2009 Equity Incentive Plan.

Dividends

On March 19, 2013, the Company declared a dividend of $0.65 per share of common stock. The dividend was paid on April 26, 2013 to shareholders of record as of the close of business on April 1, 2013.

On March 19, 2013, the Company declared a dividend of $0.4844 per share of Series A Preferred Stock. The dividend was paid on April 25, 2013 to shareholders of record as of the close of business on April 1, 2013.

Note 13 – Earnings per Share

Earnings per share for the three months ended March 31, 2013 and 2012 is computed as follows:


$ in thousands	Three Months Ended March 31,
	2013		2012
Numerator (Income)
Basic Earnings
Net income available to common shareholders		83,992		83,082
Effect of dilutive securities:
Income allocated to exchangeable senior debt		1,160		—
Income allocated to non-controlling interest		962		1,026

Dilutive net income available to shareholders		86,114		84,108


Denominator (Weighted Average Shares)
Basic Earnings:
Shares available to common shareholders		128,888		115,398
Effect of dilutive securities:
Restricted Stock Awards		26		23
OP Units		1,425		1,425
Exchangeable senior debt		3,741		—

Dilutive Shares		134,080		116,846

Note 14 – Non-controlling Interest - Operating Partnership

Non-controlling interest represents the aggregate OP Units in the Operating Partnership held by limited partners (the “Unit Holders”). Income allocated to the non-controlling interest is based on the Unit Holders’ ownership percentage of the Operating Partnership. The ownership percentage is determined by dividing the number of OP Units held by the Unit Holders by the total number of dilutive shares of common stock. The issuance of common stock (“Share” or “Shares”) or OP Units changes the percentage ownership of both the Unit Holders and the holders of common stock. Since an OP Unit is generally redeemable for cash or Shares at the option of the Company, it is deemed to be equivalent to a Share. Therefore, such transactions are treated as capital transactions and result in an allocation between shareholders’ equity and non-controlling interest in the accompanying consolidated balance sheet to account for the change in the ownership of the underlying equity in the Operating Partnership. As of March 31, 2013, non-controlling interest related to the outstanding 1,425,000 OP Units represented a 1.0% (2012: 1.2%) interest in the Operating Partnership, respectively. Income allocated to the Operating Partnership non-controlling interest for the three months ended March 31, 2013 was approximately $962,000 (2012: $1.0 million). For the three months ended March 31, 2013, distributions paid to the non-controlling interest were $926,300 (2012: $926,300).

Note 15 – Subsequent Events

The Company has reviewed subsequent events occurring through the date that these consolidation financial statements were issued, and determined that no subsequent events occurred that would require accrual or additional disclosure.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

In this quarterly report on Form 10-Q, or this “Report,” we refer to Invesco Mortgage Capital Inc. and its consolidated subsidiaries as “we,” “us,” “our Company,” or “our,” unless we specifically state otherwise or the context indicates otherwise. We refer to our external manager, Invesco Advisers, Inc., as our “Manager,” and we refer to the indirect parent company of our Manager, Invesco Ltd. (NYSE:IVZ) together with its consolidated subsidiaries (other than us), as “Invesco.”

The following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes to our consolidated financial statements, which are included in Item 1 of this report, as well as the information contained in our most recent Form 10-K filed with the Securities and Exchange Commission (the “SEC”).

Forward-Looking Statements

We make forward-looking statements in this Report and other filings we make with the SEC within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and such statements are intended to be covered by the safe harbor provided by the same. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, investment strategies, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may” or similar expressions and future or conditional verbs such as “will,” “may,” “could,” “should,” and “would,” and any other statement that necessarily depends on future events, we intend to identify forward-looking statements. Factors that could cause actual results to differ from those expressed in our forward-looking statements include, but are not limited to:

•

our business and investment strategy;

•

our investment portfolio;

•

our projected operating results;

•

actions and initiatives of the U.S. government, including the impact of Congressional debate on the U.S. debt ceiling and budget deficit, and changes to U.S. government policies, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and mortgage loan modification programs and our ability to respond to and comply with such actions, initiatives and changes;

•

our ability to obtain additional financing arrangements and the terms of such arrangements;

•

financing and advance rates for our target assets;

•

changes to our expected leverage;

•

general volatility of the markets in which we invest;

•

general volatility of foreign financial markets and their governments’ responses;

•

our expected investments;

•

our expected book value per share of common stock;

•

interest rate mismatches between our target assets and our borrowings used to fund such investments;

•

the adequacy of our cash flow from operations and borrowings to meet our short-term liquidity needs;

•

our ability to maintain sufficient liquidity to meet any margin calls;

•

changes in the credit rating of the U.S. government;

•

changes in interest rates and interest rate spreads and the market value of our target assets;

•

changes in prepayment rates on our target assets;

•

the impact of any deficiencies in foreclosure practices of third parties and related uncertainty in the timing of collateral disposition;

•

effects of hedging instruments on our target assets;

•

rates of default or decreased recovery rates on our target assets;

•

modifications to whole loans or loans underlying securities;

•

the degree to which our hedging strategies may or may not protect us from interest rate volatility;

•

counterparty defaults;

•

changes in governmental regulations, tax law and rates, and similar matters and our ability to respond to such changes;

•

our ability to maintain our qualification as a REIT for U.S. federal income tax purposes;

•

our ability to maintain our exception from the definition of “investment company” under the Investment Company Act of 1940, as amended (the “1940 Act”);

•

availability of investment opportunities in mortgage-related, real estate-related and other securities;

•

availability of U.S. Government Agency guarantees with regard to payments of principal and interest on securities;

•

availability of qualified personnel;

•

estimates relating to our ability to continue to make distributions to our shareholders in the future;

•

our understanding of our competition;

•

changes to accounting principles generally accepted in the United States of America (“US GAAP”); and

•

market trends in our industry, interest rates, real estate values, the debt securities markets or the general economy.

These forward-looking statements are based upon information presently available to our management and are inherently subjective, uncertain and subject to change. There can be no assurance that actual results will not differ materially from our expectations. We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks identified under the captions “Risk Factors,” “Forward-Looking Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Report and our most recent Form 10-K, which is available on the SEC’s website at www.sec.gov.

All written or oral forward-looking statements that we make, or that are attributable to us, are expressly qualified by this cautionary notice. We expressly disclaim any obligation to update the information in any public disclosure if any forward-looking statement later turns out to be inaccurate, except as may otherwise be required by law.

Overview

We are a Maryland corporation primarily focused on investing in, financing and managing residential and commercial mortgage-backed securities and mortgage loans which we collectively refer to as our target assets. We are externally managed and advised by Invesco Advisers, Inc., our Manager, which is an indirect, wholly-owned subsidiary of Invesco Ltd. We are a REIT for U.S. federal income tax purposes. Accordingly, we generally will not be subject to U.S. federal income taxes on our taxable income to the extent that we annually distribute currently to our shareholders as long as we maintain our qualification as a REIT. We operate our business in a manner that permits us to maintain our exclusion from the definition of “investment company” under the Investment Company Act of 1940, as amended (the “1940 Act”).

Our objective is to provide attractive risk-adjusted returns to our shareholders, primarily through dividends and secondarily through capital appreciation. To achieve this objective, we primarily invest in the following:

•

Agency RMBS, which are residential mortgage-backed securities, for which a U.S. government Agency such as the Government National Mortgage Association (“Ginnie Mae”) or a federally chartered corporation such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”) guarantees payments of principal and interest on the securities;

•

Non-Agency RMBS, which are RMBS that are not issued or guaranteed by a U.S. government agency or a federally chartered corporation;

•

CMBS, which are commercial mortgage-backed securities; and

•

Residential and commercial mortgage loans.

We finance the majority of our investments in Agency RMBS, non-Agency RMBS and CMBS through short-term borrowings structured as repurchase agreements. Our manager has secured commitments for us with a number of repurchase agreement counterparties. We have, in the past, financed our investments in certain non-Agency RMBS, CMBS and residential and commercial mortgage loans by contributing capital to the Invesco IMRF Fund that received financing under the U.S. government’s PIPP, established and managed by our Manager or one of its affiliates, which, in turn, invests in our target assets.

Recent Developments

On January 28, 2013, we completed a public offering of 15,000,000 shares of our common stock and an issuance of an additional 2,250,000 shares of common stock pursuant to the underwriters’ full exercise of their over-allotment option at $21.00 per share, resulting in net proceeds of approximately $359.0 million, after deducting underwriting discounts and estimated offering costs.

On March 12, 2013, our subsidiary issued $350.0 million in aggregate principal amount of our Exchangeable Senior Notes (the “Notes”) due 2018. Subsequently, on March 15, 2013, upon the exercise of the purchasers’ option, our subsidiary issued $50.0 in aggregate principal amount of the Notes for a total of $400.0 million. The Notes bear interest at 5.0% per annum, payable semi-annually in arrears on March 15 and September 15 of each year beginning September 15, 2013. The Notes are exchangeable into shares of our common stock at an initial exchange rate of 42.0893 shares of common stock per $1,000 principal amount of the Notes, subject to adjustment under certain circumstances.

On March 19, 2013, we declared a dividend of $0.65 per share of common stock. The dividend was paid on April 26, 2013 to shareholders of record as of the close of business on April 1, 2013.

On March 19, 2013, we declared a dividend of $0.4844 per share of Series A Preferred Stock. The dividend was paid on April 25, 2013 to shareholders of record as of the close of business on April 1, 2013.

On March 28, 2013, we purchased a controlling interest in a securitization trust which we determined to be a VIE. The securitization trust securitized a pool of 488 residential mortgage loans with an aggregate principal amount of $389.9 million and issued $389.9 million aggregate principal amount of ABS, of which $361.4 million of senior ABS and certain interest-only strips were sold to unaffiliated third parties, and $28.5 million of subordinate ABS and certain interest-only and designated cash classes were purchased by the Company We incurred $1.9 million in debt issuance and organizational costs related to this purchase.

Factors Impacting Our Operating Results

Our operating results can be affected by a number of factors and primarily depend on, among other things, the level of our net interest income, the market value of our assets and the supply of, and demand for, the target assets in which we invest. Our net interest income, which includes the amortization of purchase premiums and accretion of purchase discounts, varies primarily as a result of changes in market interest rates and prepayment speeds, as measured by the constant prepayment rate (“CPR”) on our target assets. Interest rates and prepayment speeds vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty.

Market Conditions

Beginning in the summer of 2007, significant adverse changes in financial market conditions resulted in a deleveraging of the entire global financial system. As part of this process, residential and commercial mortgage markets in the United States experienced a variety of difficulties, including loan defaults, credit losses and reduced liquidity. As a result, many lenders tightened their lending standards, reduced lending capacity, liquidated significant portfolios or exited the market altogether, and therefore, financing with attractive terms was generally unavailable. In response to these unprecedented events, the U.S. government has taken a number of actions to stabilize the financial markets and encourage lending. Significant measures include the enactment of the Emergency Economic Stabilization Act of 2008 to, among other things, establish the Troubled Asset Relief Program (“TARP”), the enactment of the Housing and Economic Recovery Act of 2008 (“HERA”), which established a new regulator for Fannie Mae and Freddie Mac and the establishment of the Term Asset-Backed Securities Loan Facility (“TALF”) and the PPIP. Some of these programs have expired and the impact of the wind-down of these programs on the financial sector and on the economic recovery is unknown. Continuing volatility in the RMBS markets may have an adverse effect on the market value and performance of the RMBS in which we invest. Moreover, we rely on financing to acquire, on a leveraged basis, the target assets in which we invest. If market conditions deteriorate, our lenders may exit the repurchase market, further tighten lending standards, or increase the amount of equity capital required to obtain financing making it more difficult and costly for us to obtain financing.

The Dodd-Frank Act enacted in July 2010, contains numerous provisions affecting the financial and mortgage industries, many of which may have an impact on our operating environment and the target assets in which we invest. Consequently, the Dodd-Frank Act may affect our cost of doing business, may limit our investment opportunities and may affect the competitive balance within our industry and market areas.

“Operation Twist,” was a program conducted by the U.S. Federal Reserve in 2011 and 2012. Pursuant to the first Operation Twist, instituted between September 2011 and June 2012, the Federal Reserve purchased $400 billion of U.S. Treasury securities with remaining maturities between 6 and 30 years and sold an equal amount of U.S. Treasury securities with remaining maturities of 3 years or less. From July 2012 through December 2012, the Federal Reserve deployed $267 billion to purchase Treasury securities with remaining maturities of 6 years to 30 years and sold or redeemed an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. While it is difficult to identify the specific impact Operation Twist had on our business, the program generally reduced asset values and lowered the interest income we received.

In December 2012, the Federal Reserve announced that it would replace “Operation Twist” with another round of long-term asset purchases, or quantitative easing, pursuant to which the Federal Reserve will continue to purchase $40 billion of Agency MBS as well as $45 billion of longer-term Treasury securities per month. We expect that during these large scale purchases of Agency MBS, yields on Agency MBS values will be lower and refinancing volumes will be higher. As a result, returns on our Agency MBS may be adversely affected.

The Federal Housing Finance Agency (“FHFA”) and the Department of the Treasury introduced the Home Affordable Refinance Program (“HARP”) in early 2009. HARP provides borrowers, who may not otherwise qualify for refinancing because of declining home values or reduced access to mortgage insurance, the ability to refinance their mortgages into a lower interest rate and/or more stable mortgage product. On October 24, 2011, the FHFA announced a series of changes to the rules regarding HARP with the intent of increasing the number of borrowers eligible to refinance their mortgage under this program. The FHFA announced changes to the guidelines related to loan-to-value, appraisals, and certain fees, among other things, subject to a variety of qualifications and the extension of the end date for HARP until December 31, 2015. It does not change the time period in which these loans were originated, maintaining the requirement that the loans must have been guaranteed by Fannie Mae or Freddie Mac on or before May 31, 2009. We do not expect the current HARP or future modifications to have a material impact on our results of operations in future periods.

On January 30, 2013, the U.S. Federal Reserve announced that it would keep the target range for the federal funds rate at zero to ¹/₄ percent as long as the unemployment rate remains above 6.5% or until inflation reaches 2.5%. Low levels of federal funds rates may reduce our borrowing costs. However, there can be no assurance that federal funds rates will remain near zero percent, or that such low levels will reduce our cost of funds.

Investment Activities

As of March 31, 2013, 51.2% (2012: 52.0%) of our equity was invested in Agency RMBS, 39.1% (2012: 28.5%) in non-Agency RMBS, 21.1% (2012: 17.1%) in CMBS, 1.1% in residential loans (2012: 0%), held-for-investments and 1.2% (2012: 2.4%) in other investments. We use leverage on our target assets to achieve our return objectives. With respect to our MBS portfolio, we focus on securities we believe provide attractive returns when levered approximately 3 to 7 times. The leverage on classes of assets may periodically exceed the stated ranges as we adjust our borrowings to obtain the best available source and minimize total interest expense, while maintaining our overall portfolio leverage guidelines.

The change in allocations between our classes of assets reflects our views on the current risk/return opportunities in the market for our target assets.

As of March 31, 2013, we held $12.2 billion (2012: $7.4 billion) 30-year fixed rate Agency RMBS securities that offered higher coupons and call protection based on the collateral attributes. In addition, we held $2.1 billion (2012: $2.5 billion) in 15-year fixed rate Agency RMBS securities, $486.3 million (2012: $1.5 billion) in hybrid adjustable-rate mortgages Agency RMBS (“ARMs”) and approximately $74.1 million (2012: $177.8 million) in Agency ARM RMBS we believe to have similar durations based on prepayment speeds. As of March 31, 2013, we held $3.6 billion (2012: $2.3 billion) non-Agency RMBS.

As of March 31, 2013, we owned $2.4 billion (2012: $1.2 billion) in CMBS. As of March 31, 2013, we held $503.1 million (2012: $456.8 million) in CMOs. In addition, as of March 31, 2013, we held $405.5 million of Residential loans, held for investments, securitized by $374.2 million of asset-backed securities issued.

During the three months ended March 31, 2013, we purchased $4.6 billion (2012: $2.3 billion) of mortgage-backed securities. The average yield on these purchases as of March 31, 2013 is 2.9% (2012: 3.1%).

During March 2013, we purchased a controlling interest in a $389.9 million securitization trust which we considered a VIE. The VIE holds 488 residential mortgage loans paying interest at an aggregate weighted average fixed rate of 3.77% and having an original stated maturity of 30 years.

Portfolio Characteristics

The table below represents the vintage of our credit assets as of March 31, 2013:


	2003			2004			2005			2006			2007			2008			2009			2010			2011			2012			2013			Total

Re-REMIC Senior (1)		—			—			—			—			0.2	%		—			0.7	%		5.0	%		32.6	%		11.2	%		—			49.7	%
Prime		0.5	%		1.2	%		4.6	%		5.1	%		13.2	%		2.9	%		—			—			0.3	%		—			4.6	%		32.4	%
Alt-A		—			0.3	%		5.3	%		5.8	%		6.2	%		—			—			—			—			—			—			17.6	%
Subprime		—			0.2	%		—			0.1	%		—			—			—			—			—			—			—			0.3	%

Total Non-Agency		0.5	%		1.7	%		9.9	%		11.0	%		19.6	%		2.9	%		0.7	%		5.0	%		32.9	%		11.2	%		4.6	%		100.0	%



CMBS		—			—			15.1	%		15.1	%		0.9	%		—			—			13.1	%		34.5	%		13.7	%		7.6	%		100.0	%

(1)

For Re-REMIC Seniors, the table reflects the year in which the resecuritizations were issued. The vintage distribution of the securities that collateralize the Company’s Re-REMIC Senior investments is 10.9% 2005, 37.8% 2006 and 51.3% 2007. Additionally, 6.2% of our Re-REMIC holdings are not senior classes.

The tables below represent the geographic concentration of the underlying collateral for our MBS portfolio as of March 31, 2013:


Non-Agency RMBS State	Percentage			CMBS State	Percentage
California		48.7	%	California		15.2	%
Florida		7.3	%	New York		11.8	%
New York		6.2	%	Texas		10.1	%
Virginia		3.6	%	Florida		5.5	%
Maryland	</

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