Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K

(Mark One)
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from                      to                     
Commission file number 001-34385
ivrsinglelogojpega20.jpg
(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)
Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, par value $0.01 per share
 
New York Stock Exchange
7.75% Series A Cumulative Redeemable Preferred Stock
 
New York Stock Exchange
7.75% Fixed-to-Floating Series B Cumulative Redeemable Preferred Stock
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Securities Exchange Act of 1934: None
________________________________________________ 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ý    No  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  ý
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  ý    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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ý
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):
Large accelerated filer
 
ý
Accelerated filer
 
¨
 
 
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  ý
The aggregate market value of the registrant’s common stock held by non-affiliates was $1,526,549,106 based on the closing sales price on the New York Stock Exchange on June 30, 2016. As of February 16, 2017, there were 111,594,595 outstanding shares of common stock of Invesco Mortgage Capital Inc.
Documents Incorporated by Reference
Part III of this Form 10-K incorporates by reference certain information (solely to the extent explicitly indicated) from the registrant’s proxy statement for the 2017 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A.
 



Invesco Mortgage Capital Inc.
TABLE OF CONTENTS
 
 
 
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
 
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
 
 
 
Item 15.
Item 16.
 
 
 


Table of Contents

Forward-Looking Statements
We make forward-looking statements in this Report on Form 10-K (“Report”) and other filings we make with the Securities and Exchange Commission (“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;
general volatility of financial markets and effects of governmental responses, including actions and initiatives of the U.S. governmental agencies and changes to U.S. government policies, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), mortgage loan modification programs, actions and initiatives of foreign governmental agencies and central banks, monetary policy actions of the Federal Reserve, including actions relating to its agency mortgage-backed securities portfolio and the continuation of re-investment of principal payments, and our ability to respond to and comply with such actions, initiatives and changes;
the availability of financing sources, including 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;
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;
our reliance on third parties in connection with services related to our target assets;
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 and foreign currency exchange rate volatility;
the degree to which derivative contracts expose us to contingent liabilities;
counterparty defaults;
compliance with financial covenants in our financing arrangements;
changes in governmental regulations, zoning, insurance, eminent domain and tax laws and rates, and similar matters and our ability to respond to such changes;


 
1
 

Table of Contents

our ability to maintain our qualification as a real estate investment trust 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;
the market price and trading volume of our capital stock;
availability of qualified personnel of our Manager;
the relationship with our Manager;
estimates relating to taxable income and our ability to continue to make distributions to our stockholders in the future;
estimates relating to fair value of our target assets and loan loss reserves;
our understanding of our competition;
changes to generally accepted accounting principles in the United States of America (“U.S. GAAP”);
the adequacy of our disclosure controls and procedures and internal controls over financial reporting; and
market trends in our industry, interest rates, real estate values, the debt securities markets or the general economy.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. You should not place undue reliance on these forward-looking statements. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. Some of these factors are described under the headings “Business”, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. New risks and uncertainties arise over time, and it is not possible for us to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.


 
2
 

Table of Contents

PART I
Item 1. Business.
Our Company
We are a Maryland corporation primarily focused on investing in, financing and managing residential and commercial mortgage-backed securities (“MBS”) and mortgage loans. Our objective is to provide attractive risk-adjusted returns to our investors, primarily through dividends and secondarily through capital appreciation. To achieve this objective, we primarily invest in the following:
Residential mortgage-backed securities (“RMBS”) that are guaranteed by 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”) (collectively “Agency RMBS”);
RMBS that are not guaranteed by a U.S. government agency (“non-Agency RMBS”);
Credit risk transfer securities that are unsecured obligations issued by government-sponsored enterprises (“GSE CRT”);
Commercial mortgage-backed securities (“CMBS”); 
Residential and commercial mortgage loans; and
Other real estate-related financing arrangements.
We were incorporated on June 5, 2008 and commenced operations in 2009. We have 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. To maintain our REIT qualification, we are generally required to distribute at least 90% of our REIT taxable income to our stockholders annually. We operate our business in a manner that permits our exclusion from the definition of an “Investment Company” under the 1940 Act.
Capital Activities
During the three months ended December 31, 2016, we did not repurchase any shares of our common stock. During the year ended December 31, 2016, we repurchased 2,063,451 shares of our common stock at an average repurchase price of $12.12 per share for a net cost of $25.0 million, including acquisition expenses. As of December 31, 2016, we had authority to purchase 18,239,082 shares of our common stock through our share repurchase program.
Our Manager
We are externally managed and advised by Invesco Advisers, Inc., our Manager, which is an indirect, wholly-owned subsidiary of Invesco Ltd. (“Invesco”). Our Manager provides us with our management team, including our officers and appropriate support personnel. Each of our officers is an employee of our Manager or one of its affiliates. We do not have any employees. Our Manager is not obligated to dedicate any of its employees exclusively to us, and our Manager and its employees are not obligated to dedicate any specific portion of time to our business. Our Manager is at all times subject to the supervision and oversight of our Board of Directors and has only such functions and authority as we delegate to it. Refer to “Certain Relationships and Related Transactions, and Director Independence” for a discussion of our management fee and our relationship with our Manager.


 
3
 

Table of Contents

Our Competitive Advantages
We believe that our competitive advantages include the following:
Significant Experience of Our Senior Management and Our Manager
Our senior management and structured investments team of our Manager has a long track record and broad experience in managing residential and commercial mortgage-related assets through a variety of credit and interest rate environments and has demonstrated the ability to generate attractive risk-adjusted returns under different market conditions and cycles. In addition, we benefit from the insight and capabilities of Invesco’s real estate team, through which we have access to broad and deep teams of experienced investment professionals in real estate and distressed investing. Through these teams, we have real time access to research and data on the mortgage and real estate industries. We believe having in-house access to these resources and expertise provides us with a competitive advantage over other companies investing in our target assets who have less internal resources and expertise.
Extensive Strategic Relationships and Experience of our Manager and its Affiliates
Our Manager maintains extensive long-term relationships with other financial intermediaries, including primary dealers, leading investment banks, brokerage firms, leading mortgage originators and commercial banks. We believe these relationships enhance our ability to source, finance and hedge investment opportunities and, thus, will enable us to grow in various credit and interest rate environments.
Disciplined Investment Approach
We seek to maximize our risk-adjusted returns through our disciplined investment approach, which relies on rigorous quantitative and qualitative analysis. Our Manager monitors our overall portfolio risk and evaluates the characteristics of our investments in our target assets including, but not limited to, asset type, interest rate, interest rate type, loan balance distribution, geographic concentration, property type, occupancy, loan-to-value ratio and credit score. In addition, with respect to any particular target asset, our Manager’s investment team evaluates, among other things, relative valuation, supply and demand trends, shape of yield curves, prepayment rates, loan delinquencies, default rates and loss severity rates. We believe this strategy and our commitment to capital preservation provide us with a competitive advantage when operating in a variety of market conditions.
Access to Our Manager’s Sophisticated Analytical Tools, Infrastructure and Expertise
Our Manager has created and maintains analytical and portfolio management capabilities to aid in asset selection and risk management. We capitalize on the market knowledge and ready access to data across our target markets that our Manager and its affiliates obtain through their established platforms. We focus on in-depth analysis of the numerous factors that influence our target assets, including: (1) fundamental market and sector review; (2) rigorous cash flow analysis; (3) disciplined asset selection; (4) controlled risk exposure; and (5) prudent balance sheet management. Through the use of these tools, we analyze factors that affect the rate at which mortgage prepayments occur, including changes in the level of interest rates, trends in residential and commercial real estate prices, general economic conditions, the locations of the properties securing the mortgage loans and other social and demographic conditions.
We also benefit from our Manager’s and its affiliates’ comprehensive financial and administrative infrastructure, including its risk management, financial reporting, legal and compliance teams.
Investment Strategy
We invest in a diversified pool of mortgage assets that generate attractive risk-adjusted returns. Our target assets generally include Agency RMBS, non-Agency RMBS, GSE CRT, CMBS, residential and commercial mortgage loans and other real estate-related financing arrangements. In addition to direct purchases of our target assets, we also invest in ventures managed by an affiliate of our Manager, which, in turn, invest in our target assets. We accept varying levels of interest rate risk by managing our hedge portfolio and accept credit and spread risk in order to earn income.
Agency RMBS
Agency RMBS are residential mortgage-backed securities issued by a U.S. government agency such as Ginnie Mae, or a federally chartered corporation such as Fannie Mae or Freddie Mac that are secured by a collection of mortgages. Payments of principal and interest on Agency RMBS, not the market value of the securities themselves, are guaranteed by the issuer. Agency RMBS differ from other forms of traditional debt securities, which normally provide for periodic payments of interest in fixed amounts with principal payments at maturity or on specified call dates. Instead, Agency RMBS provide for monthly payments


 
4
 

Table of Contents

of both principal and interest. In effect, these payments are a “pass-through” of scheduled and unscheduled principal payments and the monthly interest payments made by the individual borrowers on the mortgage loans, net of any fees paid to the servicers, guarantors or other related parties of the securities.
The principal may be prepaid at any time due to prepayments or defaults on the underlying mortgage loans. These differences can result in significantly greater price and yield volatility than is the case with other fixed-income securities.
Various factors affect the rate at which mortgage prepayments occur, including changes in the level and directional trends in housing prices, interest rates, general economic conditions, the age of the mortgage loan, the location of the property, social and demographic conditions, government initiated refinance programs, legislative regulations, and industry capacity. Generally, prepayments on Agency RMBS increase during periods of falling mortgage interest rates and decrease during periods of rising mortgage interest rates. However, this may not always be the case. We may reinvest principal repayments at a yield that is higher or lower than the yield on the repaid investment, thus affecting our net interest income by altering the average yield on our assets.
In addition, when interest rates are declining, the value of Agency RMBS with prepayment options may not increase as much as other fixed income securities. The rate of prepayments on underlying mortgages will affect the price and volatility of Agency RMBS and may have the effect of shortening or extending the duration of the security beyond what was anticipated at the time of purchase. When interest rates rise, our holdings of Agency RMBS may experience reduced returns if the owners of the underlying mortgages pay off their mortgages slower than previously anticipated. This is generally referred to as extension risk.
Mortgage pass-through certificates, collateralized mortgage obligations (“CMOs”), Freddie Mac Gold Certificates, Fannie Mae Certificates and Ginnie Mae Certificates are types of Agency RMBS that are collateralized by either fixed-rate mortgage loans (“FRMs”), adjustable-rate mortgage loans (“ARMs”), or hybrid ARMs. FRMs have an interest rate that is fixed for the term of the loan and do not adjust. The interest rates on ARMs generally adjust annually (although some may adjust more frequently) to an increment over a specified interest rate index. Hybrid ARMs have interest rates that are fixed for a specified period of time (typically three, five, seven or ten years) and, thereafter, adjust to an increment over a specified interest rate index. ARMs and hybrid ARMs generally have periodic and lifetime constraints on how much the loan interest rate can change on any predetermined interest rate reset date. Our allocation of our Agency RMBS collateralized by FRMs, ARMs or hybrid ARMs will depend on various factors including, but not limited to, relative value, expected future prepayment trends, supply and demand, costs of hedging, costs of financing, expected future interest rate volatility and the overall shape of the U.S. Treasury and interest rate swap yield curves. We take these factors into account when we make investments.
Non-Agency RMBS
Non-Agency RMBS are residential mortgage-backed securities that are not issued or guaranteed by a U.S. government agency. Like Agency RMBS, non-Agency RMBS represent interests in “pools” of mortgage loans secured by residential real property. The mortgage loan collateral for non-Agency RMBS generally consists of residential mortgage loans that do not conform to the U.S. government agency underwriting guidelines due to certain factors including mortgage balance in excess of such guidelines, borrower characteristics, loan characteristics and level of documentation. We invest in securities collateralized by the following types of mortgage loans:
Prime and Jumbo Prime Mortgage Loans
Prime mortgage loans are mortgage loans that generally require borrower credit histories, debt-to-income ratios and loan-to-value ratios similar to those dictated by GSE underwriting guidelines, though in certain cases they may not meet the same income documentation or other requirements. Jumbo prime mortgage loans are mortgage loans with requirements similar to prime mortgage loans except that the mortgage balance exceeds the maximum amount permitted by GSE underwriting guidelines.
Alt-A Mortgage Loans
Alt-A mortgage loans are mortgage loans made to borrowers whose qualifying mortgage characteristics do not conform to GSE underwriting guidelines, but whose borrower characteristics may. Generally, Alt-A mortgage loans allow homeowners to qualify for a mortgage loan with reduced or alternative forms of documentation. The credit quality of Alt-A borrowers generally exceeds the credit quality of subprime borrowers.
Subprime Mortgage Loans
Subprime mortgage loans are loans that do not conform to GSE underwriting guidelines. Subprime borrowers generally have imperfect or impaired credit histories and low credit scores.


 
5
 

Table of Contents

Reperforming Mortgage Loans
Reperforming mortgage loans are residential mortgage loans that have a history of delinquency and generally have been restructured since origination.  Reperforming mortgage loans may or may not have originally conformed to GSE underwriting guidelines.  Due to past delinquencies, borrowers generally have impaired credit histories and low credit scores, and may have a greater than normal risk of future delinquencies and defaults.
We also invest in non-Agency RMBS structured as re-securitizations of a real estate mortgage investment conduit (“Re-REMIC”). A Re-REMIC is a transaction in which an existing security or securities is transferred to a special purpose entity that has formed a securitization vehicle that has issued multiple classes of securities secured by and payable from cash flows on the underlying securities.
Government-Sponsored Enterprises Credit Risk Transfer Securities
GSE CRTs are unsecured general obligations of Fannie Mae and Freddie Mac that are structured to provide credit protection to the issuer with respect to defaults and other credit events within pools of residential mortgage loans that collateralize MBS issued and guaranteed by the GSEs.  This credit protection is achieved by allowing the GSEs to reduce the outstanding class principal balance of the securities as designated credit events on the loans arise. The GSEs make monthly payments of accrued interest and periodic payments of principal to the holders of the securities.  To date, all GSE CRTs have paid a floating interest rate benchmarked to one-month LIBOR.
CMBS
CMBS are securities backed by obligations (including certificates of participation in obligations) that are principally secured by commercial mortgages on real property or interests therein having a multifamily or commercial use, such as regional malls, retail space, office buildings, industrial or warehouse properties, hotels, apartments, nursing homes and senior living facilities.
CMBS are typically issued in multiple tranches whereby the more senior classes are entitled to priority distributions to make specified interest and principal payments on such tranches. Losses and other shortfalls from expected amounts to be received on the mortgage pool are borne by the most subordinate classes, which receive payments only after the more senior classes have received all principal and/or interest to which they are entitled. The credit quality of CMBS depends on the credit quality of the underlying mortgage loans, which is a function of factors such as the principal amount of loans relative to the value of the related properties, the mortgage loan terms, such as amortization, market assessment and geographic location, construction quality of the property, and the creditworthiness of the borrowers.
Commercial Mortgage Loans
Commercial mortgage loans are mortgage loans secured by first or second liens on commercial properties such as regional malls, retail space, office buildings, industrial or warehouse properties, hotels, apartments, nursing homes and senior living facilities. These loans, which tend to range in term from two to ten years, can carry either fixed or floating interest rates. They generally permit pre-payments before final maturity but may require the payment to the lender of yield maintenance pre-payment penalties. First lien loans represent the senior lien on a property while second lien loans or second mortgages represent a subordinate or second lien on a property.
Mezzanine Loans
Mezzanine loans are generally structured to represent a senior position in the borrower’s equity in, and subordinate to a first mortgage loan, on a property. These loans are generally secured by pledges of ownership interests, in whole or in part, in entities that directly or indirectly own the real property. At times, mezzanine loans may be secured by additional collateral, including letters of credit, personal guarantees, or collateral unrelated to the property. Mezzanine loans may be structured to carry either fixed or floating interest rates as well as carry a right to participate in a percentage of gross revenues and a percentage of the increase in the fair market value of the property securing the loan. Mezzanine loans may also contain prepayment lockouts, penalties, minimum profit hurdles and other mechanisms to protect and enhance returns to the lender. Mezzanine loans usually have maturities that match the maturity of the related mortgage loan but may have shorter or longer terms.
Unconsolidated Ventures
We have investments in unconsolidated ventures. In circumstances where we have a non-controlling interest but we are deemed to be able to exert significant influence over the affairs of the enterprise, we utilize the equity method of accounting.


 
6
 

Table of Contents

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.
Financing Strategy
We generally finance our investments through short- and long-term borrowings structured as repurchase agreements and secured loans. We have historically financed our residential loans held-for-investment through asset-backed securities issued by consolidated securitization trusts. We have also financed investments through the issuances of debt and equity, and may utilize other forms of financing in the future.
Repurchase Agreements
Repurchase agreements are financings pursuant to which we sell our target assets to the repurchase agreement counterparty, the buyer, for an agreed upon price with the obligation to repurchase these assets from the buyer at a future date and at a price higher than the original purchase price. The amount of financing we receive under a repurchase agreement is limited to a specified percentage of the estimated market value of the assets we sell to the buyer. The difference between the sale price and repurchase price is the cost, or interest expense, of financing under a repurchase agreement. Under repurchase agreement financing arrangements, certain buyers require us to provide additional cash collateral in the event the market value of the asset declines to maintain the ratio of value of the collateral to the amount of borrowing.
Secured Loans
Our wholly-owned subsidiary, IAS Services LLC, is a member of the Federal Home Loan Bank of Indianapolis (“FHLBI”). As a member of the FHLBI, IAS Services LLC has borrowed funds from the FHLBI in the form of secured advances. FHLBI advances are treated as secured financing transactions and are carried at their contractual amounts. The Federal Housing Finance Agency’s (“FHFA”) final rule governing Federal Home Loan Bank membership (the “FHFA Rule”) became effective on February 19, 2016. The FHFA Rule, among other provisions, excludes captive insurance companies from membership eligibility. The FHFA Rule permits existing captive insurance companies, such as IAS Services LLC, to remain members until February 2021. New advances or renewals that mature after February 2021 are prohibited. As permitted by the FHFA Rule, the FHLBI has indicated it will honor the contractual maturity dates of existing advances to IAS Services LLC that were made prior to the effective date of the final FHFA Rule and extend beyond February 2021.
Leverage
We use leverage on our target assets to achieve our return objectives, which are adjusted as our investment and financing opportunities change. The amount of leverage we apply to a given asset depends primarily on the expected price volatility and liquidity of the asset we use as collateral, the type of financing, the advance rate against our collateral, and the cost of financing. Shorter duration and higher quality liquid assets generally merit higher leverage due to lower price volatility, higher advance rates, and more attractive financing rates. Assets that are less liquid or exhibit higher price volatility tend to be held unlevered or with lower leverage applied.
We include a table that shows the allocation of our equity to our target assets, our debt-to-equity ratio, and our repurchase agreement debt-to-equity ratio (a non-GAAP financial measure of leverage) in Item 7, “Management's Discussion and Analysis of Operations” of this Report.
Risk Management Strategy
Market Risk Management
Risk management is an integral component of our strategy to deliver returns to our stockholders. Because we invest in MBS, investment losses from prepayment, interest rate volatility or other risks can meaningfully impact our earnings and our distributions to stockholders. In addition, because we employ financial leverage in funding our investment portfolio, mismatches in the maturities of our assets and liabilities can create the need to continually renew or otherwise refinance our liabilities. Our results are dependent upon a positive spread between the returns on our asset portfolio and our overall cost of funding. To minimize the risks to our portfolio, we actively employ portfolio-wide and security-specific risk measurement and management processes in our daily operations. Our Manager’s risk management tools include software and services licensed or purchased from third parties, in addition to proprietary software and analytical methods developed by Invesco.
Interest Rate Risk
We engage in a variety of interest rate management techniques that seek to mitigate the influence of interest rate changes on the costs of liabilities and help us achieve our risk management objective. Specifically, we seek to hedge our exposure to potential interest rate mismatches between the interest we earn on our investments and our borrowing costs caused by


 
7
 

Table of Contents

fluctuations in short-term interest rates. We may utilize various derivative financial instruments including puts and calls on securities or indices of securities, futures, interest rate swaps and swaptions, interest rate caps, exchange-traded derivatives, U.S. Treasury securities and options on U.S. Treasury securities and interest rate floors to hedge all or a portion of the interest rate risk associated with the financing of our investment portfolio.
Spread Risk
We employ a variety of spread risk management techniques that seek to mitigate the influences of spread changes on our book value and our liquidity to help us achieve our investment objectives. We refer to the difference between interest rates on our investments and interest rates on risk free instruments as spreads. The yield on our investments changes over time due to the level of risk free interest rates, the creditworthiness of the security, and the price of the perceived risk. The change in the market yield of our interest rate hedges also changes primarily with the level of risk free interest rates. We manage spread risk through careful asset selection, sector allocation, regulating our portfolio value-at-risk, and maintaining adequate liquidity. Changes in spreads impact our book value and our liquidity and could cause us to sell assets and to change our investment strategy in order to maintain liquidity and preserve book value.
Credit Risk
We believe that our investment strategy will generally keep our credit losses and financing costs low. However, we retain the risk of potential credit losses on all of our residential and commercial mortgage investments. We seek to manage this risk in part through our pre-acquisition due diligence process. In addition, we re-evaluate the credit risk inherent in our investments on a regular basis pursuant to fundamental considerations such as gross domestic product (“GDP”), unemployment, interest rates, retail sales, store closings/openings, corporate earnings, housing inventory, affordability and regional home price trends. We also review key loan credit metrics including, but not limited to, payment status, current loan-to-value ratios, current borrower credit scores and debt yields. These characteristics assist in determining the likelihood and severity of loan loss as well as prepayment and extension expectations. We then perform structural analysis under multiple scenarios to establish likely cash flow profiles and credit enhancement levels relative to collateral performance projections. This analysis allows us to quantify our opinions of credit quality and fundamental value, which are key drivers of portfolio management decisions.
Liquidity Risk
We engage in a variety of liquidity management techniques to mitigate the risk of volatility in the marketplace, which may bring significant security price fluctuations, associated margin calls, changing cash needs, and variability in counterparty financing terms.  We perform statistical analysis in order to measure and quantify our required liquidity needs under multiple scenarios and time horizons.  Liquidity in the form of cash, unencumbered assets, and future cash inflows is consistently monitored and evaluated versus internal targets. 
Foreign Exchange Rate Risk
We have an investment in a commercial loan denominated in foreign currency and an investment in an unconsolidated joint venture whose net assets and results of operations are exposed to foreign currency translation risk when translated in U.S. dollars upon consolidation. We seek to hedge our foreign currency exposures by purchasing currency forward contracts.
Investment Guidelines
Our board of directors has adopted the following investment guidelines:
no investment shall be made that would cause us to fail to qualify as a REIT for federal income tax purposes;
no investment shall be made that would cause us to be regulated as an investment company under the 1940 Act;
our assets will be invested within our target assets; and
until appropriate investments can be identified, our Manager may pay off short-term debt, or invest the proceeds of any offering in interest-bearing, short-term investments, including funds that are consistent with maintaining our REIT qualification.
These investment guidelines may be changed from time to time by our board of directors without the approval of our stockholders.
Investment Committee
Our investment committee is comprised of certain of our officers and certain of our Manager’s investment professionals. The investment committee periodically reviews our investment portfolio for risk characteristics, investment performance,


 
8
 

Table of Contents

liquidity, portfolio composition, leverage and other applicable items. It also reviews its compliance with our investment policies and procedures, including our investment guidelines, and our Manager provides our board of directors an investment performance report at the end of each quarter in conjunction with its review of our quarterly results.
Investment Process
Our Manager’s investment team has a strong focus on asset selection and on the relative value of various sectors within the mortgage market. Our Manager utilizes this expertise to build a diversified portfolio. Our Manager incorporates its views on the economic environment and the outlook for the mortgage market, including relative valuation, supply and demand trends, the level of interest rates, the shape of the yield curve, prepayment rates, financing and liquidity, housing prices, delinquencies, default rates and loss severity rates of various collateral types.
Our investment process includes sourcing and screening investment opportunities, assessing investment suitability, conducting interest rate and prepayment analysis, evaluating cash flow and collateral performance, reviewing legal structure and servicer and originator information and investment structuring, as appropriate, to ensure an attractive return commensurate with the risk we are bearing. Upon identification of an investment opportunity, the investment will be screened and monitored by our Manager to determine its impact on maintaining our REIT qualification and our exemption from registration under the 1940 Act. We make investments in sectors where our Manager has strong core competencies and where we believe market risk and expected performance can be reasonably quantified.
Our Manager evaluates each of our investment opportunities based on its expected risk-adjusted return relative to the returns available from other, comparable investments. In addition, we evaluate new opportunities based on their relative expected returns compared to assets held in our portfolio. The terms of any leverage available to us for use in funding an investment purchase are also taken into consideration, as are any risks posed by illiquidity or correlations with other assets in the portfolio. Our Manager also develops a macro outlook with respect to each target asset class by examining factors in the broader economy such as gross domestic product, interest rates, unemployment rates and availability of credit, among other factors. Our Manager analyzes fundamental trends in the relevant target asset class sector to adjust or maintain its outlook for that particular target asset class. These macro decisions guide our Manager’s assumptions regarding model inputs and portfolio allocations among target assets. Additionally, our Manager conducts extensive diligence with respect to each target asset class by, among other things, examining and monitoring the capabilities and financial wherewithal of the parties responsible for the origination, administration and servicing of relevant target assets.
Competition
Our net income depends, in large part, on our ability to acquire assets at favorable spreads over our borrowing costs. In acquiring our investments, we compete with other REITs, specialty finance companies, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, financial institutions, governmental bodies and other entities. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Conditions.” In addition, there are numerous REITs with similar asset acquisition objectives. These other REITs increase competition for the available supply of mortgage assets suitable for purchase. Many of our competitors are significantly larger than we are, have access to greater capital and other resources and may have other advantages over us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than we can. Market conditions may attract more competitors, which may increase the competition for sources of financing. An increase in the competition for sources of financing could adversely affect the availability and cost of financing.
We have access to our Manager’s professionals and their industry expertise, which we believe provides us with a competitive advantage. These professionals help us assess investment risks and determine appropriate pricing for certain potential investments. These relationships enable us to compete more effectively for attractive investment opportunities. Despite certain competitive advantages, we may not be able to achieve our business goals or expectations due to the competitive risks that we face. For additional information concerning these competitive risks, refer to “Risk Factors — Risks Related to Our Investments — We operate in a highly competitive market for investment opportunities and competition may limit our ability to acquire desirable investments in our target assets and could also affect the pricing of these securities.”



 
9
 

Table of Contents

Our Corporate Information
Our principal executive offices are located at 1555 Peachtree Street, N.E., Suite 1800, Atlanta, Georgia 30309. Our telephone number is (404) 892-0896. Our website is www.invescomortgagecapital.com. We make available free of charge, through our corporate website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information on our website is not intended to form a part of or be incorporated by reference into this Report.

Item 1A. Risk Factors.
Set forth below are the material risks and uncertainties that, if they were to occur, could materially and adversely affect our business, financial condition, results of operations and the trading price of our securities. Additional risks not presently known, or that we currently deem immaterial, also may have a material adverse effect on our business, financial condition and results of operation.
Risks Related to Our Investments
Difficult conditions in the mortgage, residential and commercial real estate markets may cause us to experience market losses related to our investments.
Our results of operations are materially affected by conditions in the mortgage market, the residential and commercial real estate markets, the financial markets and the economy generally. Ongoing concerns about the mortgage market and real estate market, as well as inflation, energy costs, geopolitical issues and the availability and cost of credit, continue to contribute to market volatility. There is a strong correlation between home price growth rates and mortgage loan delinquencies. Any deterioration of the real estate market may cause us to experience losses related to our assets and to sell assets at a loss.
Declines in the market values of our investments may adversely affect our results of operations and credit availability, which may reduce earnings and, in turn, cash available for distribution to our stockholders. In addition, a substantial portion of our investments are classified for accounting purposes as “available-for-sale.” Changes in the market values of those assets will be directly charged or credited to stockholders' equity. As a result, a decline in values may reduce our book value.
Because assets we acquire may experience periods of illiquidity, we may lose profits or be prevented from earning capital gains if we cannot sell mortgage-related assets at an opportune time.
We bear the risk of being unable to dispose of our target assets at advantageous times or in a timely manner because mortgage-related assets generally experience periods of illiquidity. The lack of liquidity may result from the absence of a willing buyer or an established market for these assets, as well as legal or contractual restrictions on resale or the unavailability of financing for these assets. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited, which may cause us to incur losses.
In addition, some of the assets that comprise our investment portfolio and that we acquire are not publicly traded. These securities may be less liquid than publicly-traded securities. The illiquidity of our investments may make it difficult for us to sell such investments if the need or desire arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our investments. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be relatively limited, which could adversely affect our results of operations and financial condition.
Our investments may be concentrated and will be subject to risk of default.
While we diversify and intend to continue to diversify our portfolio of investments, we are not required to observe specific diversification criteria, except as may be set forth in the investment guidelines adopted by our board of directors. Therefore, our investments in our target assets may at times be concentrated in certain property types that are subject to higher risk of foreclosure, or secured by properties concentrated in a limited number of geographic locations. For example, as of December 31, 2016, a significant percentage of our non-Agency RMBS, GSE CRTs and CMBS was secured by property located in California, as well as New York with respect to our CMBS. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Investment Activities - Portfolio Characteristics” for additional information. To the extent that our portfolio is concentrated in any one region or type of security, downturns relating generally to such region or type of security may result in defaults on a number of our investments within a short time period, which may reduce our net income and the value of our capital stock and accordingly reduce our ability to pay dividends to our stockholders.


 
10
 

Table of Contents

We operate in a highly competitive market for investment opportunities and competition may limit our ability to acquire desirable investments in our target assets and could also affect the pricing of these securities.
We operate in a highly competitive market for investment opportunities. Our profitability depends, in large part, on our ability to acquire our target assets at attractive prices. In acquiring our target assets, we compete with a variety of institutional investors, including other REITs, specialty finance companies, public and private funds (including other funds managed by Invesco), commercial and investment banks, commercial finance and insurance companies and other financial institutions. Many of our competitors are substantially larger and have considerably greater financial, technical, marketing and other resources than we do. Some competitors may have a lower cost of funds and access to funding sources that may not be available to us, such as funding from the U.S. government, if we are not eligible to participate in programs established by the U.S. government. Many of our competitors are not subject to the operating constraints associated with REIT tax compliance or maintenance of an exemption from the 1940 Act. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships. Furthermore, competition for investments in our target assets may lead to the price of such assets increasing, which may further limit our ability to generate desired returns. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, desirable investments in our target assets may be limited in the future and we may not be able to take advantage of attractive investment opportunities from time to time, as we can provide no assurance that we will be able to identify and make investments that are consistent with our investment objectives.
We may invest in investments with which our stockholders may not agree.
Our stockholders will be unable to evaluate the manner in which we invest or the economic merit of our expected investments and, as a result, we may invest in investments with which our stockholders may not agree. The failure of our management to find investments that meet our investment criteria could cause a material adverse effect on our business, financial condition, liquidity, results of operations and ability to make distributions to our stockholders, and could cause the value of our capital stock to decline.
We acquire mortgage-backed and credit risk transfer securities and loans that are subject to defaults, foreclosure timeline extension, fraud and residential and commercial price depreciation, and unfavorable modification of loan principal amount, interest rate and amortization of principal, which could result in losses to us.
Mortgage-backed securities are secured by mortgage loans (primarily single family residential properties for RMBS and single commercial mortgage loans or a pool of commercial mortgage loans for CMBS). GSE CRTs are unsecured obligations of Fannie Mae and Freddie Mac. Coupon payments on GSE CRTs are based on LIBOR, and principal payments and losses are based on prepayments and defined credit events in a reference pool of mortgage loans that collateralize Agency RMBS. Accordingly, our MBS and GSE CRT investments are subject to all the risks of the respective underlying mortgage loans, including risks of defaults, foreclosure timeline extension, fraud, price depreciation and unfavorable modification of loan principal amount, interest rate and amortization of principal.
The ability of a borrower to repay a mortgage loan secured by a residential property is dependent in part upon the income and assets of the borrower. A number of factors over which we have no control may impair a borrower’s ability to repay their loans.
Commercial mortgage loans are secured by multifamily or commercial property and are subject to risks of delinquency and foreclosure, and risks of loss that may be greater than similar risks associated with loans made on the security of single-family residential property. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired. Net operating income of an income-producing property can be affected by a number of factors over which we have no control.
In the event of any default under a mortgage loan held directly by us, we bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan, which could have a material adverse effect on our cash flow from operations. In the event of defaults on the mortgage loans that underlie our investments and the exhaustion of any underlying or any additional credit support, we may not realize our anticipated return on our investments and we may incur a loss on these investments.
Our investments include non-Agency RMBS collateralized by Alt-A and subprime mortgage loans, which are subject to increased risks.
Our investments include non-Agency RMBS backed by collateral pools of mortgage loans known as “Alt-A mortgage loans,” or “subprime mortgage loans.” These loans have been originated using underwriting standards that are less restrictive


 
11
 

Table of Contents

than those used in underwriting “prime mortgage loans.” These lower standards include mortgage loans made to borrowers having imperfect or impaired credit histories, mortgage loans where the amount of the loan at origination is 80% or more of the value of the mortgage property, mortgage loans made to borrowers who have other debt that represents a large portion of their income and mortgage loans made to borrowers whose income is not required to be disclosed or verified. Due to economic conditions, a decline in home prices, and aggressive lending practices, many Alt-A and subprime mortgage loans have experienced increased rates of delinquency, foreclosure, bankruptcy and loss, and they are likely to continue to experience delinquency, foreclosure, bankruptcy and loss rates that are higher, and that may be substantially higher, than those experienced by mortgage loans underwritten in a more traditional manner. Thus, because of the higher delinquency rates and losses associated with many Alt-A and subprime mortgage loans, the performance of non-Agency RMBS backed by Alt-A and subprime mortgage loans that we may acquire could be correspondingly adversely affected, which could adversely impact our results of operations, financial condition and business.
Our subordinated MBS assets may be in the “first loss” position, subjecting us to greater risks of loss.
We invest in certain tranches of MBS that are only entitled to a portion of the principal and interest payments made on mortgage loans underlying the securities issued by the trust. In general, losses on a mortgage loan included in a RMBS trust will be borne first by the equity holder of the issuing trust if any, and then by the “first loss” subordinated security holder and then by the “second loss” subordinate holder and so on. For CMBS assets, losses on a mortgaged property securing a mortgage loan included in a securitization will be borne first by the equity holder of the property, then by a cash reserve fund or letter of credit, if any, then by the holder of a mezzanine loan or B-Note, if any, then by the “first loss” subordinated security holder (generally, the “B-Piece” buyer) and then by the holder of a higher-rated security.
We may acquire securities at every level of such a trust, from the equity position to the most senior tranche. In the event of default and the exhaustion of any classes of securities junior to those which we acquire, our securities will suffer losses as well. In addition, if we overvalue the underlying mortgage portfolio, or if the values subsequently decline and, as a result, less collateral is available to satisfy interest and principal payments due on the related MBS, the securities which we acquire may effectively become the “first loss” position ahead of the more senior securities, which may result in significant losses. The prices of lower credit quality securities are generally less sensitive to interest rate changes than more highly rated securities, but more sensitive to adverse economic downturns or individual issuer developments. A projection of an economic downturn could cause a decline in the value of lower credit quality securities because the ability of obligors of mortgages underlying MBS to make principal and interest payments may be impaired. In such event, existing credit support in the securitization structure may be insufficient to protect us against loss of our principal on these securities.
Fluctuations in interest rates could adversely affect the value of our investments and cause our interest expense to increase, which could result in reduced earnings, affect our profitability and dividends as well as the cash available for distribution to our stockholders.
Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Interest rate fluctuations present a variety of risks, including the risk of a narrowing of the difference between asset yields and borrowing rates, flattening or inversion of the yield curve and fluctuating prepayment rates, and may adversely affect our income and the value of our assets and capital stock.
We invest in Agency RMBS, non-Agency RMBS, GSE CRTs, CMBS and mortgage loans that are subject to risks related to interest rate fluctuations. In a normal yield curve environment, short-term interest rates are lower than long-term interest rates. Fluctuations in short- or long-term interest rates could have adverse effects on our operations and financial condition, which may negatively affect cash available for distribution to our stockholders. Fluctuations in interest rates could impact us as follows:
If long-term rates increased significantly, the market value of investments in our target assets would decline, and the duration and weighted average life of the investments may increase. We could realize a loss if the securities were sold. Further, declines in market value may reduce book value and ultimately reduce earnings or result in losses to us.
An increase in short-term interest rates would increase the amount of interest owed on the repurchase agreements we enter into to finance the purchase of our investments.
If short-term interest rates rise disproportionately relative to longer-term interest rates (a flattening of the yield curve), our borrowing costs may increase more rapidly than the interest income earned on our assets. Because we expect our investments, on average, generally will bear interest based on longer-term rates than our borrowings, a flattening of the yield curve would tend to decrease our net income. Additionally, to the extent cash flows from investments that return scheduled and unscheduled principal are reinvested, the spread between the yields on the new investments and available borrowing rates may decline, which would likely decrease our net income.


 
12
 

Table of Contents

If short-term interest rates exceed longer-term interest rates (a yield curve inversion), our borrowing costs may exceed our interest income and we could incur operating losses.
If interest rates fall, we may recognize losses on our swap positions that are not offset by gains on our assets, which may adversely affect our liquidity and financial position.
In a period of rising interest rates, our operating results will depend in large part on the difference between the income from our assets and financing costs. We anticipate that, in most cases, the income from such assets will respond more slowly to interest rate fluctuations than the cost of our borrowings. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income. Increases in these rates will tend to decrease our net income and the market value of our assets and may negatively affect cash available for distribution to our stockholders.
In addition, market values of our investments may decline without any general increase in interest rates for a number of reasons, such as increases or expected increases in defaults, or increases or expected increases in voluntary prepayments for those investments that are subject to prepayment risk or widening of credit spreads, which may negatively affect cash available for distribution to our stockholders.
An increase in interest rates may cause a decrease in the volume of certain of our target assets which could adversely affect our ability to acquire target assets that satisfy our investment objectives and to generate income and pay dividends.
Rising interest rates generally reduce the demand for mortgage loans due to the higher cost of borrowing. A reduction in the volume of mortgage loans originated may affect the volume of target assets available to us, which could adversely affect our ability to acquire assets that satisfy our investment objectives. Rising interest rates may also cause our target assets that were issued prior to an interest rate increase to provide yields that are below prevailing market interest rates. If rising interest rates cause us to be unable to acquire a sufficient volume of our target assets with a yield that is above our borrowing cost, our ability to satisfy our investment objectives and to generate income and pay dividends may be materially and adversely affected.
We may not control the special servicing of the mortgage loans included in the MBS in which we invest and, in such cases, the special servicer may take actions that could adversely affect our interests.
With respect to each series of MBS in which we invest, overall control over the special servicing of the related underlying mortgage loans is held by a “directing certificate holder” or a “controlling class representative,” which is appointed by the holders of the most subordinate class of MBS in such series. Depending on the class of MBS in which we invest, we may not have the right to appoint the directing certificate holder. In connection with the servicing of the specially serviced mortgage loans, the related special servicer may, at the direction of the directing certificate holder, take actions with respect to the specially serviced mortgage loans that could adversely affect our interests.
We and our third party loan originators and servicers’ due diligence of potential assets may not reveal all of the liabilities associated with such assets and may not reveal other weaknesses in such assets, which could lead to losses.
Before making an asset acquisition, we will assess the strengths and weaknesses of the originator or issuer of the asset as well as other factors and characteristics that are material to the performance of the asset. In making the assessment and otherwise conducting customary due diligence, we will rely on resources available to us, including our third party loan originators and servicers. This process is particularly important with respect to newly formed originators or issuers because there may be little or no information publicly available about these entities and assets. There can be no assurance that our due diligence process will uncover all relevant facts or that any asset acquisition will be successful, which could lead to losses in the value of our portfolio.
We depend on third-party service providers, including mortgage servicers, for a variety of services related to our RMBS. We are, therefore, subject to the risks associated with third-party service providers.
We depend on a variety of services provided by third-party service providers related to our RMBS. We rely on the mortgage servicers who service the mortgage loans backing our RMBS to, among other things, collect principal and interest payments and administer escrow accounts on the underlying mortgages and perform loss mitigation services. At times, mortgage servicers and other service providers to our RMBS, such as trustees, bond insurance providers and custodians, may not perform in a manner that promotes our interests.
For example, recent legislation intended to reduce or prevent foreclosures through, among other things, loan modifications, short sales and other foreclosure alternatives, may reduce the value of mortgage loans underlying our RMBS. Mortgage servicers may be incentivized to pursue such loan modifications, as well as forbearance plans and other actions intended to prevent foreclosure, even if such loan modifications and other actions are not in the best interests of the beneficial owners of the mortgage loans.  Similarly, legislation at both the federal and state level delaying the initiation or completion of foreclosure proceedings on specified types of residential mortgage loans or otherwise limiting the ability of mortgage servicers to take actions that may be essential to preserve the value of the mortgage loans may also reduce the value of mortgage loans


 
13
 

Table of Contents

underlying our RMBS. Any such limitations are likely to cause delayed or reduced collections from mortgagors and generally increase servicing costs and potential foreclosure-related litigation. As a consequence of the foregoing matters, our business, financial condition and results of operations may be adversely affected.
In addition, federal and state governmental and regulatory bodies have pursued settlement agreements with a number of mortgage servicers to address alleged servicing and foreclosure deficiencies related to foreclosure practices, staffing levels and/ or documentation. These agreements may result in the temporary delay of foreclosure proceedings while certain third party servicers modify their foreclosure practices. The extension of foreclosure timelines may increase the backlog of foreclosures and the inventory of distressed homes on the market and create greater uncertainty about housing prices. Prior to making investments in non-Agency RMBS, we carefully consider many factors, including housing prices and foreclosure timelines, and formulate loss assumptions. The concerns about deficiencies in foreclosure practices of servicers may impact our loss assumptions and affect the values of, and our returns on, our investments in non-Agency RMBS.
Our commercial loans held-for investment include investments that involve greater risks of loss than senior loan assets secured by income-producing properties.
We may acquire mezzanine loans, which take the form of subordinated loans secured by second mortgages on the underlying property or loans secured by a pledge of the ownership interests of either the entity owning the property or the entity that owns the interest in the entity owning the property. These types of assets involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property, because the loan may become unsecured as a result of foreclosure by the senior lender. In the event of a bankruptcy of the entity providing the pledge of its ownership interests as security, we may not have full recourse to the assets of such entity, or the assets of the entity may not be sufficient to satisfy our mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt. As a result, we may not recover some or all of our initial expenditure. In addition, mezzanine loans may have higher loan-to-value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal.
In addition, we may make commercial loans structured as preferred equity investments. These investments involve a higher degree of risk than conventional debt financing due to a variety of factors, including their non-collateralized nature and subordinated ranking to other loans and liabilities of the entity in which such preferred equity is held. Accordingly, if the issuer defaults on our investment, we would only be able to proceed against such entity in accordance with the terms of the preferred security, and not against any property owned by such entity. Furthermore, in the event of bankruptcy or foreclosure, we would only be able to recoup our investment after all lenders to, and other creditors of, such entity are paid in full. As a result, we may lose all or a significant part of our investment, which could result in significant losses.
We may acquire B-Notes, mortgage loans typically (i) secured by a first mortgage on a single large commercial property or group of related properties, and (ii) subordinated to an A-Note secured by the same first mortgage on the same collateral. As a result, if a borrower defaults, there may not be sufficient funds remaining for B-Note holders after payment to the A-Note holders. However, because each transaction is privately negotiated, B-Notes can vary in their structural characteristics and risks. For example, the rights of holders of B-Notes to control the process following a borrower default may vary from transaction to transaction. Further, B-Notes typically are secured by a single property and reflect the risks associated with significant concentration.
Significant losses related to our commercial loans held for investment would result in operating losses for us and may limit our ability to make distributions to our stockholders.
If we foreclose on an asset, we may come to own and operate the property securing the loan, which would expose us to the risks inherent in that activity.
When we foreclose on an asset, we may take title to the property securing that asset, and if we do not or cannot sell the property, we would then come to own and operate it as “real estate owned.” Owning and operating real property involves risks that are different (and in many ways more significant) than the risks faced in owning an asset secured by that property. In addition, we may end up owning a property that we would not otherwise have decided to acquire directly at the price of our original investment or at all. We may not manage these properties as well as they might be managed by another owner, and our returns to investors could suffer. If we foreclose on and come to own property, our financial performance and returns to stockholders could suffer.
Liability relating to environmental matters may impact the value of properties that we may acquire or foreclose on.
If we acquire or foreclose on properties with respect to which we have extended mortgage loans, we may be subject to environmental liabilities arising from such foreclosed properties. Under various U.S. federal, state and local laws, an owner or operator of real property may become liable for the costs of removal of certain hazardous substances released on its property.


 
14
 

Table of Contents

These laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances.
The presence of hazardous substances may adversely affect an owner’s ability to sell real estate or borrow using real estate as collateral. To the extent that an owner of a property underlying one of our debt investments becomes liable for removal costs, the ability of the owner to make payments to us may be reduced, which in turn may adversely affect the value of the relevant mortgage asset held by us and our ability to make distributions to our stockholders. If we acquire any properties, the presence of hazardous substances on a property may adversely affect our ability to sell the property and we may incur substantial remediation costs, thus harming our financial condition. The discovery of material environmental liabilities attached to such properties could have a material adverse effect on our results of operations and financial condition and our ability to make distributions to our stockholders.
 We may experience a decline in the market value of our mortgage-backed and credit risk transfer securities.
We are required to recognize an "other-than-temporary" impairment under U.S. GAAP if we experience a decline in the market value of our mortgage-backed and credit risk transfer securities if such assets are in an unrealized loss position and we determine that we intend to sell and it is more likely than not that we will be required to sell such assets before recovery of the amortized cost of such assets. If such a determination were to be made, we would recognize unrealized losses through earnings and write down the amortized cost of such assets to a new cost basis, based on the fair market value of such assets on the date they are considered to be other-than-temporarily impaired. Such impairment charges reflect non-cash losses at the time of recognition; subsequent disposition or sale of such assets could further affect our future losses or gains, as they are based on the difference between the sale price received and adjusted amortized cost of such assets at the time of sale.
If our Manager underestimates the collateral loss on our investments, we may experience losses.
Our Manager values our potential investments based on loss-adjusted yields, taking into account estimated future losses on the mortgage loans that collateralize the investments, and the estimated impact of these losses on expected future cash flows. Our Manager’s loss estimates may not prove accurate, as actual results may vary from estimates. In the event that our Manager underestimates the pool level losses relative to the price we pay for a particular investment, we may experience losses with respect to such investment.
Our mortgage-backed and credit risk transfer securities are recorded at estimated fair value and, as a result, there is uncertainty as to the value of these investments.
Some of our mortgage-backed and credit risk transfer securities are in the form of securities that are not publicly or actively traded. The fair value of mortgage-backed and credit risk transfer securities that are not publicly or actively traded may not be readily determinable. We value these investments quarterly at fair value, which may include unobservable inputs. Because such valuations are subjective, the fair value of certain of our assets may fluctuate over short periods of time and our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. The value of our capital stock could be adversely affected if our determinations regarding the fair value of these investments were materially higher than the values that we ultimately realize upon their disposal.
Prepayment rates may adversely affect the value of our investment portfolio.
Pools of residential mortgage loans underlie the RMBS that we acquire. In the case of residential mortgage loans, there are seldom any restrictions on borrowers’ abilities to prepay their loans. We generally receive prepayments of principal that are made on these underlying mortgage loans. When borrowers prepay their mortgage loans faster than expected, the prepayments on the RMBS are also faster than expected. Faster than expected prepayments could adversely affect our profitability, including in the following ways:
We may purchase RMBS that have a higher interest rate than the market interest rate at the time. In exchange for this higher interest rate, we may pay a premium over the par value to acquire the security. In accordance with U.S. GAAP, we may amortize this premium over the estimated term of the RMBS. If the RMBS is prepaid in whole or in part prior to its maturity date, however, we may be required to expense the premium that was prepaid at the time of the prepayment.
A substantial portion of our adjustable-rate RMBS may bear interest rates that are lower than their fully indexed rates, which are equivalent to the applicable index rate plus a margin. If an adjustable-rate RMBS is prepaid prior to or soon after the time of adjustment to a fully-indexed rate, we will have held that RMBS while it was least profitable and lost the opportunity to receive interest at the fully indexed rate over the remainder of its expected life.
If we are unable to acquire new RMBS similar to the prepaid RMBS, our financial condition, results of operation and cash flow would suffer. Prepayment rates generally increase when interest rates fall and decrease when interest rates


 
15
 

Table of Contents

rise, but changes in prepayment rates are difficult to predict. Prepayment rates also may be affected by conditions in the housing and financial markets, general economic conditions and the relative interest rates on FRMs and ARMs.
While we seek to minimize prepayment risk to the extent practical, in selecting investments we must balance prepayment risk against other risks and the potential returns of each investment. No strategy can completely insulate us from prepayment risk.
Market conditions may upset the historical relationship between interest rate changes and prepayment trends, which would make it more difficult for us to analyze our investment portfolio.
Our success depends on our ability to analyze the relationship of changing interest rates on prepayments of the mortgage loans that underlie our RMBS and mortgage loans we acquire. Changes in interest rates and prepayments affect the market price of the target assets. As part of our overall portfolio risk management, we analyze interest rate changes and prepayment trends separately and collectively to assess their effects on our investment portfolio. In conducting our analysis, we depend on certain assumptions based upon historical trends with respect to the relationship between interest rates and prepayments under normal market conditions. If dislocations in the mortgage market or other developments change the way that prepayment trends have historically responded to interest rate changes, our ability to (1) assess the market value of our investment portfolio, (2) implement our hedging strategies, and (3) implement techniques to reduce our prepayment rate volatility would be significantly affected, which could materially adversely affect our financial position and results of operations.

Risks Related to Financing and Hedging
We use leverage in executing our business strategy, which may adversely affect the return on our assets and may reduce cash available for distribution to our stockholders, as well as increase losses when economic conditions are unfavorable.
We use leverage to finance our assets through borrowings from repurchase agreements and other secured and unsecured forms of borrowing (including Federal Home Loan Bank advances), and we contribute capital to equity investments. The amount of leverage we may deploy for particular assets will depend upon our Manager’s assessment of the credit and other risks of those assets and is limited by our debt covenants.
Our access to financing depends upon a number of factors over which we have little or no control, including:
general market conditions;
the lender’s view of the quality of our assets, valuation of our assets and our liquidity;
the lender’s perception of our growth potential;
regulatory requirements of the Federal Housing Finance Authority or Federal Home Loan Bank;
our current and potential future earnings and cash distributions; and
the market price of the shares of our capital stock.
Any weakness or volatility in the financial markets, the residential and commercial mortgage markets or the economy generally could adversely affect the factors listed above. In addition, such weakness or volatility could adversely affect one or more of our potential lenders and could cause one or more of our potential lenders to be unwilling or unable to provide us with financing or to increase the costs of that financing. Some of our target assets may be more difficult to finance than others and the market for such financing can change based on many factors over which we have little or no control.
The return on our assets and cash available for distribution to our stockholders may be reduced to the extent that market conditions prevent us from leveraging our assets or cause the cost of our financing to increase relative to the income that can be derived from the assets acquired. Our financing costs will reduce cash available for distributions to stockholders. We may not be able to meet our financing obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to liquidation or sale to satisfy the obligations.
Adverse market conditions and a significantly expanded regulatory environment may make it more difficult for us to secure financing.
Our results of operations are materially affected by conditions in the financial markets and the economy generally. Continuing concerns over the expansion of consumer protection rules and regulations, regulatory enforcement actions and their impact on underwriting standards and the overall availability of consumer credit, as well as inflation, energy price volatility, geopolitical issues, unemployment, the cost of credit, the mortgage market and the real estate market contribute to market volatility.
Dramatic declines in residential and commercial real estate prices and increased loan defaults could result in significant asset writedowns by financial institutions, which could cause financial institutions to seek additional capital, to merge with other institutions or, in some cases, to fail. In addition, interest rates may experience volatility over concerns related to actual or


 
16
 

Table of Contents

anticipated economic growth rates, unemployment, inflation or uncertainty regarding future U.S. monetary policy.  Declines in the value of our assets, or perceived market uncertainty about their value, may make it difficult for us to secure financing on favorable terms, or at all, and to comply with the terms of our existing financing agreements.  Further, our profitability may be adversely affected by this significantly expanded regulatory environment and aggressive enforcement climate in addition to the prospect of liquidity challenges if we are unable to secure financing for our assets.
We depend on repurchase agreement financing to acquire our target assets and our inability to access this funding on acceptable terms could have a material adverse effect on our results of operations, financial condition and business.
We use repurchase agreement financing as a strategy to increase the return on our assets. However, we may not be able to achieve our desired leverage ratio for a number of reasons, including if the following events occur:
our lenders do not make repurchase agreement financing available to us at acceptable rates;
certain of our lenders exit the repurchase market;
our lenders require that we pledge additional collateral to cover our borrowings, which we may be unable to do; or
we determine that the leverage would expose us to excessive risk.
Our ability to fund our target assets may be impacted by our ability to secure repurchase agreement financing on acceptable terms. We can provide no assurance that lenders will be willing or able to provide us with sufficient financing. In addition, because repurchase agreements are short-term commitments of capital, lenders may respond to market conditions making it more difficult for us to secure continued financing. During certain periods of the credit cycle, lenders may curtail their willingness to provide financing. For example, in response to market conditions lenders have in the past and may in the future increase financing rates and decrease advance rates. Repurchase agreement counterparties have taken these steps in order to compensate themselves for a perceived increased risk due to the illiquidity of the underlying collateral. In some cases, margin calls have forced borrowers to liquidate collateral in order to meet the capital requirements of these margin calls, resulting in losses. In addition, if major market participants were to exit the repurchase agreement financing business, the value of our portfolio could be negatively impacted, thus reducing net stockholder equity, or book value. Furthermore, if many of our current or potential lenders are unwilling or unable to provide us with repurchase agreement financing, we could be forced to sell our assets at an inopportune time when prices are depressed. In addition, if the regulatory capital requirements imposed on our lenders change, they may be required to significantly increase the cost of the financing that they provide to us. Our lenders also may revise their eligibility requirements for the types of assets they are willing to finance or the terms of such financings, based on, among other factors, the regulatory environment and their management of perceived risk, particularly with respect to assignee liability.
If a counterparty to our repurchase transactions defaults on its obligation to resell the underlying security back to us at the end of the transaction term, if the value of the underlying security has declined as of the end of that term, or if we default on our obligations under the repurchase agreement, we may incur a loss on our repurchase transactions.
When we engage in repurchase transactions, we generally sell securities to lenders (repurchase agreement counterparties) and receive cash from these lenders. The lenders are obligated to resell the same or similar securities back to us at the end of the term of the transaction. Because the cash we receive from the lender when we initially sell the securities to the lender is less than the value of those securities (this difference is the haircut), if the lender defaults on its obligation to resell the same securities back to us we may incur a loss on the transaction equal to the amount of the haircut (assuming there was no change in the value of the securities). As of December 31, 2016, two counterparties held collateral that exceeded the amounts borrowed under the related repurchase agreements by more than $113.5 million, or 5% of our stockholders’ equity. Refer to Note 7 - “Borrowings” of our consolidated financial statements included in Part IV, Item 15 of this Report, for additional detail. We may incur a loss on a repurchase transaction if the value of the underlying securities has declined as of the end of the transaction term, as we would have to repurchase the securities for their initial value but would receive securities worth less than that amount. Further, if we default on one of our obligations under a repurchase transaction, the lender can terminate the transaction and cease entering into any other repurchase transactions with us. Some of our repurchase agreements contain cross-default provisions, so that if a default occurs under any one agreement, the lenders under our other agreements could also declare a default. Any losses we incur on our repurchase transactions could adversely affect our earnings and thus our cash available for distribution to our stockholders.
The repurchase agreements, secured loans and other financing arrangements that we use to finance our investments may require us to provide additional collateral and may restrict us from leveraging our assets as fully as desired.
The amount of financing we receive, or may in the future receive, under our repurchase agreements, secured loans and other financing arrangements, is directly related to the lenders’ valuation of the assets that secure the outstanding borrowings. Lenders under our repurchase agreements and secured loans typically have the absolute right to reevaluate the market value of the assets that secure outstanding borrowings at any time. If a lender determines in its sole discretion that the value of the assets has decreased, it has the right to initiate a margin call or increase collateral requirements. A margin call or increased collateral


 
17
 

Table of Contents

requirements would require us to transfer additional assets to such lender without any advance of funds from the lender for such transfer or to repay a portion of the outstanding borrowings. Any such margin call or increased collateral requirements could have a material adverse effect on our results of operations, financial condition, business, liquidity and ability to make distributions to our stockholders, and could cause the value of our capital stock to decline. We may be forced to sell assets at significantly depressed prices to meet such margin calls and to maintain adequate liquidity, which could cause us to incur losses. Moreover, to the extent we are forced to sell assets at such time, given market conditions, we may be selling at the same time as others facing similar pressures, which could exacerbate a difficult market environment and which could result in our incurring significantly greater losses on our sale of such assets. In an extreme case of market duress, a market may not even be present for certain of our assets at any price. Such a situation would likely result in a rapid deterioration of our financial condition and possibly necessitate a filing for bankruptcy protection.
Further, financial institutions providing the repurchase facilities may require us to maintain a certain amount of cash uninvested or to set aside non-levered assets sufficient to maintain a specified liquidity position which would allow us to satisfy our collateral obligations. In addition, the FHLBI could increase our collateral requirements. As a result, we may not be able to leverage our assets as fully as desired, which could reduce our return on equity. If we are unable to meet these collateral obligations, our financial condition could deteriorate rapidly.

A failure to comply with covenants in our repurchase agreements, secured loans and other financing arrangements would have a material adverse effect on us, and any future financings may require us to provide additional collateral or pay down debt.

We are subject to various covenants contained in our existing financing arrangements and may become subject to additional covenants in connection with future financings. Many of our master repurchase agreements, as well as our FHLBI financing arrangements and swap agreements, require us to maintain compliance with various financial covenants, including a minimum tangible net worth, specified financial ratios, such as total debt to total assets and financial information delivery obligations. These covenants may limit our flexibility to pursue certain investments or incur additional debt. If we fail to meet or satisfy any of these covenants, we would be in default under these agreements, and our lenders could elect to declare outstanding amounts due and payable, terminate their commitments, require the posting of additional collateral and/or enforce their interests against existing collateral. We may also be subject to cross-default and acceleration rights and, with respect to collateralized debt, the posting of additional collateral and foreclosure rights upon default. Further, this could also make it difficult for us to satisfy the distribution requirements necessary to maintain our status as a REIT for U.S. federal income tax purposes.
Our use or future use of repurchase agreements to finance our target assets may give our lenders greater rights in the event that either we or a lender files for bankruptcy.
Our borrowings or future borrowings under repurchase agreements for our target assets may qualify for special treatment under the U.S. Bankruptcy Code, giving our lenders the ability to avoid the automatic stay provisions of the U.S. Bankruptcy Code and to take possession of and liquidate the assets that we have pledged under their repurchase agreements without delay in the event that we file for bankruptcy. Furthermore, the special treatment of repurchase agreements under the U.S. Bankruptcy Code may make it difficult for us to recover our pledged assets in the event that a lender party to such agreement files for bankruptcy. Therefore, our use of repurchase agreements to finance our investments exposes our pledged assets to risk in the event of a bankruptcy filing by either a lender or us.
We enter into hedging transactions that could expose us to contingent liabilities in the future.
Part of our investment strategy involves entering into hedging transactions that could require us to fund cash payments in certain circumstances (such as the early termination of the hedging instrument caused by an event of default or other early termination event, or the decision by a counterparty to request margin securities it is contractually owed under the terms of the hedging instrument). The amount due would be equal to the unrealized loss of the open swap positions with the respective counterparty and could also include other fees and charges. Such economic losses would be reflected in our results of operations, and our ability to fund these obligations would depend on the liquidity of our assets and access to capital at the time, and the need to fund these obligations could adversely impact our financial condition.
Hedging may adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.
We pursue various hedging strategies to seek to reduce our exposure to adverse changes in interest rates and currency exchange rates. Our hedging activity varies in scope based on the level and volatility of interest rates, currency exchange rates, the type of assets held and other changing market conditions. Hedging may fail to protect or could adversely affect us because, among other things:
interest rate and/or currency hedging can be expensive, particularly during periods of rising and volatile interest rates;
available interest rate hedges may not correspond directly with the interest rate risk for which protection is sought;


 
18
 

Table of Contents

due to a credit loss, the duration of the hedge may not match the duration of the related liability;
the amount of income that a REIT may earn from hedging transactions (other than hedging transactions that satisfy certain requirements of the Internal Revenue Code or that are done through a taxable REIT subsidiary (“TRS”)) to offset interest rate losses is limited by U.S. federal tax provisions governing REITs;
the credit quality of the hedging counterparty owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and
the hedging counterparty owing money in the hedging transaction may default on its obligation to pay.
Our hedging transactions, which are intended to limit losses, may actually adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.
In addition, the enforceability of agreements underlying hedging transactions may depend on compliance with applicable statutory and commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. Any actions taken by regulators could constrain our investment strategy and could increase our costs, either of which could materially and adversely impact our results of operations.
The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in its default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our commitments, if any, at the then current market price. Although generally we seek to reserve the right to terminate our hedging positions, it may not always be possible to dispose of or close out a hedging position without the consent of the hedging counterparty and we may not be able to enter into an offsetting contract in order to cover our risk. We cannot assure you that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.
We may enter into derivative contracts that expose us to contingent liabilities and those contingent liabilities may not appear on our balance sheet. We may invest in synthetic securities, credit default swaps, and other credit derivatives, which expose us to additional risks.
We have entered, and may again in the future, enter into derivative contracts that could require us to make cash payments in certain circumstances. Potential payment obligations would be contingent liabilities and may not appear on our balance sheet. Our ability to satisfy these contingent liabilities depends on the liquidity of our assets and our access to capital and cash. The need to fund these contingent liabilities could adversely impact our financial condition.
We may invest in synthetic securities, credit default swaps, and other credit derivatives that reference other real estate securities or indices. These investments may present risks in excess of those resulting from the referenced security or index. These investments are typically a contractual relationship with counterparties and not an acquisition of a referenced security or other asset. In these types of investments, we have no right to directly enforce compliance with the terms of the referenced security or other assets and we have no voting or other consensual rights of ownership with respect to the referenced security or other assets. In the event of insolvency of a counterparty, we will be treated as a general creditor of the counterparty and will have no claim of title with respect to the referenced security.
The markets for these types of investments may not be liquid. Many of these investments incorporate “pay as you go” credit events. For example, the terms of credit default swaps are still evolving and may change significantly, which could make it more difficult to assign such an instrument or determine the “loss” pursuant to the underlying agreement. In a credit default swap, the party wishing to “buy” protection will pay a premium. When interest rates, spreads or the prevailing credit premiums on credit default swaps change, the amount of the termination payment due could change by a substantial amount. In an illiquid market, the determination of this change could be difficult to ascertain and, as a result, we may not achieve the desired benefit of entering into this contractual relationship. As of December 31, 2016, we have no outstanding credit default swaps. We may over time enter into these types of investments as the market for them grows and during times when acquiring other real estate loans and securities may be difficult. We may find credit default swaps and other forms of synthetic securities to be a more efficient method of providing exposure to target investments. Our efforts to manage the risk associated with these investments, including counterparty risks, may prove to be insufficient in enabling us to generate the returns anticipated.


 
19
 

Table of Contents

Risks Related to Our Company
Maintaining 1940 Act exclusions for our subsidiaries imposes limits on our operations. Failure to maintain an exclusion could have a material negative impact on our operations.
We conduct our operations so that neither we, nor our operating partnership, IAS Operating Partnership LP (the “Operating Partnership”) nor the subsidiaries of the Operating Partnership are required to register as an investment company under the 1940 Act.
Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. We believe neither we nor our Operating Partnership will be considered an investment company under Section 3(a)(1)(A) of the 1940 Act because neither we nor our Operating Partnership will engage primarily or hold ourselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through our Operating Partnership’s wholly-owned or majority-owned subsidiaries, we and our Operating Partnership will be primarily engaged in the non-investment company businesses of these subsidiaries, namely the business of purchasing or otherwise acquiring real property, mortgages and other interests in real estate.
Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis, which we refer to as the 40% test. Excluded from the term “investment securities,” among other things, are U.S. government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.
We are a holding company that conduct businesses through the Operating Partnership and the Operating Partnership’s wholly-owned or majority-owned subsidiaries. Both we and the Operating Partnership conduct our operations so that we comply with the 40% test. Accordingly, the securities issued by these subsidiaries that are excepted from the definition of “investment company” under Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any other investment securities the Operating Partnership may own, may not have a value in excess of 40% of the value of the Operating Partnership's total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. Compliance with the 40% test limits the types of businesses in which we are permitted to engage through our subsidiaries. Furthermore, IAS Asset I LLC and certain of the Operating Partnership’s other subsidiaries that we may form in the future intend to rely upon an exception from the definition of investment company under Section 3(c)(5)(C) of the 1940 Act, which is available for entities “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” This exception generally requires that at least 55% of a subsidiary’s portfolio must be comprised of qualifying assets and at least 80% of its portfolio must be comprised of qualifying assets and real estate-related assets (and no more than 20% comprised of miscellaneous assets). In analyzing a subsidiary's compliance with Section 3(c)(5)(C) of the 1940 Act, we classify investments based in large measure on SEC staff guidance, including no-action letters, and, in the absence of SEC guidance, on our view of what constitutes a qualifying real estate asset and a real estate-related asset.
Qualification for exception from the definition of investment company under the 1940 Act limits our ability to make certain investments. Therefore, IAS Asset I LLC and the Operating Partnership’s other subsidiaries may need to adjust their respective assets and strategy from time-to-time in order to continue to rely on the exception from the definition of investment company under Section 3(c)(5)(C) of the 1940 Act. Any such adjustment in assets or strategy is not expected to have a material adverse effect on our business or strategy. There can be no assurance that we will be able to maintain this exception from the definition of investment company for IAS Asset I LLC and the Operating Partnership’s other subsidiaries intending to rely on Section 3(c)(5)(C) of the 1940 Act.
We may in the future organize one or more subsidiaries that seek to rely on other exceptions from being deemed an investment company under the 1940 Act, such as the exception provided to certain structured financing vehicles by Rule 3a-7. Any such subsidiary would need to be structured to comply with any guidance that may be issued by the SEC staff on the restrictions contained in Rule 3a-7 or any other exception on which we seek to rely.
There can be no assurance that the laws and regulations governing the 1940 Act status of REITs will not change in a manner that adversely affects our operations or inhibits our ability to pursue our strategies. Any issuance of more specific or different guidance relating to the relevant exemptions and exceptions from the definition of an investment company under the 1940 Act could similarly affect or inhibit our operations. If we, the Operating Partnership or its subsidiaries fail to maintain an exception or exemption from the 1940 Act, we could, among other things, be required to (a) change the investments that we hold or the manner in which we conduct our operations to avoid being required to register as an investment company, (b) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so, or (c) register as an investment company. Any of these events could cause us to incur losses and negatively affect the value of our capital stock, the


 
20
 

Table of Contents

sustainability of our business model, and our ability to make distributions, which could have an adverse effect on our business and the market price for our shares of capital stock. In addition, if it were established that we were an unregistered investment company, there would be a risk that we would be subject to monetary penalties or injunctive relief imposed by the SEC.
We may be adversely affected by the current and future economic, regulatory and other actions of government bodies and their agencies.
The U.S. government, Federal Reserve, U.S. Treasury, SEC and other governmental and regulatory bodies have taken a number of economic actions and regulatory initiatives designed to stabilize and stimulate the economy and the financial markets, and additional actions and initiatives may occur in the future.
In addition, foreign financial markets have experienced significant volatility related to events such as the European debt crisis, declining currencies in certain emerging markets and governments’ and central banks' responses. Such responses have included the implementation of various financial reforms including but not limited to development of the Basel III standards by the Basel Committee on Banking Supervision.
More broadly, uncertainties regarding geopolitical developments can produce volatility in global financial markets. In this regard, the United Kingdom (“U.K.”) electorate voted on June 23, 2016 to exit the European Union (“Brexit”), resulting in market volatility that may continue during the negotiation process.  This may impact foreign exchange rate and create regulatory changes, which could have an adverse effect on our business connected with commercial loans originated in the U.K.
There can be no assurance that, in the long term, actions that governments and regulatory bodies or central banks have taken in the past or may take in the future will improve the efficiency and stability of mortgage or financial markets. To the extent the financial markets do not respond favorably to any of these actions or such actions do not function as intended, our business may be harmed. In addition, because the programs are designed, in part, to improve the markets for certain of our target assets, the establishment of these programs may result in increased competition for attractive opportunities in our target assets or, in the case of government-backed refinancing and modification programs, may have the effect of reducing the revenues associated with certain of our target assets. We cannot predict whether or when additional actions or initiatives to stabilize and stimulate the economy and the financial markets may occur, and such actions could have an adverse effect on our business, results of operations and financial condition.
We may change any of our strategies, policies or procedures without stockholder consent.
We may change any of our strategies, policies or procedures with respect to investments, acquisitions, growth, operations, indebtedness, capitalization and distributions at any time without the consent of our stockholders, which could result in an investment portfolio with a different risk profile. A change in our investment strategy may increase our exposure to interest rate risk, default risk and real estate market fluctuations. Furthermore, a change in our asset allocation could result in our making investments in asset categories different from those described in this Report. These changes could adversely affect our business, financial condition, results of operations, the market price of our capital stock and our ability to make distributions to our stockholders.
We are highly dependent on information systems and systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our capital stock and our ability to pay dividends.
Our business is highly dependent on third parties’ information systems, including our Manager and other service providers. Any failure or interruption of such systems or cyber-attacks or security breaches could cause delays or other problems in our securities trading activities and financial, accounting and other data processing activities, which could have a material adverse effect on our operating results and negatively affect the market price of our capital stock and our ability to pay dividends to our stockholders. In addition, we also face the risk of operational failure, termination or capacity constraints of any of the third parties with which we do business or that facilitate our business activities, including clearing agents or other financial intermediaries we use to facilitate our securities transactions.
Computer malware, viruses and computer hacking and phishing attacks have become more prevalent in our industry and may occur on our Manager's and other service providers' systems in the future. We rely heavily on our and our third party providers’ financial, accounting and other data processing systems. It is difficult to determine what, if any, negative impact may directly result from any specific interruption or cyber-attacks or security breaches of such networks or systems or any failure to maintain the performance, reliability and security of our technical infrastructure. As a result, any computer malware, viruses and computer hacking and phishing attacks may negatively affect our operations.


 
21
 

Table of Contents

We may repurchase shares of our common stock or other securities from time to time.  Share repurchases may negatively impact our compliance with covenants in our financing agreements and regulatory requirements (including maintaining exclusions from the requirements of the 1940 Act and qualification as a REIT). Any compliance failures associated with share repurchases could have a material negative impact on our business, financial condition and results of operations.  Share repurchases also may negatively impact our ability to invest in our target assets in the future.
As of December 31, 2016, 18,239,082 shares of common stock were available under our Board authorized share repurchase program.  We may engage in share repurchases from time-to-time through open market purchases, including block purchases or privately negotiated transactions, or pursuant to any trading plan that may adopted in accordance with Rules 10b5-1 and 10b-18 of the Exchange Act.  Certain of our financing agreements have financial covenants, including covenants related to maintaining a certain level of stockholders equity, that may be impacted by our share repurchases.  In addition, we generally fund share repurchases with interest income or income from the sale of our assets.  The sale of assets to fund share repurchases could impact the allocation of our portfolio for purposes of maintaining an exclusion from the requirements of the 1940 Act and could impact our ability to comply with income and asset tests required to qualify as a REIT.  The failure to comply with covenants in our financing agreements, to maintain our exemption from the 1940 Act or to qualify as a REIT could have a material negative impact on our business, financial condition and results of operations.  In addition, our decision to repurchase shares of our common stock or other securities and reduce our stockholders' equity could negatively impact our competitive position with peer mortgage REIT companies and other competitors and could negatively impact our ability in the future to invest in assets that have a greater potential return than the repurchase of our common stock.
Our independent registered public accounting firm has advised us that it identified an issue related to an independence requirement contained in the Securities Exchange Act of 1934 regulations regarding auditor independence.
In May 2016, PricewaterhouseCoopers LLP (“PwC”) advised us that it had identified an issue related to its independence under Rule 2-01(c)(1)(ii)(A) of Regulation S-X (the “Loan Rule”) with respect to certain of PwC’s lenders who own certain Invesco registered funds managed by our Manager or certain other investment adviser affiliates of Invesco Ltd., our Manager's parent company. The Company and such funds are required to have their financial statements audited by a public accounting firm that qualifies as independent under various SEC rules. As discussed below, the Staff of the Securities and Exchange Commission (the “SEC Staff”) has issued a “no-action” letter to another mutual fund complex under substantially similar circumstances that provides temporary relief for eighteen months from the date of the no-action letter issuance.
The Loan Rule prohibits accounting firms, such as PwC, from having certain financial relationships with their audit clients and affiliated entities. Specifically, the Loan Rule provides, in relevant part, that an accounting firm is not independent if it receives a loan from a lender that is a “record or beneficial owner of more than ten percent of the audit client’s equity securities.” For purposes of the Loan Rule, audit clients include the Company, all of the registered investment companies advised by affiliates of Invesco Ltd., as well as Invesco Ltd. and its other subsidiaries (collectively, the “Invesco Fund Complex”) for which PwC also serves as independent auditor. PwC informed us it has relationships with lenders who hold, as record owner, more than ten percent of the shares of certain funds within the Invesco Fund Complex. These relationships call into question PwC’s independence under the Loan Rule with respect to those funds, as well as the Company and all other funds in the Invesco Fund Complex.
On June 20, 2016, the SEC Staff issued a “no-action” letter to another mutual fund complex (see Fidelity Management & Research Company et al., No-Action Letter) related to the audit independence issue described above. In that letter, the SEC Staff confirmed that it would not recommend enforcement action against an audit client that relied on audit services performed by an audit firm that was not in compliance with the Loan Rule in certain specified circumstances. The circumstances described in the no-action letter appear to be substantially similar to the circumstances that called into question PwC’s independence under the Loan Rule with respect to the Invesco Fund Complex, including the Company. We therefore believe that we can rely on the letter to continue to issue financial statements that are audited by PwC, and we intend to do so. The SEC Staff has indicated that the no-action relief will expire eighteen months from its issuance (i.e., on December 20, 2017). PwC has advised the Audit Committee that it is continuing to have discussions with the SEC Staff regarding permanent relief.
If in the future the independence of PwC is called into question under the Loan Rule by circumstances that are not addressed in the SEC Staff’s no-action letter or permanent relief regarding this matter is not granted by the SEC, we will need to take other action and incur additional costs in order for our filings with the SEC containing financial statements to be deemed compliant with applicable securities laws. Such action may include obtaining the review and audit of the financial statements filed by the Company by another independent registered public accounting firm. In addition, under such circumstances the Company’s eligibility to issue securities under its existing registration statements on Form S-3 and Form S-8 may be impacted and certain financial reporting covenants with our counterparties may be impacted. A default under our financing agreements could have a material adverse effect on our business, results of operations, financial condition and stock price.


 
22
 

Table of Contents

Risks Related to Accounting
The preparation of our financial statements involves use of estimates, judgments and assumptions, and our financial statements may be materially affected if our estimates prove to be inaccurate.
Financial statements prepared in accordance with U.S. GAAP require the use of estimates, judgments and assumptions that affect the reported amounts. Different estimates, judgments and assumptions reasonably could be used that would have a material effect on the financial statements, and changes in these estimates, judgments and assumptions are likely to occur from period to period in the future. Significant areas of accounting requiring the application of management’s judgment include, but are not limited to, determining the fair value of investment securities, interest income recognition and reserves for loan losses. These estimates, judgments and assumptions are inherently uncertain, and, if they prove to be wrong, we face the risk that charges to income will be required. Any such charges could significantly harm our business, financial condition, results of operations and the price of our securities. Refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” for a discussion of the accounting estimates, judgments and assumptions that we believe are the most critical to an understanding of our business, financial condition and results of operations.
Changes in the fair value of our interest rate swap agreements may result in volatility in our U.S. GAAP earnings.
We enter into derivative transactions to reduce the impact that changes in interest rates will have on our net interest margin. Changes in the fair value of our interest rate swap agreements are recorded in our consolidated statement of operations as "gain (loss) on derivative instruments, net" and may result in volatility in our U.S. GAAP earnings. The total changes in fair value may exceed our consolidated net income in any period or for a full year. Volatility in our net income may adversely affect the price of our capital stock.
Our reported U.S. GAAP financial results differ from our REIT taxable income that impact our dividend distribution requirements and, therefore, our U.S. GAAP results may not be an accurate indicator of future taxable income and dividend distributions.
Generally, the cumulative net income we report over the life of an asset will be the same for U.S. GAAP and tax purposes, although the timing of this income recognition over the life of the asset could be materially different.  Differences exist in the accounting for U.S. GAAP net income and REIT taxable income which can lead to significant variances in the amount and timing of when income and losses are recognized under these two measures.  Due to these differences, our reported U.S. GAAP financial results could materially differ from our determination of taxable income, which impacts our dividend distribution requirements. Therefore, our U.S. GAAP results may not be an accurate indicator of future REIT taxable income and dividend distributions. Capital gains and losses in a period may impact REIT taxable income and impact the dividend paid in future periods.
Risks Related to Our Relationship with Our Manager
We are dependent on our Manager and its key personnel for our success.
We have no separate facilities and are completely reliant on our Manager. We do not have any employees. Our executive officers are employees of our Manager or one of its affiliates. Our Manager has significant discretion as to the implementation of our investment and operating policies and strategies. Accordingly, we believe that our success depends to a significant extent upon the efforts, experience, diligence, skill and network of business contacts of the executive officers and key personnel of our Manager. The executive officers and key personnel of our Manager evaluate, negotiate, close and monitor our investments; therefore, our success depends on their continued service. The departure of any of the executive officers or key personnel of our Manager who provide management services to us could have a material adverse effect on our performance. In addition, we offer no assurance that our Manager will remain our investment manager or that we will continue to have access to our Manager’s principals and professionals. The initial term of our management agreement with our Manager expired on July 1, 2011. The agreement automatically renews for successive one-year terms, and the management agreement is currently in a renewal term. If the management agreement is terminated and no suitable replacement is found to manage us, we may not be able to execute our business plan. Moreover, our Manager is not obligated to dedicate certain of its personnel exclusively to us nor is it obligated to dedicate any specific portion of its time to our business.
There are conflicts of interest in our relationship with our Manager and Invesco, which could result in decisions that are not in the best interests of our stockholders.
We are subject to conflicts of interest arising out of our relationship with Invesco and our Manager. Specifically, each of our officers and certain members of our board of directors are employees of our Manager or one of its affiliates. Our Manager and our executive officers may have conflicts between their duties to us and their duties to, and interests in, Invesco. We compete for investment opportunities directly with other clients of our Manager or Invesco and its subsidiaries. A substantial


 
23
 

Table of Contents

number of separate accounts managed by our Manager have limited exposure to our target assets. In addition, in the future our Manager may have additional clients that compete directly with us for investment opportunities. Our Manager has investment allocation policies in place intended to enable us to share equitably with the other clients of our Manager or Invesco and its subsidiaries. There is no assurance that our Manager’s allocation policies that address some of the conflicts relating to our access to investment and financing sources will be adequate to address all of the conflicts that may arise. Therefore, we may compete for investment or financing opportunities sourced by our Manager and, as a result, we may either not be presented with the opportunity or have to compete with other clients of our Manager or clients of Invesco and its subsidiaries to acquire these investments or have access to these sources of financing. Our Manager and our executive officers may choose to allocate favorable investments to other clients of Invesco instead of to us. Further, when there are turbulent conditions in the mortgage markets, distress in the credit markets or other times when we will need focused support and assistance from our Manager, Invesco or entities for which our Manager also acts as an investment manager will likewise require greater focus and attention, placing our Manager’s resources in high demand. In such situations, we may not receive the level of support and assistance that we may receive if we were internally managed or if our Manager did not act as a manager for other entities.
We pay our Manager substantial management fees regardless of the performance of our portfolio. Our Manager’s entitlement to a management fee, which is not based upon performance metrics or goals, might reduce its incentive to devote its time and effort to seeking investments that provide attractive risk-adjusted returns for our portfolio. This in turn could hurt both our ability to make distributions to our stockholders and the market price of our capital stock.
Our Manager would have a conflict in recommending our participation in any equity investment it manages.
Our Manager has a conflict of interest in recommending our participation in any equity investment it manages because the fees payable to it may be greater than the fees payable by us under the management agreement. With respect to equity investments we have made in partnerships managed by an affiliate of our Manager, our Manager has agreed to waive fees at the equity investment level to avoid duplication. To address any potential conflict of interest, we require the terms of any equity investment managed by our Manager to be approved by our audit committee consisting of our independent directors. However, there can be no assurance that all conflicts of interest will be eliminated.
The management agreement with our Manager was not negotiated on an arm’s-length basis and may not be as favorable to us as if it had been negotiated with an unaffiliated third party and may be costly and difficult to terminate.
Our executive officers and certain members of our board of directors are employees of our Manager or one of its affiliates. Our management agreement with our Manager was negotiated between related parties and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third party.
Termination of the management agreement with our Manager without cause is difficult and costly. Our independent directors review our Manager’s performance and the management fees annually and the management agreement may be terminated annually upon the affirmative vote of at least two-thirds of our independent directors based upon: (1) our Manager’s unsatisfactory performance that is materially detrimental to us, or (2) a determination that the management fees payable to our Manager are not fair, subject to our Manager’s right to prevent termination based on unfair fees by accepting a reduction of management fees agreed to by at least two-thirds of our independent directors. Our Manager will be provided 180 days prior notice of any such termination. Additionally, upon such a termination, the management agreement provides that we will pay our Manager a termination fee equal to three times the sum of the average annual management fee received by our Manager during the prior 24-month period before such termination, calculated as of the end of the most recently completed fiscal quarter. These provisions may increase the cost of terminating the management agreement and adversely affect our ability to terminate our Manager without cause. If the management agreement is terminated and no suitable replacement is found to manage us, we may not be able to execute our business plan.
Pursuant to the management agreement, our Manager does not assume any responsibility other than to render the services called for thereunder and is not responsible for any action of our board of directors in following or declining to follow its advice or recommendations. Our Manager maintains a contractual, as opposed to a fiduciary, relationship with us. Under the terms of the management agreement, our Manager, its officers, stockholders, members, managers, partners, directors and personnel, any person controlling or controlled by our Manager and any person providing sub-advisory services to our Manager will not be liable to us, any subsidiary of ours, our directors, our stockholders or any subsidiary’s stockholders or partners for acts or omissions performed in accordance with and pursuant to the management agreement, except because of acts constituting bad faith, willful misconduct, gross negligence, or reckless disregard of their duties under the management agreement, as determined by a final non-appealable order of a court of competent jurisdiction. We have agreed to indemnify our Manager, its officers, stockholders, members, managers, directors and personnel, any person controlling or controlled by our Manager and any person providing sub-advisory services to our Manager with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts of our Manager not constituting bad faith, willful misconduct, gross negligence, or reckless disregard of duties, performed in good faith in accordance with and pursuant to the management agreement.


 
24
 

Table of Contents

Our board of directors approved very broad investment guidelines for our Manager and does not approve each investment and financing decision made by our Manager.
Our Manager is authorized to follow very broad investment guidelines. Our board of directors will periodically review our investment guidelines and our investment portfolio but does not, and is not required to, review all of our proposed investments, except that an investment in a security structured or issued by an entity managed by Invesco must be approved by a majority of our independent directors prior to such investment. In addition, in conducting periodic reviews, our board of directors may rely primarily on information provided to them by our Manager. Furthermore, our Manager may use complex strategies, and transactions entered into by our Manager may be costly, difficult or impossible to unwind by the time they are reviewed by our board of directors. Our Manager has great latitude within the broad parameters of our investment guidelines in determining the types and amounts of Agency RMBS, non-Agency RMBS, GSE CRT, CMBS, mortgage loans and mortgage and real-estate financing arrangements (including mezzanine debt and private equity interests) it may decide are attractive investments for us, which could result in investment returns that are substantially below expectations or that result in losses, which would materially and adversely affect our business operations and results.
Risks Related to Our Capital Stock
The market price and trading volume of our capital stock may be volatile.
The market price of our capital stock may be highly volatile and be subject to wide fluctuations. In addition, the trading volume in our capital stock may fluctuate and cause significant price variations to occur. If the market price of our capital stock declines significantly, our stockholders may be unable to resell their shares at or above the price our stockholders paid for their shares. We cannot assure you that the market price of our capital stock will not fluctuate or decline significantly in the future. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our capital stock include:
actual or anticipated variations in our quarterly operating results or distributions;
changes in our earnings estimates or publication of research reports about us or the real estate or specialty finance industry;
decreases in the market valuations of our target assets;
increased difficulty in maintaining or obtaining financing on attractive terms, or at all;
increases in market interest rates that lead our stockholders to demand a higher yield;
changes in market valuations of similar companies;
adverse market reaction to any increased indebtedness we incur in the future;
additions or departures of key management personnel;
actions by institutional stockholders;
speculation in the press or investment community; 
general market and economic conditions; and
changes to U.S. federal income tax laws or regulations governing REITs or the administrative interpretation of those laws.
Common stock eligible for future sale may have adverse effects on our share price.
We cannot predict the effect, if any, of future sales of our common stock, or the availability of shares for future sales, on the market price of our common stock. Sales of substantial amounts of common stock or the perception that such sales could occur may adversely affect the prevailing market price for our common stock. Also, we may issue additional shares in public offerings or private placements to make new investments or for other purposes. We are not required to offer any such shares to existing stockholders on a preemptive basis. Therefore, it may not be possible for existing stockholders to participate in such future share issuances, which may dilute existing stockholders’ interests in us.
We have not established a minimum distribution payment level, and we cannot assure our stockholders of our ability to pay distributions in the future.
We pay quarterly distributions and make other distributions to our stockholders in an amount such that we distribute all or substantially all of our REIT taxable income in each year, subject to certain adjustments. We have not established a minimum distribution payment level and our ability to pay distributions may be adversely affected by a number of factors, including the risk factors described in this Report. All distributions will be made at the discretion of our board of directors and will depend on our earnings, our financial condition, debt covenants, maintenance of our REIT qualification, applicable provisions of Maryland law and other factors as our board of directors may deem relevant from time to time. We believe that a change in any


 
25
 

Table of Contents

one of the following factors could adversely affect our results of operations and impair our ability to pay distributions to our stockholders:
our ability to make profitable investments;
margin calls or other expenses that reduce our cash flow;
defaults in our asset portfolio or decreases in the value of our portfolio; and
the fact that anticipated operating expense levels may not prove accurate, as actual results may vary from estimates.
We cannot assure our stockholders that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions in the future. In addition, some of our distributions may include a return in capital.
Investing in our capital stock may involve a high degree of risk.
The investments we make in accordance with our investment objectives may result in a high amount of risk when compared to alternative investment options and volatility or loss of principal. Our investments may be highly speculative and aggressive, and therefore an investment in our capital stock may not be suitable for someone with lower risk tolerance.
A change in market interest rates may cause a material decrease in the market price of our capital stock.
One of the factors that investors may consider in deciding whether to buy or sell shares of our capital stock is our distribution rate as a percentage of our share price relative to market interest rates. If the market price of our capital stock is based primarily on the earnings and return that we derive from our investments and income with respect to our investments and our related distributions to stockholders, and not from the market value of the investments themselves, then interest rate fluctuations and capital market conditions are likely to adversely affect the market price of our capital stock. For instance, if market rates rise without an increase in our distribution rate, the market price of our capital stock could decrease as potential investors may require a higher distribution yield or seek other securities paying higher distributions or interest.
Future offerings of debt or equity securities, that would rank senior to our common stock, may adversely affect the market price of our common stock.
We have issued Series A Preferred Stock, Series B Preferred Stock and 5.00% Exchangeable Senior Notes due 2018. If we decide to issue debt or equity securities in the future, which would rank senior to our common stock, it is likely that they will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock and may result in dilution to owners of our common stock. For example, our preferred shares and debt have a preference on liquidating distributions or a preference on dividend or interest payments that could limit our ability to make a distribution to the holders of our common stock. We and, indirectly, our stockholders, will bear the cost of issuing and servicing such securities. Because our decision to issue debt or equity securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings.
Holders of our common stock are not entitled to preemptive rights or other protections against dilution. Thus holders of our common stock will bear the risk of our future offerings reducing the market price of our common stock and diluting the value of their stock holdings in us. Holders of our common stock also bear the risk of holders of our exchangeable notes making an election to exchange their notes for common stock, which could result in significant dilution to our existing stockholders. In addition, future issuances and sales of preferred stock on parity to our Series A Preferred Stock or the Series B Preferred Stock, or the perception that such issuances and sales could occur, may also cause prevailing market prices for the Series A Preferred Stock, Series B Preferred Stock and our common stock to decline and may adversely affect our ability to raise additional capital in the financial markets at times and prices favorable to us.


 
26
 

Table of Contents

Risks Related to Our Organization and Structure
Certain provisions of Maryland law could inhibit changes in control.
Certain provisions of the Maryland General Corporation Law (the “MGCL”), may have the effect of deterring a third party from making a proposal to acquire us or of impeding a change in control under circumstances that otherwise could provide the holders of our common stock with the opportunity to realize a premium over the then-prevailing market price of our common stock. Under the MGCL, certain “business combinations” (including a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities) between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of our then outstanding voting capital stock or an affiliate or associate of ours who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of our then outstanding voting capital stock) or an affiliate thereof are prohibited for five years after the most recent date on which the stockholder becomes an interested stockholder. After the five-year prohibition, any business combination between us and an interested stockholder generally must be recommended by our board of directors and approved by the affirmative vote of at least (1) 80% of the votes entitled to be cast by holders of outstanding shares of our voting capital stock; and (2) two-thirds of the votes entitled to be cast by holders of voting capital stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder. These super-majority vote requirements do not apply if our common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. These provisions of the MGCL also do not apply to business combinations that are approved or exempted by a board of directors prior to the time that the interested stockholder becomes an interested stockholder. Pursuant to the statute, our board of directors has by resolution exempted business combinations between us and any other person, provided that such business combination is first approved by our board of directors (including a majority of our directors who are not affiliates or associates of such person).
The “control share” provisions of the MGCL provide that “control shares” of a Maryland corporation (defined as shares which, when aggregated with other shares controlled by the stockholder (except solely by virtue of a revocable proxy), entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding votes entitled to be cast by the acquiror of control shares, our officers and our employees who are also our directors. Our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of shares of our stock. There can be no assurance that this provision will not be amended or eliminated at any time in the future.
The “unsolicited takeover” provisions of the MGCL permit our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement takeover defenses, some of which (for example, a classified board) we do not yet have. These provisions may have the effect of inhibiting a third party from making an acquisition proposal for us or of delaying, deferring or preventing a change in control of us under circumstances that otherwise could provide the holders of shares of common stock with the opportunity to realize a premium over the then current market price. Our charter contains a provision whereby we have elected to be subject to the provisions of Title 3, Subtitle 8 of the MGCL relating to the filling of vacancies on our board of directors.
Ownership limitations may restrict change of control of business combination opportunities in which our stockholders might receive a premium for their shares.
In order for us to qualify as a REIT, no more than 50% in value of our outstanding capital stock may be owned, directly or indirectly, by five or fewer individuals during the last half of any calendar year. “Individuals” for this purpose include natural persons, private foundations, some employee benefit plans and trusts, and some charitable trusts. To preserve our REIT qualification, among other purposes, our charter generally prohibits any person from directly or indirectly owning more than 9.8% in value or in number of shares, whichever is more restrictive, of the outstanding shares of our capital stock or more than 9.8% in value or in number of shares, whichever is more restrictive, of the outstanding shares of our common stock. This ownership limitation could have the effect of discouraging a takeover or other transaction in which holders of our common stock might receive a premium for their shares over the then prevailing market price or which holders might believe to be otherwise in their best interests.
Our authorized but unissued shares of capital stock may prevent a change in our control.
Our charter authorizes us to issue additional authorized but unissued shares of common or preferred stock. In addition, our board of directors may, without stockholder approval, amend our charter to increase the aggregate number of our shares of stock or the number of shares of stock of any class or series that we have authority to issue and classify or reclassify any unissued shares of common or preferred stock and set the preferences, rights and other terms of the classified or reclassified


 
27
 

Table of Contents

shares. As a result, our board of directors may establish a series of shares of common or preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for our shares of common stock or otherwise be in the best interest of our stockholders.
The change of control conversion feature of our Series A Preferred Stock, Series B Preferred Stock and our Exchangeable Senior Notes may make it more difficult for a party to acquire us or discourage a party from acquiring us.
The change of control conversion feature of our Series A Preferred Stock, Series B Preferred Stock and our Exchangeable Senior Notes may have the effect of discouraging a third party from making an acquisition proposal for us or of delaying, deferring or preventing certain of our change of control transactions under circumstances that otherwise could provide the holders of our common stock, Series A Preferred Stock and Series B Preferred Stock with the opportunity to realize a premium over the then-current market price of such stock or that stockholders may otherwise believe is in their best interests.
We are the sole general partner of our Operating Partnership and could become liable for the debts and other obligations of our Operating Partnership beyond the amount of our initial expenditure.
We are the sole general partner of our Operating Partnership and directly or indirectly conduct all of our business activities through the Operating Partnership and its subsidiaries. As the sole general partner, we are liable for our Operating Partnership’s debts and other obligations. Therefore, if our Operating Partnership is unable to pay its debts and other obligations, we will be liable for such debts and other obligations beyond the amount of our expenditure for ownership interests in our Operating Partnership. These obligations could include unforeseen contingent liabilities and could materially adversely affect our financial condition, operating results and ability to make distributions to our stockholders.
Our Exchangeable Senior Notes are recourse obligations to us.
In 2013, our Operating Partnership issued $400,000,000 in aggregate principal amount of 5.00% Exchangeable Senior Notes due March 15, 2018 (the “Notes”). Because the Company is the sole general partner of the Operating Partnership, these amounts are full recourse obligations of the Company. If we are not able to extend, refinance or repurchase the Notes, we may not have the ability to repay these amounts when they come due. Our inability to repay the Notes could cause the acceleration of our other borrowings, which would have a material adverse effect on our business.
The indenture governing the Notes contains cross-default provisions whereby a default or acceleration of borrowings under other agreements could result in a default under the indenture. If a cross-default occurred, we may not be able to pay our liabilities or access capital from external sources in order to refinance our borrowings. If some or all of our borrowings default and it causes a default under other borrowings, our business, financial condition and results of operations could be materially and adversely affected.
Tax Risks
Investment in our capital stock has various U.S. federal income tax risks.
This summary of certain tax risks is limited to the U.S. federal tax risks addressed below. Additional risks or issues may exist that are not addressed in this Report and that could affect the U.S. federal income tax treatment of us or our stockholders.
In December 2015, President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (the “Act”).  The Act includes a number of provisions affecting taxation of REITs and REIT stockholders, some of which include a change to the percentage of assets that may be represented by securities of a Taxable REIT Subsidiary (“TRS”), favorable changes related to prohibited transaction safe harbors, elimination of applicability of preferential dividend rules to ‘publicly offered REITs’, changes related to debt instruments issued by publicly offered REITs and certain secured debt obligations for purposes of the REIT qualification asset tests and certain changes related to the treatment of hedging income.
We strongly urge you to seek advice based on your particular circumstances from an independent tax advisor concerning the effects of U.S. federal, state and local income tax law on an investment in our capital stock and on your individual tax situation.
Our failure to qualify as a REIT would subject us to U.S. federal income tax and potentially increased state and local taxes, which would reduce the amount of cash available for distribution to our stockholders.
We believe that we have been organized and operated, and we intend to continue to operate, in a manner that enables us to qualify as a REIT for U.S. federal income tax purposes. However, qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which only a limited number of judicial and administrative interpretations exist. Even an inadvertent or technical mistake could jeopardize our REIT status. Our continued qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis.


 
28
 

Table of Contents

Moreover, new legislation, court decisions or administrative guidance, in each case possibly with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT. Thus, while we intend to operate so that we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, and the possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year.
If we fail to qualify as a REIT in any taxable year, and we do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax on our taxable income, and distributions to our stockholders would not be deductible by us in determining our taxable income. In such a case, we might need to borrow money or sell assets in order to pay our taxes. Our payment of income tax would decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to maintain our qualification as a REIT, we no longer would be required to distribute substantially all of our taxable income to our stockholders. In addition, unless we were eligible for certain statutory relief provisions, we could not re-elect to qualify as a REIT until the fifth calendar year following the year in which we failed to qualify.
Complying with REIT requirements may cause us to forego otherwise attractive investment opportunities or financing or hedging strategies.
To qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy various tests regarding the sources of our income, the nature and diversification of our assets, and the amounts we distribute to our stockholders. To meet these tests, we may be required to forego investments we might otherwise make or financing or hedging strategies we might otherwise employ. We may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may hinder our investment performance.
Complying with REIT requirements may force us to liquidate otherwise attractive investments.
To qualify as a REIT, we generally must ensure that at the end of each calendar quarter at least 75% of the value of our total assets consists of cash, cash items, government securities, including GSE CRT securities, and qualifying real estate assets, including MBS and certain mortgage loans. The remainder of our investment in securities (other than government securities, securities of our TRSs and qualifying real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, no more than 5% of the value of our assets can consist of the securities of any one issuer (other than government securities, securities of our TRSs and qualifying real estate assets), no more than 25% (20% after 2017) of the value of our total securities can be represented by securities of one or more TRSs, and no more than 25% of the value of our assets may consist of “nonqualified publicly offered REIT debt instruments.” If we fail to comply with these requirements at the end of any quarter, we must correct the failure within 30 days after the end of such calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate from our portfolio otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.
REIT distribution requirements could adversely affect our ability to execute our business plan and may require us to incur debt, sell assets or take other actions to make such distributions.
To qualify as a REIT, we must distribute at least 90% of our REIT taxable income (including certain items of non-cash income) to our stockholders each calendar year, determined without regard to the deduction for dividends paid and excluding net capital gains. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to U.S. federal corporate income tax on our undistributed taxable income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any calendar year are less than a minimum amount specified under U.S. federal income tax laws. We intend to make sufficient distributions to our stockholders to satisfy the 90% distribution requirement and to avoid both corporate income tax and the 4% nondeductible excise tax.
Our taxable income may be substantially different from our net income as determined by U.S. GAAP. For example, realized capital losses are deducted in determining our U.S. GAAP net income, but may not be deductible in computing our taxable income. In addition, differences in timing between the recognition of taxable income and the actual receipt of cash may occur. For example, we may invest in debt instruments requiring us to accrue original issue discount (“OID”) or recognize market discount income that generate taxable income in excess of economic income or in advance of the corresponding cash flow. We may also acquire distressed debt investments that are subsequently modified by agreement with the borrower. If amendments to the outstanding debt are “significant modifications” under applicable Treasury Regulations, the modified debt may be considered to have been reissued to us in a debt-for-debt exchange with the borrower, with gain recognized by us to the extent that the principal amount of the modified debt exceeds our cost of purchasing it prior to modification. Finally, we may be required under the terms of the indebtedness that we incur, to use cash received from interest payments to make principal payment on that indebtedness, with the effect that we will recognize income but will not have a corresponding amount of cash available for distribution to our stockholders.


 
29
 

Table of Contents

As a result of the foregoing, we may find it difficult or impossible to meet the REIT distribution requirements in certain circumstances. In such circumstances, we may be required to (1) sell assets in adverse market conditions, (2) borrow on unfavorable terms, (3) distribute amounts that would otherwise be invested or used to repay debt, or (4) make a taxable distribution of our shares of common stock as part of a distribution in which stockholders may elect to receive shares of common stock or (subject to a limit measured as a percentage of the total distribution) cash, in order to comply with the REIT distribution requirements. Thus, compliance with the REIT distribution requirements may hinder our ability to grow, which could adversely affect the value of our common stock.
We may choose to pay dividends in our own stock, in which case our stockholders may be required to pay income taxes in excess of the cash dividends received.
We may distribute taxable dividends that are payable in cash and in shares of our common stock at the election of each stockholder. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend income to the extent of our current and accumulated earnings and profits for federal income tax purposes. As a result, a U.S. stockholder may be required to pay income taxes with respect to such dividends in excess of the cash dividends received. If a U.S. stockholder sells the stock it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our common stock.
Our ownership of and relationship with any TRS that we may form or acquire is subject to limitations, and a failure to comply with the limits would jeopardize our REIT qualification and may result in the application of a 100% excise tax.
A REIT may own up to 100% of the stock of one or more TRSs. A TRS may earn income that would not be qualifying income if earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. Overall, no more than 25% (20% after 2017) of the value of a REIT’s assets may consist of stock or securities of one or more TRSs at the end of any calendar quarter. In addition, the TRS rules impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s length basis. There can be no assurance that we will be able to comply with the TRS limitations or to avoid application of the 100% excise tax discussed above.
Our domestic TRSs would pay U.S. federal, state and local income tax on their taxable income, and their after-tax net income would be available for distribution to us but would not be required to be distributed to us. If we were to organize a TRS as a non-U.S. corporation (or non-U.S. entity treated as a corporation for U.S. federal income tax purposes), we may generate income inclusions relating to the earnings of the non-U.S. TRS, the treatment of which under the REIT gross income tests is not clear.
Liquidation of our assets to repay obligations to our lenders may jeopardize our REIT qualification.
To qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our investments to repay obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT.
Characterization of the repurchase agreements we enter into to finance our investments as sales for tax purposes rather than as secured borrowing transactions, or the failure of a mezzanine loan to qualify as a real estate asset, could adversely affect our ability to qualify as a REIT.
We have entered into repurchase agreements with a variety of counterparties to finance assets in which we invest. When we enter into a repurchase agreement, we generally sell assets to our counterparty to the agreement and receive cash from the counterparty. The counterparty is obligated to resell the assets back to us at the end of the term of the transaction. We believe that, for U.S. federal income tax purposes, we will be treated as the owner of the assets that are the subject of repurchase agreements and that the repurchase agreements will be treated as secured borrowing transactions notwithstanding that such agreements may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could successfully assert that we did not own these assets during the term of the repurchase agreements, in which case we could fail to qualify as a REIT.
In addition, we may acquire mezzanine loans, which are loans secured by equity interests in a partnership or limited liability company that directly or indirectly owns real property. In Revenue Procedure 2003-65, the IRS provided a safe harbor pursuant to which a mezzanine loan, if it meets each of the requirements contained in the Revenue Procedure, will be treated by the IRS as a real estate asset for purposes of the REIT asset tests, and interest derived from the mezzanine loan will be treated as qualifying mortgage interest for purposes of the 75% gross income test. Although the Revenue Procedure provides a safe harbor on which taxpayers may rely, it does not prescribe rules of substantive tax law. We acquire or originate mezzanine loans


 
30
 

Table of Contents

that do not meet all of the requirements for reliance on this safe harbor. The IRS could challenge treatment of such loans as real estate assets for purposes of the REIT asset and income tests, and if such a challenge were sustained, we could fail to qualify as a REIT.
The “taxable mortgage pool” rules may limit our financing options.
Certain securitizations and other financing structures could result in the creation of taxable mortgage pools for federal income tax purposes. A taxable mortgage pool owned by our Operating Partnership would be treated as a corporation for U.S. federal income tax purposes and may cause us to fail the REIT asset tests. Accordingly, if we were to consider a securitization that would create a taxable mortgage pool, we would have to undertake such securitization through a TRS or a subsidiary that qualified as a REIT. These rules may limit our financing options.
The tax on prohibited transactions will limit our ability to engage in transactions, including certain methods of securitizing mortgage loans, which would be treated as sales for federal income tax purposes.
A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, but including mortgage loans, held primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were to dispose of or securitize loans in a manner that was treated as a sale of the loans for federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales of loans at the REIT level and may limit the structures we utilize for our securitization transactions, even though the sales or such structures might otherwise be beneficial to us.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Internal Revenue Code limit our ability to enter into hedging transactions. In order to qualify as a REIT, we must satisfy two gross income tests annually. For these purposes, income with respect to certain hedges of our liabilities or foreign currency risks will be disregarded. Income from other hedges will be non-qualifying income for purposes of both gross income tests. As a result, we might have to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear.
Purchases of mortgages at a discount may affect our ability to satisfy the REIT asset and gross income tests.
Whether our loan holdings are treated as real estate assets and interest income thereon is treated as qualifying income for purposes of the 75% gross income test depends on whether the loans are adequately secured by real property. If a mortgage loan is secured by both real property and personal property, the value which exceeds 15% of the value of all property securing such loan, and the value of the real property at the time the REIT commits to make or acquire the loan is less than the highest principal amount (i.e., the face amount) of the loan during the year, interest on the loan will be treated as qualifying income only in proportion to the ratio of the value of the real property at the time the REIT commits to make or acquire the loan to the highest principal amount of the loan during the year. Similarly, the IRS issued guidance for determining the extent to which an interest in an “eligible REMIC” (relating to the Home Affordable Refinance Program) is treated as a real estate asset and generates qualifying income for purposes of the 75% gross income test. Failure to accurately apply these rules and manage our income and assets could cause us to fail to qualify as a REIT.
Our qualification as a REIT could be jeopardized as a result of our interests in joint ventures or investment funds.
We currently own, and may continue to acquire, interests in partnerships or limited liability companies that are joint ventures or investment funds. We may not have timely access to information from such partnerships and limited liability companies related to monitoring and managing our REIT qualification. If a partnership or limited liability company in which we own an interest but do not control takes or expects to take actions that could jeopardize our REIT qualification or require us to pay tax, we may be forced to dispose of our interest in such entity. It is possible that a partnership or limited liability company could take an action which could cause us to fail a REIT gross income or asset test and that we would not become aware of such action in time to dispose of our interest in the partnership or limited liability company or take other corrective action on a timely basis. In that case, we could fail to qualify as a REIT unless we are able to qualify for a statutory REIT “savings” provision, which may require us to pay a significant penalty tax to maintain our REIT qualification.
We may be required to report taxable income for certain investments in excess of the economic income we ultimately realize from them.
We acquire debt instruments in the secondary market for less than their face amount. The discount at which such debt instruments are acquired may reflect doubts about their ultimate collectibility rather than current market interest rates. The amount of such discount will nevertheless generally be treated as “market discount” for federal income tax purposes. Accrued market discount is reported as income when, and to the extent that, any payment of principal of the debt instrument is made. If


 
31
 

Table of Contents

we collect less on the debt instrument than our purchase price plus the market discount we had previously reported as income, we may not be able to benefit from any offsetting loss deductions.
Some of the debt instruments that we acquire may have been issued with OID. We will be required to report such original issue discount based on a constant yield method and will be taxed based on the assumption that all future projected payments due on such debt instruments will be made. If such debt instruments or MBS and GSE CRT turn out not to be fully collectible, an offsetting loss deduction will become available only in the later year that uncollectibility is provable.
In addition, we may acquire debt instruments that are subsequently modified by agreement with the borrower. If the amendments to the outstanding instrument are "significant modifications" under the applicable Treasury regulations, the modified instrument will be considered to have been reissued to us in a debt-for-debt exchange with the borrower. In that event, we may be required to recognize taxable gain to the extent the principal amount of the modified instrument exceeds our adjusted tax basis in the unmodified instrument, even if the value of the instrument or the payment expectations have not changed. Following such a taxable modification, we would hold the modified loan with a cost basis equal to its principal amount for federal tax purposes.
Finally, in the event that any debt instruments acquired by us are delinquent as to mandatory principal and interest payments, or in the event payments with respect to a particular instrument are not made when due, we may nonetheless be required to continue to recognize the unpaid interest as taxable income as it accrues, despite doubt as to its ultimate collectibility. Similarly, we may be required to accrue interest income with respect to debt instruments at its stated rate regardless of whether corresponding cash payments are received or are ultimately collectible. In each case, while we would in general ultimately have an offsetting loss deduction available to us when such interest was determined to be uncollectible, the utility of that deduction could depend on our having taxable income in that later year or thereafter.
Even if we qualify as a REIT, we may face tax liabilities that reduce our cash flow.
Even if we qualify as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, franchise, property and transfer taxes, including mortgage-related taxes.
We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our capital stock.
At any time, the U.S. federal income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be amended. We cannot predict when or if any new U.S. federal income tax law, regulation or administrative interpretation, or any amendment to any existing federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective. Any such law, regulation or interpretation may take effect retroactively. We and our stockholders could be adversely affected by any such change in, or any new, federal income tax law, regulation or administrative interpretation.
Dividends paid by REITs do not qualify for the reduced tax rates that apply to other corporate dividends.
The maximum tax rate for “qualified dividends” paid by corporations to individuals is currently 20%. Dividends paid by REITs, however, generally are not “qualified dividends” and generally are taxed at the normal ordinary income rates, currently subject to a maximum rate of 39.6% in the case of non-corporate taxpayers. The more favorable rates applicable to qualified dividends could cause potential investors who are individuals to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay qualified dividends, which could adversely affect the value of the stock of REITs, including our capital stock.
Dividends paid by REITs may be subject to Medicare tax on net investment income.
High-income U.S. individuals, estates, and trusts will be subject to an additional 3.8% tax on net investment income. For these purposes, net investment income includes dividends and gains from sales of stock. In the case of an individual, the tax will be 3.8% of the lesser of the individuals’ net investment income or the excess of the individuals’ modified adjusted gross income over $250,000 in the case of a married individual filing a joint return or a surviving spouse, $125,000 in the case of a married individual filing a separate return, or $200,000 in the case of a single individual.
Tax-exempt stockholders may realize unrelated business taxable income if we generate excess inclusion income.
If we acquire REMIC residual interests or equity interests in taxable mortgage pools (in a manner consistent with our REIT qualification) and generate “excess inclusion income,” a portion of our dividends received by a tax-exempt stockholder will be treated as unrelated business taxable income. Excess inclusion income would also be subject to adverse federal income tax rules in the case of U.S. taxable stockholders and non-U.S. stockholders.


 
32
 

Table of Contents

Changing the nature of our assets may complicate our ability to satisfy the REIT gross income and asset tests.
We have large holdings of RMBS that are qualifying assets for purposes of the REIT asset tests and generate interest income that is qualifying income for purposes of the REIT gross income tests. The REIT asset tests do not require that all assets be qualifying assets, nor do the REIT gross income tests require that all income be qualifying income. Our substantial RMBS holdings have given us room to make investments that may not qualify, all or in part, as real estate assets or that may generate income that may not qualify, all or in part, under one or both of the gross income tests. Reductions in our RMBS holdings would reduce our room for non-qualifying assets and income. In addition, the market value or income potential of real estate-related investments declines as a result of increased interest rates, prepayment rates or other factors, we may need to increase our real estate investments and income and/or liquidate our non-qualifying assets in order to maintain our REIT qualification or exemption from the 1940 Act. If the decline in real estate asset values and/or income occurs quickly, this may be especially difficult to accomplish. This difficulty may be exacerbated by the illiquid nature of any non-real estate assets that we may own. We may have to make investment decisions that we otherwise would not make absent the REIT and Investment Company Act considerations. Furthermore, we may make investments in which the proper application of the REIT gross income and assets tests may not be clear. Mistakes in classifying assets or income for REIT purposes or in projecting the amount of qualifying and non-qualifying income could cause us to fail to qualify as a REIT.
Our qualification as a REIT may depend upon the accuracy of legal opinions or advice rendered or given or statements by the issuers of assets we acquire.
When purchasing securities, we may rely on opinions or advice of counsel for the issuer of such securities, or statements made in related offering documents, for purposes of determining, among other things, whether such securities represent debt or equity securities for U.S. federal income tax purposes, the value of such securities, and also to what extent those securities constitute qualified real estate assets for purposes of the REIT asset tests and produce qualified income for purposes of the 75% gross income test. The inaccuracy of any such opinions, advice or statements may adversely affect our ability to qualify as a REIT.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Our principal executive office is located at 1555 Peachtree Street, NE, Suite 1800, Atlanta, Georgia 30309. As part of our management agreement, our Manager is responsible for providing office space and office services required in rendering services to us.
Item 3. Legal Proceedings.
From time to time, we may be involved in various claims and legal actions arising in the ordinary course of business. As of December 31, 2016, we were not involved in any such legal proceedings.
Item 4. Mine and Safety Disclosures.
Not applicable.


 
33
 

Table of Contents

PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock is traded on the NYSE under the symbol “IVR.” The following table sets forth, for the periods indicated, the high and low sale price of our common stock as reported on the NYSE.
 
High
 
Low
2016
Fourth quarter
$
16.04

 
$
14.18

Third quarter
$
16.28

 
$
13.42

Second quarter
$
14.73

 
$
11.95

First quarter
$
12.95

 
$
9.74

2015
Fourth quarter
$
13.50

 
$
11.92

Third quarter
$
15.14

 
$
12.02

Second quarter
$
16.13

 
$
14.32

First quarter
$
16.21

 
$
15.10

Holders
As of February 16, 2017, there were 108 stockholders of record.
Dividends
U.S. federal income tax law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates on its undistributed taxable income. We intend to continue to pay regular quarterly dividends to our stockholders. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service obligations. If our cash available for distribution is less than our taxable income, we could be required to sell assets or borrow funds to make cash distributions, or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.
The following table sets forth the dividends declared per share of our common stock for the periods indicated.
Date Declared
Dividends Declared Per Share
 
Amount
 
Date Paid
2016
 
 
 
December 15, 2016
$
0.40

 
January 26, 2017
September 14, 2016
$
0.40

 
October 26, 2016
June 15, 2016
$
0.40

 
July 26, 2016
March 15, 2016
$
0.40

 
April 26, 2016
2015
 
 
 
December 15, 2015
$
0.40

 
January 26, 2016
September 15, 2015
$
0.40

 
October 27, 2015
June 15, 2015
$
0.45

 
July 28, 2015
March 17, 2015
$
0.45

 
April 28, 2015



 
34
 

Table of Contents

The following table sets forth the dividends declared per share of our common stock and the related tax characterization for the fiscal tax years ended December 31, 2016 and 2015.
 
 
 
 
Tax Characterization of Dividends
Fiscal Tax Year
 
Dividends Declared
 
Ordinary Dividends
 
Capital Gain Distribution
 
Carry Forward
Common Stock Dividends
 
 
 
 
 
 
 
 
Fiscal tax year 2016 (1)
 
1.600000

 
1.857840

 

 

Fiscal tax year 2015 (1)
 
1.700000

 
1.615469

 

 
0.257840

(1)
Ordinary dividends include $0.257840 of spillover dividend carried-forward from fiscal tax year 2015.
Performance Graph
The following graph matches the cumulative 5-year total return of holders of Invesco Mortgage Capital Inc.'s common stock with the cumulative total returns of the S&P 500 index and the FTSE NAREIT Mortgage REITs index. The graph assumes that the value of the investment in our common stock and in each of the indices (including reinvestment of dividends) was $100 on December 31, 2011 and tracks it through December 31, 2016.
 
ivr-2016123_chartx46835.jpg

Index
12/31/2011
12/31/2012
12/31/2013
12/31/2014
12/31/2015
12/31/2016
Invesco Mortgage Capital Inc.
100.00
160.48
136.53
161.82
146.01
192.94
S&P 500
100.00
116.00
153.57
174.60
177.01
198.18
FTSE NAREIT Mortgage REITs
100.00
119.89
117.54
138.56
126.26
155.11
The stock price performance included in this graph is not necessarily indicative of future stock price performance.


 
35
 

Table of Contents

Use of Proceeds
We used the net proceeds from our common and preferred stock offerings to acquire our target assets in accordance with our objectives and strategies described in Item 1, Business - Investment Strategy. We focus on purchasing our target assets, subject to our investment guidelines and to the extent consistent with maintaining our REIT qualification and exclusion from the requirements of the 1940 Act. Our Manager determines the percentage of our equity that will be invested in each of our target assets.
Repurchases of Equity Securities
In December 2011, our board of directors approved a share repurchase program with no stated expiration date. During the year ended December 31, 2016, we repurchased and concurrently retired 2,063,451 (2015: 9,539,251) shares of our common stock at a weighted average repurchase price of $12.12 (2015: $13.17) per share for a net cost of $25.0 million (2015: $125.6 million), including acquisition expenses.
As of December 31, 2016, there were 18,239,082 common shares available for repurchase. No shares of common stock were purchased during the quarter ended December 31, 2016. The shares may be repurchased from time to time through privately negotiated transactions or open market transactions, including pursuant to a trading plan in accordance with Rules 10b5-1 and 10b-18 under the Exchange Act or by any combination of such methods. The manner, price, number and timing of share repurchases will be subject to a variety of factors, including market conditions and applicable SEC rules.
Equity Compensation Plans
We will provide the equity compensation plan information required in Item 201(d) of Regulation S-K in our definitive Proxy Statement or in an amendment to this Report not later than 120 days after the end of the fiscal year covered by this Report and is incorporated into this Item 5 by reference.



 
36
 

Table of Contents

Item 6. Selected Financial Data.
The selected historical financial information as of and for the years ended December 31, 20162015, 2014, 2013 and 2012 presented in the tables below have been derived from our audited financial statements. The information presented below is not necessarily indicative of the trends in our performance.
The information presented below is only a summary and does not provide all of the information contained in our historical financial statements, including the related notes. You should read the information below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical financial statements, including the related notes, included elsewhere in this Report.
Balance Sheet Data
 
As of December 31,
$ in thousands
2016
 
2015
 
2014
 
2013
 
2012
Mortgage-backed and credit risk transfer securities, at fair value
14,981,331

 
16,065,935

 
17,248,895

 
17,348,657

 
18,470,563

Residential loans, held-for-investment (1)

 

 
3,365,003

 
1,810,262

 

Commercial loans, held-for-investment
273,355

 
209,062

 
145,756

 
64,599

 

Total assets (1)
15,706,238

 
16,767,309

 
21,218,097

 
20,337,245

 
18,914,760

Repurchase agreements
11,160,669

 
12,126,048

 
13,622,677

 
15,451,675

 
15,720,460

Secured loans
1,650,000

 
1,650,000

 
1,250,000

 

 

Asset-backed securities (1)

 

 
2,924,787

 
1,640,355

 

Exchangeable senior notes
397,041

 
394,573

 
392,113

 
389,652

 

Total stockholders’ equity
2,241,560

 
2,241,035

 
2,610,315

 
2,376,115

 
2,558,098

Non-controlling interest
28,624

 
25,873

 
28,535

 
27,120

 
31,422

Total equity
2,270,184

 
2,266,908

 
2,638,850

 
2,403,235

 
2,589,520

(1)
As of December 31, 2014 and December 31, 2013, our consolidated balance sheets included assets and liabilities of consolidated variable interest entities (“VIEs”). We deconsolidated these VIEs in 2015. As of December 31, 2014 and December 31, 2013, total assets of the consolidated VIEs were $3,380,597 and $1,819,295, respectively, and total liabilities of the consolidated VIEs were $2,938,512 and $1,648,400, respectively. Refer to Note 3 - "Variable Interest Entities" of our consolidated financial statements for further discussion.



 
37
 

Table of Contents

Statements of Operations Data
 
For the Years ended December 31,
$ in thousands, except share amounts
2016
 
2015
 
2014
 
2013
 
2012
Interest income
478,682

 
650,132

 
687,080

 
680,491

 
559,730

Interest expense
157,354

 
277,973

 
281,895

 
332,252

 
237,405

Net interest income
321,328

 
372,159

 
405,185

 
348,239

 
322,325

(Reduction in) provision for loan losses

 
(213
)
 
(142
)
 
884

 

Net interest income after provision for loan losses
321,328

 
372,372

 
405,327

 
347,355

 
322,325

Other income (loss)
(21,824
)
 
(203,697
)
 
(570,001
)
 
(136,737
)
 
52,485

Expenses
41,806

 
54,620

 
52,866

 
53,144

 
39,684

Net income (loss)
257,698

 
114,055

 
(217,540
)
 
157,474

 
335,126

Net income (loss) attributable to non-controlling interest
3,287

 
1,344

 
(2,482
)
 
1,640

 
4,015

Net income (loss) attributable to Invesco Mortgage Capital Inc.
254,411

 
112,711

 
(215,058
)
 
155,834

 
331,111

Dividends to preferred stockholders
22,864

 
22,864

 
17,378

 
10,851

 
5,395

Net income (loss) attributable to common stockholders
231,547

 
89,847

 
(232,436
)
 
144,983

 
325,716

Earnings per share:
 
 
 
 
 
 
 
 
 
Net income (loss) attributable to common stockholders
 
 
 
 
 
 
 
 
 
Basic
2.07

 
0.74

 
(1.89
)
 
1.09

 
2.82

Diluted
1.98

 
0.74

 
(1.89
)
 
1.09

 
2.82

Dividends declared per common share
1.60

 
1.70

 
1.95

 
2.30

 
2.60

Weighted average number of shares of common stock:
 
 
 
 
 
 
 
 
 
Basic
111,973,404

 
121,377,585

 
123,104,934

 
132,714,012

 
115,558,668

Diluted
130,254,003

 
122,843,838

 
124,529,934

 
134,173,691

 
117,012,500

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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 Part IV, Item 15 of this Report.

Overview
We are a Maryland corporation primarily focused on investing in, financing and managing residential and commercial mortgage-backed securities ("MBS") and mortgage loans. Our objective is to provide attractive risk-adjusted returns to our investors, primarily through dividends and secondarily through capital appreciation. To achieve this objective, we primarily invest in the following:
Residential mortgage-backed securities (“RMBS”) that are guaranteed by a U.S. government agency such as the Government National Mortgage Association or a federally chartered corporation such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”) (collectively "Agency RMBS");
RMBS that are not guaranteed by a U.S. government agency ("non-Agency RMBS");
Credit risk transfer securities that are unsecured obligations issued by government-sponsored enterprises ("GSE CRT");
Commercial mortgage-backed securities (“CMBS”); 
Residential and commercial mortgage loans; and


 
38
 

Table of Contents

Other real estate-related financing arrangements.
We have 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. To maintain our REIT qualification, we are generally required to distribute at least 90% of our REIT taxable income to our stockholders annually. We operate our business in a manner that permits our exclusion from the definition of an “Investment Company” under the 1940 Act. We are externally managed and advised by Invesco Advisers, Inc., our Manager, which is an indirect, wholly-owned subsidiary of Invesco Ltd.
Capital Activities
On December 15, 2016, we declared the following dividends:
a dividend of $0.40 per share of common stock to be paid on January 26, 2017 to stockholders of record as of the close of business on December 27, 2016;
a dividend of $0.4844 per share of Series A Preferred Stock to be paid on January 25, 2017 to stockholders of record as of the close of business on January 1, 2017; and
a dividend of $0.4844 per share of Series B Preferred Stock to be paid on March 27, 2017 to stockholders of record as of the close of business on March 5, 2017.
During the three months ended December 31, 2016, we did not repurchase any shares of our common stock. During the year ended December 31, 2016, we repurchased 2,063,451 shares of our common stock at an average repurchase price of $12.12 per share for a net cost of $25.0 million, including acquisition expenses. 


 
39
 

Table of Contents

Factors Impacting Our Operating Results
Our operating results can be affected by a number of factors and primarily depend on the level of our net interest income and the market value of our assets. 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. The market value of our assets can be impacted by credit spread premiums (yield advantage over U.S. Treasury notes) and the supply of, and demand for, target assets in which we invest.
Market Conditions
Macroeconomic factors that affect our business include credit spread premiums, market interest rates, governmental policy initiatives, residential and commercial real estate prices, credit availability, consumer personal income, corporate earnings, employment conditions, financial conditions and inflation.
The global financial markets ended 2016 on a positive note following the U.S. Presidential election, with equity markets rallying and U.S. Treasury yields rising as investors priced in an increased profitability of greater fiscal stimulus, tax reform and an easing of regulatory pressures under the new administration. Subsequently, the Federal Reserve increased the Federal Funds target interest rate at its December meeting. U.S. equity markets rallied after the election, as the S&P 500 Index returned 3.82% for the quarter and returned 11.96% for all of 2016. Financial conditions remained tight throughout 2016, as energy prices rose over the course of the year (the price of WTI Crude ended the year at $53.72 per barrel, $9.13 higher than at the end of 2015, and $3.79 higher over the course of the quarter). As we move into 2017, investor concerns include the ability of the new administration to enact its intended policies, central banks' actions and their impact on the global economy, regulations related to risk retention and higher global capital requirements for financial institutions, the sustainability of China's economic growth, and the potential impact of the Brexit process and resulting stress in the European banking system.
For 2016, U.S. gross domestic product domestic grew by 1.6%, with the consensus forecast for both 2017 and 2018 at 2.3%.  Core personal consumption expenditures ended 2016 up 1.7%, while the expectation for 2017 stands at 1.8%, still shy of the 2% target communicated by the Federal Reserve.  Monthly increases in payroll employment averaged 165,000 jobs per month for the fourth quarter of 2016, slightly below the average of 179,750 over the last twelve months. The consensus of economists forecast monthly payrolls to increase by 163,000 jobs per month in 2017. Looking forward, an improving labor market coupled with relatively low interest rates and energy prices should be supportive of U.S. consumer spending. Trade may be a headwind, as U.S. dollar exchange rates relative to a basket of major world currencies strengthened to multi-year highs during the fourth quarter of 2016 following the U.S. elections. In summary, it still appears that the U.S. will continue to experience modest economic growth, and core inflation is likely to remain below the Federal Reserve’s policy objective of 2%. However, given the ambiguities surrounding the new administration’s policy decisions, this outlook remains uncertain.
After falling for the better part of 2016, U.S. Treasury bond yields reversed course and were sharply higher during the fourth quarter. Rates on the long end of the yield curve rose more than rates on the short end during the fourth quarter of 2016, with the yield on the two year U.S. Treasury note up 43 basis points (to 1.19%), the yield on the five year Treasury note up 78 basis points (to 1.93%) and the yield on the 10 year Treasury note up 84 basis points (to 2.44%). Short term rates were also higher, with three-month LIBOR ending the year 39 basis points higher (to 1.00%). We expect the rate environment to remain relatively volatile, as the Federal Reserve continues to signal a willingness to increase the Federal Funds rate, and investors wait to see how the new administration’s efforts to increase fiscal stimulus, enact tax reform and provide relief from regulatory burdens unfolds.
During 2016, the performance of Agency RMBS was mixed. Despite underperforming during the fourth quarter, Hybrid ARM Agency RMBS and 15 year fixed-rate Agency RMBS ended the year with positive excess returns, while 30 year fixed-rate Agency RMBS had negative excess returns for both the quarter and the full year. Swap spreads were modestly wider over the course of 2016, with the two year, five year and ten year swap spreads wider by 13.6, 7.0 and 2.75 basis points, respectively. Refinancing activity responded to the higher rate environment and winter seasonal period by slowing materially. The Mortgage Bankers Association refinancing index fell by more than half during the quarter (from 2,380 to 1,132) and ended the year down 11.1%.
Spreads on CMBS and GSE CRT securities tightened materially in the fourth quarter and year over year, reflecting improving real estate prices, strong investor demand and steady financial conditions. Financing markets remained accommodating in the fourth quarter and throughout 2016. Agency RMBS and credit bond repurchase agreements' rates moved higher in the fourth quarter in line with an increase in the Federal Funds rate, and normal year end bank balance sheet pressures. The outlook for Agency RMBS remains mixed, as increased interest rate volatility and the possibility that reinvestment activity by the Federal Reserve may end earlier than expected weighs on the market. On the positive side, low


 
40
 

Table of Contents

interest rates abroad should support demand for Agency RMBS due to the relatively attractive yield and the implicit U.S. government guarantee.
In addition, the regulatory landscape for our repurchase agreement counterparties continues to evolve following the adoption of new capital rules which generally affects the manner in which banks lend. Regulators are also focused on liquidity requirements which will likely impact how banks fund themselves. While we are not directly subject to compliance with the implementation of rules regarding financial institutions, the effect of these regulations and others could affect our ability to finance our assets in the future.
Investment Activities
In 2016, our investment portfolio remained positioned to take advantage of opportunities in both mortgage-backed and credit risk transfer securities and newly originated loans against a backdrop of improving real estate markets.
The table below shows the allocation of our equity as of December 31, 2016 and 2015:
 
As of December 31,


2016
 
2015
Agency RMBS
41
%
 
37
%
Commercial Credit (1)
32
%
 
33
%
Residential Credit (2)
27
%
 
30
%
Total
100
%
 
100
%
(1)
CMBS, Commercial Loans and $33.3 million of Investments in unconsolidated ventures (which are included in Other Assets), are considered commercial credit.
(2)
Non-Agency RMBS and GSE CRT are considered residential credit.
Over the past year our allocation of equity to Agency RMBS has increased to 41% and our allocation to residential and commercial credit has decreased to 59%. The shift reflects our strategy of decreasing risk in front of the U.S. Presidential election, Federal Reserve meetings and Brexit negotiations, and creates capacity to invest in credit assets should we see favorable market and asset opportunities.
The table below shows the breakdown of our investment portfolio as of December 31, 2016 and 2015:
$ in thousands
As of December 31,
 
2016
 
2015
Agency RMBS:
 
 
 
15 year fixed-rate, at fair value
3,557,928

 
1,610,930

30 year fixed-rate, at fair value
2,981,717

 
4,063,957

Hybrid ARM, at fair value
2,474,301

 
3,309,525

ARM, at fair value
307,873

 
426,025

Agency CMO, at fair value
344,041

 
388,819

Non-Agency RMBS, at fair value
1,995,551

 
2,692,487

GSE CRT, at fair value
768,200

 
658,228

CMBS, at fair value
2,551,720

 
2,915,964

Commercial loans, at amortized cost
273,355

 
209,062

Investment in unconsolidated ventures
33,301

 
38,413

Total Investment portfolio
15,287,987

 
16,313,410

During 2016, we primarily reinvested cash flows from sales and principal repayments into 15 year fixed-rate Agency RMBS. We have been increasing our holdings of 15 year fixed-rate Agency RMBS versus 30 year fixed-rate Agency RMBS to decrease our interest rate risk and further reduce book value volatility. As of December 31, 2016 our holdings of 15 year fixed-rate Agency RMBS represented 23% of our total investment portfolio versus 10% of our total investment portfolio as of December 31, 2015. We have continued to hold certain 30 year fixed-rate Agency RMBS securities that have relatively lower interest rate risk because they are collateralized by mortgages with higher coupons. We expect these securities to prepay more favorably than their applicable cohorts based on their seasoning and collateral attributes. Additionally, we hold Hybrid ARM


 
41
 

Table of Contents

Agency RMBS and ARM Agency RMBS that we believe have lower durations and better cash flow certainty relative to current coupon 30 year fixed-rate Agency RMBS. Further, we own Agency collateralized mortgage obligations ("CMOs"), some of which are interest-only securities ("IOs").
Our portfolio of investments that have credit exposure include non-Agency RMBS, GSE CRTs, CMBS and commercial estate loans. Rather than relying on the rating agencies, we utilize proprietary models as well as third party applications to quantify and monitor the credit risk associated with our portfolio holdings. Our analysis generally begins at the underlying asset level, where we gather detailed information on loan, borrower, and property characteristics that inform our expectations for future performance. In addition to base case cash flow projections, we perform a range of scenario stresses to gauge the sensitivity of returns to potential deviations in underlying asset behavior. We perform this detailed credit analysis at the time of initial purchase and regularly throughout the holding period of each investment.
With respect to our non-Agency RMBS portfolio, we primarily invest in RMBS collateralized by prime and Alt-A loans. In addition, we have invested in re-securitizations of real estate mortgage investment conduit ("Re-REMIC") RMBS and reperforming mortgage loans that we believe provide attractive risk adjusted returns. We also invest in GSE CRTs, which have the added benefit of paying a floating rate coupon and reduce our need to hedge interest rate risk. Our GSE CRT holdings increased modestly over the past twelve months. We view GSE CRT as an attractive asset class based on the strength of the U.S. housing market, the strong performance of reference mortgage loans to date, and potentially compelling relative value.
Our CMBS portfolio generally consists of assets originated during and after 2010 (“CMBS 2.0”). CMBS investments represent approximately 17% of our total investment portfolio as of December 31, 2016.
During 2016, we purchased or originated five new commercial real estate loans. As of December 31, 2016, our commercial real estate loan portfolio includes ten mezzanine loans that we purchased or originated. The commercial real estate loan portfolio's weighted average loan-to-value ratio is approximately 66%, based on the most recently attained independent property appraisals and the relevant loan amounts. For further details on the loan portfolio, refer to Note 5 - "Commercial Loans Held-for-Investment" of our consolidated financial statements in Part IV, Item 15 of this Report.
New credit risk retention rules for commercial mortgage-backed securities became effective under the Dodd-Frank Wall Street Reform and Consumer Protection Act on December 24, 2016.  The new credit risk retention rules require originators and/or an investor to retain 5% of the fair market value of any new securitizations.  Risk retention can be achieved by the originator or investor retaining a pro-rata portion of the classes of notes and equity (“vertical option”), a horizontal “first-loss” piece which is most subordinate in the capital structure (“horizontal option”) or a combination of the horizontal and vertical options (“L-shaped option”). 

The credit risk retention rules allow the sponsor of a transaction to retain at least 5% of the fair market value of the CMBS or sell all or a portion of this amount to a qualified third-party purchaser (“B-piece investor”). There is a minimum five year holding period for the retained investment.  At this point, we think it is possible we could see all of these options eventually adopted by the market. 

The new risk retention rules have the potential to increase borrowing costs and limit existing borrower loan re-financing options if the number of market participants, or the level of investor CMBS demand, decreases.  Despite this possibility, we do not expect CMBS issuance to slow materially relevant to 2016 as issuers and investors are making notable strides to adapt their businesses.  As a result, we expect to continue to find attractive opportunities in both new issue and legacy CMBS.  Additionally, our direct lending capabilities position us well to find opportunities in both mezzanine and senior mortgage commercial real estate loan investments. 


 
42
 

Table of Contents

Portfolio Characteristics
The table below illustrates the vintage distribution of our non-Agency RMBS, GSE CRT and CMBS portfolio as of December 31, 2016 as a percentage of fair value:
 
2003
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
2014
 
2015
 
2016
 
Total
Prime
0.4
%
 
1.5
%
 
4.3
%
 
3.7
%
 
8.0
%
 
2.3
%
 
%
 
%
 
%
 
%
 
12.7
%
 
10.1
%
 
1.4
%
 
0.2
%
 
44.6
%
Alt-A
%
 
0.7
%
 
7.5
%
 
6.4
%
 
7.8
%
 
%
 
%
 
%
 
%
 
%
 
%
 
%
 
%
 
%
 
22.4
%
Re-REMIC (1)
%
 
%
 
%
 
%
 
0.4
%
 
%
 
0.6
%
 
4.4
%
 
8.7
%
 
3.4
%
 
0.7
%
 
%
 
%
 
%
 
18.2
%
Subprime/reperforming
%
 
%
 
%
 
%
 
0.3
%
 
%
 
%
 
%
 
%
 
%
 
2.6
%
 
10.0
%
 
1.9
%
 
%
 
14.8
%
Total Non-Agency
0.4
%
 
2.2
%
 
11.8
%
 
10.1
%
 
16.5
%
 
2.3
%
 
0.6
%
 
4.4
%
 
8.7
%
 
3.4
%
 
16.0
%
 
20.1
%
 
3.3
%
 
0.2
%
 
100.0
%
GSE CRT
%
 
%
 
%
 
%
 
%
 
%
 
%
 
%
 
%
 
%
 
33.8
%
 
39.1
%
 
9.7
%
 
17.4
%
 
100.0
%
CMBS
%
 
%
 
0.1
%
 
0.1
%
 
%
 
%
 
%
 
6.4
%
 
24.3
%
 
14.9
%
 
15.3
%
 
33.4
%
 
5.5
%
 
%
 
100.0
%
(1)
For Re-REMICs, the table reflects the year in which the resecuritizations were issued. The vintage distribution of the securities that collateralize our Re-REMIC investments is 7.7% for 2005, 24.0% for 2006 and 68.3% for 2007.
The tables below represent the geographic concentration of the underlying collateral for our non-Agency RMBS, GSE CRT and CMBS portfolio as of December 31, 2016:
Non-Agency RMBS
State
 
Percentage
 
GSE CRT
State
 
Percentage
 
CMBS
State
 
Percentage
California
 
41.4
%
 
California
 
19.8
%
 
California
 
14.7
%
New York
 
7.7
%
 
Texas
 
6.0
%
 
New York
 
13.9
%
Florida
 
6.3
%
 
New York
 
4.4
%
 
Texas
 
10.1
%
Virginia
 
3.6
%
 
Virginia
 
4.3
%
 
Florida
 
6.0
%
Maryland
 
3.5
%
 
Florida
 
4.2
%
 
Pennsylvania
 
4.6
%
New Jersey
 
3.5
%
 
Illinois
 
3.9
%
 
Illinois
 
4.3
%
Massachusetts
 
2.9
%
 
Massachusetts
 
3.4
%
 
New Jersey
 
3.7
%
Illinois
 
2.9
%
 
Washington
 
3.3
%
 
Ohio
 
3.0
%
Washington
 
2.6
%
 
New Jersey
 
3.2
%
 
Michigan
 
3.0
%
Texas
 
2.1
%
 
Colorado
 
3.2
%
 
Virginia
 
2.8
%
Other
 
23.5
%
 
Other
 
44.3
%
 
Other
 
33.9
%
Total
 
100.0
%
 
 
 
100.0
%
 
Total
 
100.0
%
Financing and Other Liabilities.
We enter into repurchase agreements to finance the majority of our target assets. These agreements are secured by our Agency RMBS, non-Agency RMBS, GSE CRTs and CMBS. In addition, these agreements are generally settled on a short-term basis, usually ranging from one to twelve months, and bear interest at rates that have historically moved in close relationship to LIBOR. At each settlement date, we refinance each repurchase agreement at the market interest rate at that time. As of December 31, 2016, we had entered into repurchase agreements totaling $11.2 billion (2015: $12.1 billion). The decrease in our repurchase agreement balance was primarily due to a lower overall investment portfolio balance and our strategy of reducing leverage in advance of the U.S. Presidential election and anticipated increase in the Federal Funds interest rate.
Our wholly-owned subsidiary, IAS Services LLC, is a member of the FHLBI. As a member of the FHLBI, IAS Services LLC has borrowed funds from the FHLBI in the form of secured advances. As of December 31, 2016, IAS Services LLC had $1.65 billion in outstanding secured advances. For the year ended December 31, 2016, IAS Services LLC had weighted average borrowings of $1.65 billion with a weighted average borrowing rate of 0.66% and a weighted average maturity of 7.35 years.
On January 12, 2016, new FHFA rules were adopted that exclude captive insurance companies from Federal Home Loan Bank membership. Under the new rules, IAS Services LLC is permitted to remain a member of the Federal Home Loan Bank until February 2021, and the FHLBI is permitted to honor the contractual maturity of our existing advances. Accordingly, we do not expect there to be any impact to our existing FHLBI borrowings under the FHFA Rule.


 
43
 

Table of Contents

The following table presents the amount of collateralized borrowings outstanding under repurchase agreements and secured loans as of the end of each quarter, the average amount outstanding during the quarter and the maximum balance outstanding during the quarter:
$ in thousands
Collateralized borrowings under repurchase agreements and secured loans
Quarter Ended
Quarter-end balance
 
Average quarterly balance
 
Maximum balance outstanding
March 31, 2015
14,883,081

 
14,785,890

 
14,883,081

June 30, 2015
14,724,860

 
14,860,637

 
14,950,089

September 30, 2015
14,587,131

 
14,765,282

 
14,879,873

December 31, 2015
13,776,048

 
14,286,242

 
14,730,071

March 31, 2016
12,837,159

 
13,137,569

 
13,501,433

June 30, 2016
13,418,647

 
13,075,770

 
13,418,647

September 30, 2016
13,710,502

 
13,826,469

 
13,984,960

December 31, 2016
12,810,669

 
13,215,697

 
13,626,829

In 2013, our wholly-owned subsidiary, IAS Operating Partnership LP, issued $400.0 million in aggregate principal amount of Exchangeable Senior Notes (the “Notes”) due March 15, 2018. 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 our common stock at the applicable exchange rate at any time prior to the close of business on March 13, 2018. The initial exchange rate for each $1,000 aggregate principal amount of the Notes is 42.0893 shares of our common stock, equivalent to an exchange price of approximately $23.76 per share, and the maximum exchange rate is 48.4027 shares of our common stock, equivalent to an exchange price of approximately $20.66 per share.
We have also committed to invest up to $121.6 million in unconsolidated ventures that are sponsored by an affiliate of our Manager. As of December 31, 2016, $106.1 million of our commitment to these unconsolidated ventures has been called. We are committed to fund an additional $15.5 million in additional capital to fund future investments and to cover future expenses should they occur.
We record a liability for mortgage-backed and credit risk transfer securities purchased, for which settlement has not taken place, as an investment related payable. As of December 31, 2016 and 2015, we had investment related payables of $9.2 million and $167,000, respectively. Our liability balance fluctuates based on our volume of unsettled trades.
We record a receivable for mortgage-backed and credit risk transfer securities sold for which settlement has not taken place as an investment related receivable. As of December 31, 2016 and 2015, we had investment related receivables of $43.9 million and $154.6 million, respectively. Our receivable balance fluctuates based on our volume of unsettled trades.
Hedging Instruments.
We generally hedge as much of our interest rate and foreign exchange risk as we deem prudent in light of market conditions. No assurance can be given that our hedging activities will have the desired beneficial impact on our results of operations or financial condition. Our investment policies do not contain specific requirements as to the percentages or amount of risk that we are required to hedge.
Hedging may fail to protect or could adversely affect us because, among other things:
available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;
the duration of the hedges may not match the duration of the related liabilities;
our counterparty in the hedging transaction may default on its obligation to pay;
the credit quality of our counterparty on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and
the value of derivatives used for hedging may be adjusted from time-to-time in accordance with accounting rules to reflect changes in fair value.
As of December 31, 2016, we have entered into interest rate swap agreements designed to mitigate the effects of increases in interest rates under a portion of our borrowings. These swap agreements provide for fixed interest rates indexed off of one-month and three-month LIBOR and effectively fix the floating interest rates on $6.5 billion (2015: $11.5 billion) of borrowings.


 
44
 

Table of Contents

During the year ended December 31, 2016, we terminated swaps with a notional amount of $5.0 billion and realized losses of $69.1 million. The terminated swaps were predominantly maturing in 2016 and offered little protection from rising rates. Additionally, our investment and repurchase agreement balances decreased due to asset sales to facilitate stock repurchases, further reducing our need for hedging. Our overall interest rate risk did not change materially as a result of the swap terminations.
As of December 31, 2016, we have no outstanding interest rate swaptions. As of December 31, 2015, we held $300.0 million in notional amount of fixed receive interest rate swaptions as an asset with a fair value of $0. The swaptions that we held at December 31, 2015 expired unexercised, and we realized a net loss of $1.5 million. We purchase interest rate swaptions to reduce the impact that interest rate volatility has on our portfolio. The change in the notional amount of swaptions held was due to our views on the potential for change in volatility.
As of December 31, 2016 and December 31, 2015, we have no outstanding futures contracts. During the year ended December 31, 2015, we sold U.S. Treasury futures contracts of $248.3 million in notional amount and realized a net loss of $943,000. We periodically invest in U.S. Treasury futures to help mitigate the potential impact of changes in interest rates on the performance of our portfolio.
As of December 31, 2016 and December 31, 2015, we have no outstanding to-be-announced securities ("TBAs"). During the year ended December 31, 2015, we settled TBAs of $446.0 million in notional amount and realized a net loss of $2.3 million. When we enter into TBAs, we agree to purchase or deliver in the future Agency RMBS with certain principal and interest terms. We periodically purchase or sell certain TBAs to help mitigate the potential impact of changes in interest rates on the performance of our portfolio.
As of December 31, 2016, we held $62.3 million (2015: $76.3 million) in notional amount of currency forward contracts as an asset with a fair value of $101,000 (2015: $1.9 million) and a liability with a fair value of $395,000 (2015: $103,000). During the year ended December 31, 2016, we settled currency forward contracts of $307.5 million (2015: $131.0 million) in notional amount and realized a net gain of $12.6 million (2015: $1.2 million). We use currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on our investments denominated in foreign currencies.


 
45
 

Table of Contents

Book Value per Share
We calculate book value per share as follows:
 
Years Ended December 31,
In thousands except per share amounts
2016
 
2015
 
2014
Numerator (adjusted equity):
 
 
 
 
 
Total equity
2,270,184

 
2,266,908

 
2,638,850

Less: Liquidation preference of Series A Preferred Stock
(140,000
)
 
(140,000
)
 
(140,000
)
Less: Liquidation preference of Series B Preferred Stock
(155,000
)
 
(155,000
)
 
(155,000
)
Total adjusted equity
1,975,184

 
1,971,908

 
2,343,850

 
 
 
 
 
 
Denominator (number of shares - fully diluted)(1):
 
 
 
 
 
Beginning shares - fully diluted
115,045

 
124,536

 
125,935

Proceeds from issuance of common stock, net of offering costs
3

 
13

 
16

Repurchase of shares of common stock
(2,063
)
 
(9,539
)
 
(1,438
)
Stock awards
35

 
35

 
23

Ending shares - fully diluted
113,020

 
115,045

 
124,536

 
 
 
 
 
 
Book value per common share
17.48

 
17.14

 
18.82

(1)
Number of shares - fully diluted includes total common shares outstanding plus Operating Partnership Units convertible into shares of common stock (1,425,000 shares).
Our book value per diluted common share increased in 2016 due to tighter credit spreads, which resulted in an increase in valuations for our residential and commercial credit investments. Although we saw a benefit from credit spreads tightening in 2016, interest rates also rose, causing our Agency RMBS portfolio to decrease in value. The decrease was partially offset by our interest rate hedges. Refer to Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” for interest rate risk and its impact on fair value.
The decrease in our book value in 2015 from 2014 was primarily due to the change in valuation of our investment portfolio that is recorded in accumulated other comprehensive income on our consolidated balance sheets. Refer to Note 4 – “Mortgage-Backed and Credit Risk Transfer Securities” of our consolidated financial statements for the impact of changes in accumulated other comprehensive income on our investment portfolio.
Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with U.S. GAAP, which requires the use of estimates that involve the exercise of judgment regarding matters that are uncertain at the time policies were applied and estimates were made. Accounting estimates discussed in this section are those that we consider to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. All of these estimates reflect our best judgment about current, and for some estimates, future economic and market conditions and their effects based on information available as of the date of these financial statements. If conditions change from those expected, it is possible that the judgments and estimates described below could change, which may result in a change in valuation of our investment portfolio, future impairments of our MBS and GSE CRTs, change in our interest income recognition, allowance for loan losses, and a change in our tax liability among other effects.
Mortgage-Backed and Credit Risk Transfer Securities. We record our MBS except RMBS IOs, purchased prior to September 1, 2016, as available-for-sale and report them at fair value. RMBS IOs and GSE CRTs are hybrid financial instruments reported at fair value. Fair value is determined by obtaining valuations from an independent source. If the fair value of a security is not available from a third-party pricing service, we may estimate the fair value of the security using a variety of methods including other pricing services, discounted cash flow analysis, matrix pricing, option adjusted spread models and other fundamental analysis of observable market factors. It is possible that changes in these inputs could change the valuation estimate and lead to impairment of our MBS and GSE CRT portfolio. Further information is provided in Note 2 - "Summary of Significant Accounting Policies" and Note 4 - “Mortgage-Backed and Credit Risk Transfer Securities."
We have elected the fair value option for all of our MBS purchased on or after September 1, 2016. Prior to September 1, 2016, we have also elected the fair value option for our RMBS IOs. We have also previously elected the fair value option for GSE CRTs purchased on or after August 24, 2015. Under the fair value option, changes in fair value are recognized in the


 
46
 

Table of Contents

consolidated statement of operations. In our view, the fair value option election more appropriately reflects the results of our operations because MBS and GSE CRT fair value changes are accounted for in the same manner as fair value changes in economic hedging instruments. As of December 31, 2016, $427.5 million or 2.9% of our MBS and GSE CRT are accounted for under the fair value option. Further information is provided in Note 2 - “Summary of Significant Accounting Policies” and Note 4 - “Mortgage-Backed and Credit Risk Transfer Securities”.
Other-than-temporary Impairment. We regularly review our available-for-sale portfolio for other-than-temporary impairment. This determination involves both qualitative and quantitative data. It is possible that estimates may be incorrect, economic conditions may change or we may be forced to sell the investment before recovery of our amortized cost. Further information is provided in Note 2 - "Summary of Significant Accounting Policies" and Note 4 - “Mortgage-Backed and Credit Risk Transfer Securities."
Residential and Commercial Loans. Residential loans held-for-investment were carried at unpaid principal balance net of any premiums and an allowance for loan losses. An allowance for loan losses is established based on credit losses inherent in the portfolio. These estimates require consideration of various inputs including, but not limited to, historical loss experience, delinquency status, borrower credit scores, geographic concentrations and loan-to-value ratios. In addition, since we had not incurred any direct losses on our portfolio, we utilized national historical credit performance information from a third party to assist in our analysis.
Commercial loans held-for-investment are carried at amortized cost, net of any allowance for loan losses. We generally consider various factors in evaluating whether a commercial loan is impaired. These factors include, but are not limited to, the loan-to-value ratios, the most recent financial information available for each loan and associated properties, economic trends and the loan sponsor or the borrowing entity's ability to ensure that properties associated with the loan are managed and operating sufficiently.
Changes in our estimates can significantly impact the allowance for loan losses and provision expense. It is also possible that we will experience credit losses that are different from our current estimates or that the timing of those losses may differ from our estimates. Further information on the allowance for loan losses is provided in Note 2 - “Summary of Significant Accounting Policies.”
Interest Income Recognition. Interest income on MBS is accrued based on the outstanding principal or notional balance of the securities and their contractual terms. Premiums or discounts are amortized or accreted into interest income over the life of the investment using the effective interest method.
Interest income on our MBS where we may not recover substantially all of our initial investment is based on estimated future cash flows. We estimate future expected cash flows at the time of purchase and determine the effective interest rate based on these estimated cash flows and our purchase price. Over the life of the investments, we update these estimated future cash flows and compute a revised yield based on the current amortized cost of the investment. In estimating these future cash flows, there are a number of assumptions that are subject to uncertainties and contingencies, including but not limited to the rate and timing of principal payments (prepayments, repurchases, defaults and liquidations), the pass through or coupon rate, and interest rate fluctuations. These uncertainties and contingencies are difficult to predict and are subject to future events that may impact our estimate and our interest income. Changes in our original or most recent cash flow projections may result in a prospective change in interest income recognized on these securities, or the amortized cost of these securities. For non-Agency RMBS not of high credit quality, when actual cash flows vary from expected cash flows, the difference is recorded as an adjustment to the amortized cost of the security and the security's yield is revised prospectively.
For Agency RMBS that cannot be prepaid in such a way that we would not recover substantially all of our initial investment, interest income recognition is based on contractual cash flows. We do not estimate prepayments in applying the effective interest method.
Interest income on GSE CRTs purchased prior to August 24, 2015 is accrued based on the coupon rate of the debt host contract which reflects the credit risk of GSE unsecured senior debt with a similar maturity. Premiums or discounts associated with the purchase of credit risk transfer securities are amortized or accreted into interest income over the life of the debt host contract using the effective interest method. Interest income on GSE CRTs purchased on or after August 24, 2015 is based on estimated future cash flows.
Prior to the deconsolidation of the Residential Securitizations, interest income from our residential loans was recognized on an accrual basis with the related premiums amortized into interest income using the effective interest method over the weighted average life of these loans. As needed, these estimated cash flows were updated and a revised yield was computed based on the current amortized cost of the investment.
Interest income from our commercial loans is recognized when earned and deemed collectible or until a loan becomes past due based on the terms of the loan agreement.


 
47
 

Table of Contents

Accounting for Derivative Financial Instruments. We use derivatives to manage interest rate and currency exchange risk. We record all derivatives on our consolidated balance sheets at fair value. Effective December 31, 2013, we voluntarily discontinued hedge accounting for our interest rate swap agreements by de-designating the interest rate swaps as cash flow hedges. As a result of discontinuing hedge accounting, changes in the fair value of the interest rate swaps are recorded in gain (loss) on derivative instruments, net in our consolidated statement of operations, rather than in accumulated other comprehensive income (loss). Further information is provided in Note 9 - “Derivatives and Hedging Activities.”
Income Taxes. We have elected to be taxed as a REIT. Accordingly, we generally will not be subject to U.S. federal and applicable state and local corporate income tax to the extent that we make qualifying distributions and provided we satisfy on a continuing basis, through actual investment and operating results, the REIT requirements including certain asset, income, distribution and stock ownership tests. The REIT qualifications rules are complex and failure to apply them correctly could subject us to U.S. federal, state and local income taxes.
Expected Impact of New Authoritative Guidance on Future Financial Information
In January 2016, the FASB issued guidance to improve certain aspects of classification and measurement of financial instruments, including significant revisions in accounting related to the classification and measurement of investments in equity securities and presentation of certain fair value changes for financial liabilities when the fair value option is elected. The guidance also amends certain disclosure requirements associated with the fair value of financial instruments. We are required to adopt the new guidance in the first quarter of 2018. Early adoption is permitted. We are currently evaluating the potential impact of the new guidance on our consolidated financial statements, as well as available transition methods.
In June 2016, the FASB issued an amendment to the guidance on reporting credit losses for assets measured at amortized cost and available-for-sale securities. We are required to adopt the new guidance in the first quarter of 2020. Early adoption is permitted. We are currently evaluating the potential impacts of the new guidance on our consolidated financial statements, as well as available transition methods.
In August 2016, the FASB issued new guidance that is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. We are required to adopt the new guidance in the first quarter of 2018. Early adoption is permitted, provided that all of the amendments are adopted at the same period. We are currently evaluating the potential impacts of the new guidance on our consolidated financial statements.



 
48
 

Table of Contents

Results of Operations
The table below presents certain information from our consolidated statements of operations for the years ended December 31, 2016, 2015 and 2014.
 
Years Ended December 31,
In thousands except share amounts
2016
 
2015
 
2014
Interest Income
 
 
 
 
 
Mortgage-backed and credit risk transfer securities
456,444

 
523,893

 
589,499

Residential loans (1)

 
110,908

 
88,073

Commercial loans
22,238

 
15,331

 
9,508

Total interest income
478,682

 
650,132

 
687,080

Interest Expense
 
 
 
 
 
Repurchase agreements
124,000

 
166,892

 
188,699

Secured loans
10,887

 
6,579

 
2,576

Exchangeable senior notes
22,467

 
22,461

 
22,461

Asset-backed securities (1)

 
82,041

 
68,159

Total interest expense
157,354

 
277,973

 
281,895

Net interest income
321,328

 
372,159

 
405,185

Reduction in provision for loan losses

 
(213
)
 
(142
)
Net interest income after reduction in provision for loan losses
321,328

 
372,372

 
405,327

Other income (loss)
 
 
 
 
 
Gain (loss) on investments, net
(17,542
)
 
(18,005
)
 
(84,407
)
Equity in earnings of unconsolidated ventures
2,392

 
12,630

 
6,786

Gain (loss) on derivative instruments, net
(62,815
)
 
(219,048
)
 
(487,469
)
Realized and unrealized credit derivative income (loss), net
61,143

 
19,782

 
(2,866
)
Other investment income (loss), net
(5,002
)
 
944

 
(2,045
)
Total other income (loss)
(21,824
)
 
(203,697
)
 
(570,001
)
Expenses
 
 
 
 
 
Management fee — related party
34,541

 
38,632

 
37,599

General and administrative
7,265

 
7,769

 
9,191

Consolidated securitization trusts (1)

 
8,219

 
6,076

Total expenses
41,806

 
54,620

 
52,866

Net income (loss)
257,698

 
114,055

 
(217,540
)
Net income (loss) attributable to non-controlling interest
3,287

 
1,344

 
(2,482
)
Net income (loss) attributable to Invesco Mortgage Capital Inc.
254,411

 
112,711

 
(215,058
)
Dividends to preferred stockholders
22,864

 
22,864

 
17,378

Net income (loss) attributable to common stockholders
231,547

 
89,847

 
(232,436
)
Earnings per share:
 
 
 
 
 
Net income (loss) attributable to common stockholders
 
 
 
 
 
Basic
2.07

 
0.74

 
(1.89
)
Diluted
1.98

 
0.74

 
(1.89
)
Weighted average number of shares of common stock:
 
 
 
 
 
Basic
111,973,404

 
121,377,585

 
123,104,934

Diluted
130,254,003

 
122,843,838

 
124,529,934

 
(1)
The consolidated statements of operations for years ended December 31, 2015 and 2014 include income and expenses of consolidated VIEs. We deconsolidated these VIEs in 2015. Refer to Note 2 - “Summary of Significant Accounting Policies” of our consolidated financial statements for further discussion.


 
49
 

Table of Contents

Net Income Summary
For the year ended December 31, 2016, our net income attributable to common stockholders was $231.5 million (2015: $89.8 million net income; 2014: $232.4 million net loss), or $2.07 basic and $1.98 diluted net income per average share available to common stockholders (2015: $0.74 basic and diluted net income per average share available to common stockholders; 2014: $1.89 basic and diluted net loss per average share available to common stockholders).
The change in net income attributable to common stockholders for the year ended December 31, 2016 versus net income attributable to common stockholders for the year ended December 31, 2015 is primarily attributable to realized and unrealized losses on derivative instruments of $62.8 million in 2016 versus a $219.0 million loss in 2015. The change in net income attributable to common stockholders for the year ended December 31, 2016 versus 2015 is also primarily attributable to lower net interest income of $321.3 million in 2016 period versus $372.2 million in 2015. Net interest income in 2016 were lower than in 2015 primarily due to the impact of the deconsolidation of our consolidated residential securitizations ("Residential Securitizations") in December 2015 as discussed below.
Our net income (loss) attributable to common shareholders for the years ended December 31, 2015 and 2014 include interest income, interest expense and securitization trust expenses of our consolidated Residential Securitizations. On December 9, 2015, we completed the sale of certain beneficial interests in our Residential Securitizations and deconsolidated the Residential Securitizations.
The following table summarizes the net income (loss) of the Residential Securitizations excluding the loss on deconsolidation.
 
Years ended December 31,
$ in thousands
2015
 
2014
Interest income - Residential loans
110,908

 
88,073

Interest expense - Asset-backed securities
82,041

 
68,159

Net interest income
28,867

 
19,914

Reduction in provision for loan losses
(213
)
 
(142
)
Net interest income after reduction in provision for loan losses
29,080

 
20,056

Expenses - Consolidated securitization trusts
8,219

 
6,076

Net income
20,861

 
13,980

The change in net income attributable to common stockholders for the year ended December 31, 2015 versus net loss attributable to common stockholders for the year ended December 31, 2014 is primarily attributable to lower realized and unrealized losses on derivative instruments and lower losses on sales of investments in 2015.


 
50
 

Table of Contents

Interest Income and Average Earning Asset Yield
The table below presents certain information for our average earning assets as of and for the years ended December 31, 2016, 2015 and 2014. 
 
As of and for the Years Ended
 
December 31,
$ in thousands
2016
 
2015
 
2014
Average Balances (1):
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
15 year fixed-rate, at amortized cost
2,722,301

 
1,698,573

 
1,450,316

30 year fixed-rate, at amortized cost
3,646,480

 
4,368,662

 
5,723,270

ARM, at amortized cost
353,937

 
446,714

 
475,401

Hybrid ARM, at amortized cost
2,800,812

 
3,219,463

 
2,452,062

Agency-CMO, at amortized cost
375,888

 
423,409

 
476,636

Non-Agency RMBS, at amortized cost
2,167,679

 
2,660,689

 
3,214,891

GSE CRT, at amortized cost
650,189

 
665,471

 
478,929

CMBS, at amortized cost
2,582,003

 
3,173,737

 
2,947,733

U.S. Treasury securities, at amortized cost
45,375

 

 

Residential loans, at amortized cost

 
3,198,666

 
2,473,258

Commercial loans, at amortized cost
265,708

 
166,150

 
109,551

Average earning assets
15,610,372

 
20,021,534

 
19,802,047

Average Earning Asset Yields (2):
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
15 year fixed-rate
1.98
%
 
2.23
%
 
2.66
%
30 year fixed-rate
2.72
%
 
2.80
%
 
3.05
%
ARM
2.28
%
 
2.30
%
 
2.30
%
Hybrid ARM
2.12
%
 
2.13
%
 
2.28
%
Agency-CMO
2.47
%
 
3.16
%
 
3.56
%
Non-Agency RMBS
4.97
%
 
4.85
%
 
4.91
%
GSE CRT (3)
0.98
%
 
0.54
%
 
0.50
%
CMBS
4.30
%
 
4.37
%
 
4.47
%
U.S. Treasury securities
1.15
%
 
%
 
%
Residential loans
%
 
3.47
%
 
3.57
%
Commercial loans
8.35
%
 
8.36
%
 
8.56
%
Average earning asset yields
3.07
%
 
3.25
%
 
3.47
%
(1)
Average amounts for each period are based on weighted month-end balances.
(2)
Average earning asset yield for the period was calculated by dividing interest income, including amortization of premiums and discounts, by our average of the amortized cost of the investments. All yields are annualized.
(3)
GSE CRT average earning asset yield excludes coupon interest associated with embedded derivatives on securities not accounted for under the fair value option that is recorded as realized and unrealized credit derivative income (loss), net under U.S. GAAP.
Our primary source of income is interest earned on our investment portfolio. We had average earning assets of approximately $15.6 billion (2015: $20.0 billion; 2014: $19.8 billion) and earned interest income of $478.7 million (2015: $650.1 million; 2014: $687.1 million) during 2016. The yield on our average investment portfolio was 3.07% (2015: 3.25%; 2014: 3.47%).
Average earning assets and interest income declined during the year ended December 31, 2016 compared to 2015 primarily due to the deconsolidation of our Residential Securitizations in December 2015. The decrease in our earning asset


 
51
 

Table of Contents

yields for 2016 and 2015 was primarily attributable to portfolio reallocation to lower duration Agency RMBS. Our asset allocation to Agency RMBS increased from 51% as of December 31, 2015 to 63% as of December 31, 2016.
Our average earning assets were relatively unchanged for 2015 compared to 2014. The change in our earning asset yields for 2015 versus 2014 was primarily attributable to portfolio reallocation to lower duration Agency RMBS.
Prepayment Speeds
Our RMBS and GSE CRT portfolio is subject to inherent prepayment risk primarily driven by changes in interest rates, which impacts the amount of premium and discount on the purchase of these securities that is recognized into interest income. Expected future prepayment speeds on our RMBS and GSE CRT portfolio are estimated on a quarterly basis. Generally, in an environment of falling interest rates, prepayment speeds will increase as homeowners are more likely to prepay their existing mortgage and refinance into a lower borrowing rate. If the actual prepayment speed during the period is faster than estimated, the amortization on securities purchased at a premium to par value will be accelerated, resulting in lower interest income recognized. Conversely, for securities purchased at a discount to par value, interest income will be reduced in periods where prepayment speeds were slower than expected. The following tables provide the three month constant prepayment rate for our RMBS and GSE CRTs throughout 2016, 2015 and 2014.
 
Three Months Ended
 
December 31, 2016
 
September 30, 2016
 
June 30, 2016
 
March 31, 2016
15 year Agency RMBS
8.9

 
9.5

 
10.4

 
10.2

30 year Agency RMBS
17.6

 
16.2

 
13.7

 
10.8

Agency Hybrid ARM RMBS
20.5

 
21.7

 
18.4

 
12.5

Non-Agency RMBS
17.9

 
16.5

 
15.2

 
11.1

GSE CRT
21.0

 
17.9

 
14.0

 
9.2

Weighted average CPR
16.3

 
16.1

 
14.9

 
11.2

 
Three Months Ended
 
December 31, 2015
 
September 30, 2015
 
June 30, 2015
 
March 31, 2015
15 year Agency RMBS
10.7

 
13.1

 
10.7

 
9.4

30 year Agency RMBS
12.5

 
14.8

 
13.9

 
11.1

Agency Hybrid ARM RMBS
13.9

 
15.2

 
17.3

 
14.2

Non-Agency RMBS
12.5

 
15.3

 
14.0

 
10.3

GSE CRT
10.5

 
12.6

 
13.9

 
9.5

Weighted average CPR
12.6

 
14.7

 
14.4

 
11.4

 
Three Months Ended
 
December 31, 2014
 
September 30, 2014
 
June 30, 2014
 
March 31, 2014
15 year Agency RMBS
11.9

 
12.9

 
12.3

 
9.8

30 year Agency RMBS
11.8

 
12.0

 
9.4

 
7.2

Agency Hybrid ARM RMBS
14.3

 
13.0

 
9.4

 
5.9

Non-Agency RMBS
10.7

 
11.9

 
11.2

 
10.5

GSE CRT
7.7

 
8.2

 
4.5

 
4.3

Weighted average CPR
12.0

 
12.1

 
10.0

 
8.2



 
52
 

Table of Contents

We recognized $118.2 million and $117.3 million of net premium amortization during the years ended December 31, 2016 and 2015, respectively, on our RMBS and GSE CRT portfolio. Although weighted average prepayment speeds were higher during the year ended December 31, 2016 than 2015, net premium amortization was relatively constant because of lower average earning assets following share repurchases.
We recognized $117.3 million and $113.9 million of net premium amortization during the years ended December 31, 2015 and 2014, respectively, on our RMBS and GSE CRT portfolio. The increase in net premium amortization compared to 2014 reflects higher premium amortization on Agency securities and lower discount accretion on Non-Agency securities due to faster speeds in 2015 and changes in portfolio composition.
Our interest income is subject to interest rate risk. Refer to Item 7A. “Quantitative and Qualitative Disclosures about Market Risk” for more information relating to interest rate risk and its impact on our operating results.
Interest Expense and the Cost of Funds
The table below presents the components of interest expense for the years ended December 31, 2016, 2015 and 2014.
 
For the Years Ended
 
December 31,
$ in thousands
2016
 
2015
 
2014
Interest Expense
 
 
 
 
 
Interest expense on repurchase agreements outstanding
118,846

 
100,135

 
103,523

Amortization of net deferred (gain) loss on de-designated interest rate swaps
5,154

 
66,757

 
85,176

Repurchase agreements interest expense
124,000

 
166,892

 
188,699

Secured loans
10,887

 
6,579

 
2,576

Exchangeable senior notes
22,467

 
22,461

 
22,461

Asset-backed securities

 
82,041

 
68,159

Total interest expense
157,354

 
277,973

 
281,895

We enter into repurchase agreements to finance the majority of our target assets. These agreements are secured by our Agency RMBS, non-Agency RMBS, GSE CRTs and CMBS. In addition, these agreements are generally settled on a short-term basis, usually from one to twelve months, and bear interest at rates that have historically moved in close relationship to LIBOR. At each settlement date, we typically refinance each repurchase agreement at the market interest rate at that time.
Our repurchase agreement interest expense includes amortization of deferred gains and losses on de-designated interest rate swaps as summarized in the table above. Amortization of net deferred losses on de-designated interest rate swaps increased our total interest expense by $5.2 million (2015: $66.8 million; 2014: $85.2 million) during the year ended December 31, 2016. Amounts recorded in AOCI before we discontinued cash flow hedge accounting for our interest rate swaps are reclassified to interest expense on repurchase agreements on the consolidated statements of operations as interest is accrued and paid on the related repurchase agreements over the remaining life of the interest rate swap agreements. During the next twelve months, we estimate that $25.5 million of net deferred gains on de-designated interest rate swaps will be reclassified from other comprehensive income and recorded as a decrease to interest expense.
Interest expense for our secured loans increased for the year ended December 31, 2016 compared to 2015 primarily due to higher borrowing rates as a result of the December 2015 increase in the Federal Funds interest rate as well as higher average balances. For the year ended December 31, 2016, IAS Services LLC had a weighted average borrowing rate of 0.66% as compared to 0.41% for the year ended December 31, 2015 as well as weighted average borrowings of $1.65 billion compared to $1.6 billion for the year ended December 31, 2015. Interest expense for our secured loans increased for the year ended December 31, 2015 compared to 2014 primarily due to higher average borrowings. For the year ended December 31, 2015, IAS Services LLC had weighted average borrowings of $1.6 billion compared to weighted average borrowings of $707.8 million for the year ended December 31, 2014.
Our total interest expense decreased for the year ended December 31, 2016 compared to 2015 primarily due to an $82.0 million decrease in interest expense on asset-backed securities as a result of the deconsolidation of our Residential Securitizations in December 2015. In addition to the deconsolidation, amortization of net deferred losses on de-designated interest rate swaps decreased by $61.6 million for the year ended December 31, 2016. These decreases were offset by an $18.7 million increase in interest expense on repurchase agreements outstanding due to higher borrowing rates.


 
53
 

Table of Contents

The decrease in total interest expense for the year ended December 31, 2015 compared to 2014 is primarily due to an $18.4 million decrease in amortization of net deferred losses on de-designated interest rate swaps offset by a $13.9 million increase in asset-backed securities interest expense. Interest expense on asset-backed securities rose in 2015 due to the consolidation of eleven securitization trusts versus ten securitization trusts in 2014.
The table below presents certain information related to our borrowings and cost of funds as of and for the years ended December 31, 2016, 2015 and 2014.
 
As of and for the Years Ended
 
December 31,
$ in thousands
2016
 
2015
 
2014
Average Borrowings*:
 
 
 
 
 
Agency RMBS (1)
8,872,694

 
9,118,307

 
9,444,028

Non-Agency RMBS
1,750,730

 
2,439,849

 
2,821,132

GSE CRT
459,738

 
484,414

 
351,900

CMBS (1)
2,176,963

 
2,632,338

 
2,305,970

U.S. Treasury securities
54,882

 

 

Exchangeable senior notes
395,910

 
393,440

 
390,989

Asset-backed securities

 
2,774,833

 
2,174,149

Total borrowed funds
13,710,917

 
17,843,181

 
17,488,168

Maximum borrowings during the period (2)
14,381,178

 
18,416,608

 
18,202,497

Average Cost of Funds (3):
 
 
 
 
 
Agency RMBS (1)
0.69
%
 
0.39
%
 
0.34
%
Non-Agency RMBS
1.90
%
 
1.58
%
 
1.54
%
GSE CRT
2.14
%
 
1.73
%
 
1.52
%
CMBS (1)
1.14
%
 
0.93
%
 
1.11
%
U.S. Treasury securities
0.25
%
 
%
 
%
Exchangeable senior notes
5.67
%
 
5.71
%
 
5.74
%
Asset-backed securities
%
 
2.96
%
 
3.13
%
Cost of funds
1.15
%
 
1.56
%
 
1.61
%
Effective cost of funds (non-GAAP measure) (4)
1.87
%
 
2.22
%
 
2.27
%
*
 Average amounts for each period are based on weighted month-end balances.
(1)
Agency RMBS and CMBS average borrowing and average cost of funds include borrowings under repurchase agreements and secured loans.
(2)
Amount represents the maximum borrowings at month-end during each of the respective periods.
(3)
Average cost of funds is calculated by dividing annualized interest expense excluding amortization of net deferred gain (loss) on de-designated interest rate swaps by our average borrowings.
(4)
For a reconciliation of cost of funds to effective cost of funds, see "Non-GAAP Financial Measures".
The change in average borrowed funds and our cost of funds for 2016 versus 2015 was primarily the result of deconsolidation of our Residential Securitizations in December 2015 and a decline in average repurchase agreement borrowings. Average borrowed funds and average cost of funds on asset-backed securities were $2.8 billion and 2.96%, respectively, for the year ended December 31, 2015. In addition, average repurchase agreement borrowings declined by $1.4 billion in 2016 compared to 2015. The change in average borrowed funds for 2015 versus 2014 was primarily the result of a decrease in our average repurchase agreement borrowings for Agency RMBS offset by an increase in average borrowings for asset-backed securities. The decrease in our cost of funds was primarily due to shifting some of our financing for CMBS from repurchase agreement borrowing to secured loans in 2015 versus 2014.


 
54
 

Table of Contents

Net Interest Income
The table below presents the components of net interest income for the years ended December 31, 2016, 2015 and 2014.
 
For the Years Ended
 
December 31,
$ in thousands
2016
 
2015
 
2014
Interest Income
 
 
 
 
 
Mortgage-backed and credit risk transfer securities
456,444

 
523,893

 
589,499

Residential loans

 
110,908

 
88,073

Commercial loans
22,238

 
15,331

 
9,508

Total interest income
478,682

 
650,132

 
687,080

Interest Expense
 
 
 
 
 
Interest expense on repurchase agreements outstanding
118,846

 
100,135

 
103,523

Amortization of net deferred (gain) loss on de-designated interest rate swaps
5,154

 
66,757

 
85,176

Repurchase agreements interest expense
124,000

 
166,892

 
188,699

Secured loans
10,887

 
6,579

 
2,576

Exchangeable senior notes
22,467

 
22,461

 
22,461

Asset-backed securities

 
82,041

 
68,159

Total interest expense
157,354

 
277,973

 
281,895

Net interest income
321,328

 
372,159

 
405,185

Our net interest income, which equals interest income less interest expense, for the year ended December 31, 2016, totaled $321.3 million (2015: $372.2 million; 2014: $405.2 million). The decrease in net interest income for the year ended December 31, 2016 compared to 2015 was primarily due lower overall portfolio balance and reinvesting cash flows from repayment of principal and interest on our higher yielding credit assets and 30 year fixed-rate Agency RMBS portfolio into 15 year fixed-rate Agency RMBS. Our net interest rate margin for the year ended December 31, 2016, which equals our average earning asset yields for the period less the average cost of funds for the period, was 1.92% (2015: 1.69%; 2014: 1.86%). The increase in net interest rate margin for 2016 versus 2015 was primarily due to lower amortization of net deferred losses on de-designated interest rate swaps into interest expense.
The decrease in net interest income was primarily due to the decline in average investment portfolio yield in 2015 compared to 2014. The decline in net interest margin was primarily the result of increased average borrowings in the form of asset-backed securities issued by securitization trusts in 2015 versus 2014.
Refer to the table in the “Interest Income and Average Earning Asset Yield” section above for changes in average portfolio balance and yields.
Provision for Loan Losses
We evaluate the collectibility of our commercial loans held-for investment using the factors described in Note 2 - "Summary of Significant Accounting Policies" of our consolidated financial statements in Part IV, Item 15 of this Report. We determined that no provision for loan losses for our commercial loans was required as of December 31, 2016.
Our provision for loan losses for the years ended December 31, 2015 and 2014 was solely for residential loans held-for-investment by consolidated securitization trusts. We did not have a provision for residential loan losses as of December 31, 2016 because we deconsolidated our Residential Securitizations in December 2015.


 
55
 

Table of Contents

Gain (Loss) on Investments, net
The table below summarizes the components of gain (loss) on investments, net for the years ended December 31, 2016, 2015 and 2014.
 
Years Ended December 31,
$ in thousands
2016
 
2015
 
2014
Realized gains and losses on sale of investments
(7,439
)
 
2,232

 
(76,669
)
Other-than-temporary impairment losses
(8,909
)
 

 

Net unrealized gains and losses on MBS accounted for under the fair value option
(5,791
)
 
(558
)
 
(7,738
)
Net unrealized gains and losses on GSE CRT accounted for under the fair value option
4,598

 
(56
)
 

Net unrealized gains and losses on trading securities
(1
)
 

 

Total gain (loss) on deconsolidation of VIEs, net

 
(19,623
)
 

Total
(17,542
)
 
(18,005
)
 
(84,407
)
As part of our investment process, all of our mortgage-backed and credit risk transfer securities are continuously reviewed to determine if they continue to meet our risk and return targets. This process involves looking at changing market assumptions and the impact those assumptions will have on the individual securities.
We assess our investment securities for other-than-temporary impairment on 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." For additional information regarding our assessment analysis of other-than temporary impairment on our investment securities, refer to Note 4 – “Mortgage-Backed and Credit Risk Transfer Securities” of our consolidated financial statements.
We recorded $8.9 million in other-temporary-impairments ("OTTI") on RMBS interest-only and non-Agency RMBS securities for the year ended December 31, 2016. We did not record any OTTI for the years ended December 31, 2015 and 2014.
We have elected the fair value option for all of our MBS purchased on or after September 1, 2016 and all of our GSE CRTs purchased on or after August 24, 2015. Prior to September 1, 2016, we had also elected the fair value option for our RMBS IOs. Under the fair value option, changes in fair value are recognized in income in the consolidated statements of operations.
We recorded a loss of $19.6 million in our consolidated statement of operations related to the deconsolidation of our Residential Securitizations in December 2015. The deconsolidation of the Residential Securitizations did not qualify for presentation and disclosure as discontinued operations. The following table presents the components of the loss on deconsolidation.
$ in thousands
As of December 9, 2015
Gain (loss) related to derecognition of Residential Securitizations, net
(13,260
)
Gain (loss) related to remeasurement of retained interest, net
3,068

Gain (loss) on sale of the securities, net
(9,431
)
Total gain (loss) on deconsolidation of VIEs, net
(19,623
)
Equity in Earnings of Unconsolidated Ventures
For the year ended December 31, 2016, we recorded equity in earnings of unconsolidated ventures of $2.4 million (2015: $12.6 million; 2014: $6.8 million). Equity in earnings of unconsolidated ventures decreased $10.2 million in 2016 compared to 2015 primarily due to lower realized and unrealized gains on underlying portfolio investments than in the 2015 period.
Equity in earnings of unconsolidated ventures increased $5.8 million in 2015 compared to 2014 primarily due to higher realized and unrealized gains on underlying portfolio investments than in the 2014 period.
Gain (Loss) on Derivative Instruments, net
Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements on our floating rate repurchase agreements and secured loans. To accomplish these objectives, we


 
56
 

Table of Contents

primarily use interest rate derivative instruments, including interest rate swaps, interest rate swaptions, U.S. Treasury futures contracts and TBAs as part of our interest rate risk management strategy.
We also use currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on our investments denominated in foreign currencies.
We record all derivatives on our consolidated balance sheets at fair value. At the inception of a derivative contract, we determine whether the instrument will be part of a qualifying hedge accounting relationship or whether we will account for the contract as a trading instrument. We have elected not to apply hedge accounting to any derivative contracts entered into after January 1, 2014. Changes in the fair value of our derivatives are recorded in gain (loss) on derivative instruments, net in our consolidated statements of operations. Net interest paid or received under our interest rate swaps is also recognized in gain (loss) on derivative instruments, net in our consolidated statements of operations.
The tables below summarize the components of our gain (loss) on derivative instruments, net for the years ended December 31, 2016, 2015 and 2014:
$ in thousands
Year ended December 31, 2016
Derivative
not designated as
hedging instrument
Realized gain (loss) on derivative instruments, net
 
 Contractual net
interest expense
 
Unrealized
gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
(69,090
)
 
(104,804
)
 
100,503

 
(73,391
)
Interest Rate Swaptions
(1,485
)
 

 
1,485

 

Currency Forward Contracts
12,632

 

 
(2,056
)
 
10,576

Total
(57,943
)
 
(104,804
)
 
99,932

 
(62,815
)

$ in thousands
Year ended December 31, 2015
Derivative
not designated as
hedging instrument
Realized gain (loss) on derivative instruments, net
 
 Contractual net
interest expense
 
Unrealized
gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
(31,881
)
 
(184,373
)
 
(554
)
 
(216,808
)
Interest Rate Swaptions
(10,328
)
 

 
8,521

 
(1,807
)
TBAs
(2,292
)
 

 
558

 
(1,734
)
Futures Contracts
(943
)
 

 
(90
)
 
(1,033
)
Currency Forward Contracts
1,172

 

 
1,162

 
2,334

Total
(44,272
)
 
(184,373
)
 
9,597

 
(219,048
)

$ in thousands
Year ended December 31, 2014
Derivative
not designated as
hedging instrument
Realized gain (loss) on derivative instruments, net
 
 Contractual net
interest expense
 
Unrealized
gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
(28,758
)
 
(199,783
)
 
(223,944
)
 
(452,485
)
Interest Rate Swaptions
(23,275
)
 

 
10,906

 
(12,369
)
TBAs
(10,843
)
 

 
(558
)
 
(11,401
)
Futures Contracts
(11,489
)
 

 
(2,502
)
 
(13,991
)
Currency Forward Contracts
2,178

 

 
599

 
2,777

Total
(72,187
)
 
(199,783
)
 
(215,499
)
 
(487,469
)


 
57
 

Table of Contents

As of December 31, 2016 and 2015, we held the following interest rate swaps whereby we receive interest at a one-month and three-month LIBOR rate:
$ in thousands
December 31, 2016
 
December 31, 2015
Derivative instrument
Notional Amounts
 
Average Fixed Pay Rate
 
Average Receive Rate
 
Average Maturity (Years)
 
Notional Amounts (1)
 
Average Fixed Pay Rate
 
Average Receive Rate
 
Average Maturity (Years)
Interest Rate Swaps
6,500,000

 
2.14
%
 
0.79
%
 
4.64
 
9,850,000

 
2.07
%
 
0.36
%
 
3.65
(1)
Excludes $1.6 billion of notional amounts for interest rate swaps with forward start dates of February 2016, May 2016 and June 2016.
During the year ended December 31, 2016, we terminated swaps with a notional amount of $5.0 billion and realized losses of $69.1 million. The terminated swaps were predominantly maturing in 2016 and offered little protection from rising rates. Additionally, our investment and repurchase agreement balances decreased due to asset sales to facilitate stock repurchases, further reducing our need for hedging. Our overall interest rate risk did not change materially as a result of the swap terminations. As a result of swap terminations, our contractual net interest expense decreased from $184.4 million in 2015 to $104.8 million in 2016.
Realized and Unrealized Credit Derivative Income (Loss), net
The table below summarizes the components of realized and unrealized credit derivative income (loss), net for the years ended December 31, 2016, 2015 and 2014. 
 
Years Ended December 31,
$ in thousands
2016
 
2015
 
2014
GSE CRT embedded derivative coupon interest
24,343

 
24,822

 
17,536

Gain (loss) on settlement of GSE CRT embedded derivatives
(6,017
)
 
(2,184
)
 

Change in fair value of GSE CRT embedded derivatives
42,817

 
(4,227
)
 
(21,495
)
Credit Default Swap ("CDS") premium income

 
723

 
1,351

Realized gain (loss) on settlement of CDS

 
1,044

 

Change in fair value of CDS

 
(396
)
 
(258
)
Total
61,143

 
19,782

 
(2,866
)
During the year ended December 31, 2016, we recorded an unrealized gain on the change in the fair value of our GSE
CRT embedded derivatives compared to an unrealized loss in the year ended December 31, 2015. The increase in the value of our GSE CRT holdings during the year ended December 31, 2016 primarily resulted from broad credit spread tightening, increasing market demand for floating rate securities and positive rating actions by two nationally recognized statistical rating organizations.

During the year ended December 31, 2015, we recorded a $4.2 million loss compared to a $21.5 million loss in 2014. The change in the fair value of GSE CRT embedded derivatives during the year ended December 31, 2015 primarily resulted from credit spreads generally tightening in the first half of the year and credit spreads generally widening in the second half of the year, ending the year with a modest decrease in prices as compared to the beginning of the year.
We terminated our sole CDS contract in October 2015 in exchange for a payment to us of $1 million.
Other Investment Income (Loss), net
Other investment income (loss), net primarily consists of quarterly dividends from FHLBI stock and foreign exchange rate gains and losses related to commercial loan investments denominated in a foreign currency. The table below summarizes the components of other investment income (loss), net for the years ended December 31, 2016, 2015 and 2014. 
 
Years Ended December 31,
$ in thousands
2016
 
2015
 
2014
FHLBI dividend income
3,185

 
2,819

 
701

Gain (loss) on foreign currency transactions, net
(8,187
)
 
(1,875
)
 
(2,746
)
Total
(5,002
)
 
944

 
(2,045
)


 
58
 

Table of Contents

We are required to purchase and hold a certain amount of FHLBI stock, which is based, in part, upon the outstanding principal balance of secured advances from the FHLBI. We earn dividend income on our investment in FHLBI stock, and the amount of our dividend income varies based upon the number of shares that we are required to own.
We incurred foreign currency losses on the revaluation of a commercial loan investment (notional amount of £34.5 million) for the year ended December 31, 2016 due to the significant decline in the Pound Sterling/ U.S. Dollar foreign exchange rate over the last twelve months. Foreign currency losses for the year ended December 31, 2015 and 2014 relate to a foreign currency loan which prepaid in the second quarter 2015. We enter into currency forward contracts as an economic hedge against our foreign currency exposure. Changes in the fair value of our currency forward contracts are recognized in gain (loss) derivative instruments, net in the consolidated statements of operations. During the years ended December 31, 2016, 2015 and 2014, we recognized net gains of $10.6 million, $2.3 million and $2.8 million, respectively, on our currency forward contracts.
Expenses
For the year ended December 31, 2016, we incurred management fees of $34.5 million (2015: $38.6 million; 2014: $37.6 million), which are payable to our Manager under our management agreement. Management fees decreased for the year ended December 31, 2016 compared to 2015 due to (i) a cumulative one-time adjustment of $2.3 million related to a prior adjustment for the accounting for premiums and discounts associated with non-Agency RMBS not of high credit quality and (ii) the full year impact of shares repurchased in the second half of 2015 and first quarter of 2016. We repurchased 9.5 million shares of common stock in the second half of 2015 and 2.1 million shares of common stock in the first quarter of 2016.
The increase in 2015 management fees of $1.0 million compared to 2014 is primarily due to the full year impact of our September 2014 Series B Preferred Stock offering and the impact of the July 2015 change in our management fee calculation, which was partially offset by distributions in excess of earnings and the repurchase of 9.5 million shares of common stock in the second half of 2015. Refer to Note 12 – “Related Party Transactions” of our consolidated financial statements for a discussion of our relationship with our Manager and a description of how our management fees are calculated.
For the year ended December 31, 2016, our general and administrative expenses not covered under our management agreement amounted to $7.3 million (2015: $7.8 million; 2014: $9.2 million). General and administrative expenses not covered under our management agreement primarily consist of directors and officers insurance, legal costs, accounting, auditing and tax services, filing fees, organization expenses associated with our consolidated securitization trusts and miscellaneous general and administrative costs. During 2015, we incurred expenses for third party consulting, accounting, auditing and legal fees of approximately $950,000 related to the restatement of our financial statements. During 2014, we incurred approximately $1.0 million of offering costs related to our consolidated Residential Securitizations. Excluding restatement-related expenses in 2015 and residential securitization offering costs in 2014, general and administrative expenses decreased approximately $1.4 million in 2015 primarily due to lower legal and transaction costs associated with new commercial loans in 2015 and higher income tax expense associated with our taxable REIT subsidiary in 2014.
We deconsolidated our Residential Securitizations in December 2015 and therefore did not incur any consolidated securitization trust expenses in 2016. For the year ended December 31, 2015, consolidated securitization trust expenses totaled $8.2 million (2014: $6.1 million). Consolidated securitization trust expenses consist of direct operating expenses incurred by consolidated Residential Securitizations. Prior to the deconsolidation, we consolidated eleven Residential Securitizations as of December 31, 2015 and ten Residential Securitizations as of December 31, 2014. The $2.1 million increase in securitization trust expenses for the year ended December 31, 2015 is primarily due to the full year impact of Residential Securitizations consolidated in 2014.


 
59
 

Table of Contents

Net Income (Loss) after Preferred Dividends and Return on Average Equity
For the year ended December 31, 2016, our net income after preferred dividends was $234.8 million (2015: $91.2 million net income; 2014: $234.9 million net loss) and our annualized income on average equity was 11.50% (2015: 3.91% income; 2014: 9.72% loss).
For the year ended December 31, 2016, the change in net income (loss) after preferred dividends and return on average equity was primarily attributable to realized and unrealized losses on derivatives instruments of $62.8 million in 2016 versus $219.0 million in 2015. For the year ended December 31, 2016, we recognized unrealized gains for the change in fair value of our interest rates swaps of $100.5 million compared to unrealized losses of $554,000 for the year ended December 31, 2015. In addition, during the year ended December 31, 2016, we recognized amortization of net deferred losses on de-designated interest rate swaps previously recognized in other comprehensive income of $5.2 million versus $66.8 million in 2015.
For the year ended December 31, 2015, the change in net income (loss) after preferred dividends and return on average equity was primarily attributable to realized and unrealized losses on derivatives instruments of $219.0 million in 2015 versus $487.5 million in 2014. For the year ended December 31, 2015, we recognized unrealized losses for the change in fair value of our interest rates swaps of $554,000 compared to unrealized losses of $223.9 million for the year ended December 31, 2014. In addition, during the year ended December 31, 2015, we recognized amortization of net deferred losses on de-designated interest rate swaps previously recognized in other comprehensive income of $66.8 million versus $85.2 million in 2014.
Non-GAAP Financial Measures
We are presenting the following non-GAAP financial measures: core earnings (and by calculation, core earnings per common share), effective interest income (and by calculation, effective yield), effective interest expense (and by calculation, effective cost of funds), effective net interest income (and by calculation, effective interest rate margin), and repurchase agreement debt-to-equity ratio. Our management uses these non-GAAP financial measures in our internal analysis of results and believes these measures are useful to investors for the reasons explained below. The most directly comparable U.S. GAAP measures are net income (loss) attributable to common stockholders (and by calculation, basic earnings (loss) per common share), total interest income (and by calculation, earning asset yield), total interest expense (and by calculation, cost of funds), net interest income (and by calculation, net interest rate margin) and debt-to-equity ratio. Certain prior period U.S. GAAP and non-GAAP financial measures have been revised to correct immaterial errors in accounting for premiums and discounts on non-Agency RMBS not of high credit quality. For further information, see Note 17 - "Revision of Previously Issued Financial Statements" of our consolidated financial statements in Part IV, Item 15. of this Report.
These non-GAAP financial measures should not be considered as substitutes for any measures derived in accordance with U.S. GAAP and may not be comparable to other similarly titled measures of other companies. An analysis of any non-GAAP financial measure should be made in conjunction with results presented in accordance with U.S. GAAP. Additional reconciling items may be added in the future to these non-GAAP measures if deemed appropriate.
Core Earnings
We calculate core earnings as U.S. GAAP net income (loss) attributable to common stockholders adjusted for (gain) loss on investments, net; realized (gain) loss on derivative instruments, net; unrealized (gain) loss on derivative instruments, net; realized and unrealized (gain) loss on GSE CRT embedded derivatives, net; (gain) loss on foreign currency transactions, net; amortization of net deferred (gain) loss on de-designated interest rate swaps; and cumulative adjustments attributable to non-controlling interest. We record changes in the valuation of our mortgage-backed securities, excluding securities for which we elected the fair value option and the valuation assigned to the debt host contract associated with our GSE CRTs in other comprehensive income on our consolidated balance sheets.
We believe the presentation of core earnings provides a consistent measure of operating performance by excluding the impact of gains and losses described above from operating results. We believe that providing transparency into core earnings enables our investors to consistently measure, evaluate and compare our operating performance to that of our peers over multiple reporting periods. However, we caution that core earnings should not be considered as an alternative to net income (determined in accordance with U.S. GAAP), or as an indication of our cash flow from operating activities (determined in accordance with U.S. GAAP), a measure of our liquidity, or as an indication of amounts available to fund our cash needs, including our ability to make cash distributions.


 
60
 

Table of Contents

The table below provides a reconciliation of U.S. GAAP net income (loss) attributable to common stockholders to core earnings for the following periods:
 
Years Ended December 31,
$ in thousands, except per share data
2016
 
2015
 
2014
Net income (loss) attributable to common stockholders
231,547

 
89,847

 
(232,436
)
Adjustments:
 
 
 
 
 
(Gain) loss on investments, net
17,542

 
18,005

 
84,407

Realized (gain) loss on derivative instruments, net (1)
57,943

 
44,272

 
72,187

Unrealized (gain) loss on derivative instruments, net (1)
(99,932
)
 
(9,597
)
 
215,499

Realized and unrealized (gain) loss on GSE CRT embedded derivatives, net (2)
(36,800
)
 
6,411

 
21,495

(Gain) loss on foreign currency transactions, net (3)
8,187

 
1,875

 
2,746

Amortization of net deferred loss on de-designated interest rate swaps (4)
5,154

 
66,757

 
85,176

Subtotal
(47,906
)
 
127,723

 
481,510

Cumulative adjustments attributable to non-controlling interest
653

 
(1,461
)
 
(5,500
)
Core earnings attributable to common stockholders
184,294

 
216,109

 
243,574

Basic earnings (loss) per common share
2.07

 
0.74

 
(1.89
)
Core earnings per share attributable to common stockholders (5)
1.65

 
1.78

 
1.98


(1)
U.S. GAAP gain (loss) on derivative instruments, net on the consolidated statements of operations includes the following components:
 
Years Ended December 31,
$ in thousands
2016
 
2015
 
2014
Realized gain (loss) on derivative instruments, net
(57,943
)
 
(44,272
)
 
(72,187
)
Unrealized gain (loss) on derivative instruments, net
99,932

 
9,597

 
(215,499
)
Contractual net interest expense
(104,804
)
 
(184,373
)
 
(199,783
)
Gain (loss) on derivative instruments, net
(62,815
)
 
(219,048
)
 
(487,469
)

(2)
U.S. GAAP realized and unrealized credit derivative income (loss), net on the consolidated statements of operations includes the following components:
 
Years Ended December 31,
$ in thousands
2016
 
2015
 
2014
Realized and unrealized gain (loss) on GSE CRT embedded derivatives, net
36,800

 
(6,411
)
 
(21,495
)
GSE CRT embedded derivative coupon interest
24,343

 
24,822

 
17,536

Unrealized gain (loss) on CDS contract

 
648

 
(258
)
CDS premium fee income

 
723

 
1,351

Realized and unrealized credit derivative income (loss), net
61,143

 
19,782

 
(2,866
)

(3)
U.S. GAAP other investment income (loss), net on the consolidated statements of operations includes the following components:
 
Years Ended December 31,
$ in thousands
2016
 
2015
 
2014
FHLBI dividend income
3,185

 
2,819

 
701

Gain (loss) on foreign currency transactions, net
(8,187
)
 
(1,875
)
 
(2,746
)
Other investment income (loss), net
(5,002
)
 
944

 
(2,045
)



 
61
 

Table of Contents

(4)
U.S. GAAP repurchase agreements interest expense on the consolidated statements of operations includes the following components:
 
Years Ended December 31,
$ in thousands
2016
 
2015
 
2014
Interest expense on repurchase agreements outstanding
118,846

 
100,135

 
103,523

Amortization of net deferred (gain) loss on de-designated interest rate swaps
5,154

 
66,757

 
85,176

Repurchase agreements interest expense
124,000

 
166,892

 
188,699


(5)
Core earnings per share attributable to common stockholders is equal to core earnings divided by the basic weighted average number of common shares outstanding.
Core earnings for the year ended December 31, 2016 decreased from 2015 primarily due to lower overall portfolio balance and reinvesting cash flows from repayment of principal and interest on our higher yielding credit assets and 30 year fixed-rate Agency RMBS portfolio into 15 year fixed-rate Agency RMBS. Our average earning assets decreased from $20.0 billion for the year ended December 31, 2015 to $15.6 billion for the year ended December 31, 2016.

Core earnings for the year ended December 31, 2015 decreased compared to 2014 primarily due to lower effective interest rate margin for the year ended December 31, 2015. Our effective interest rate margin for the year ended December 31, 2015 was 1.15% as compared to 1.29% for the year ended December 31, 2014.

Effective Interest Income / Effective Yield/ Effective Interest Expense / Effective Cost of Funds / Effective Net Interest Income / Effective Interest Rate Margin
We calculate effective interest income (and by calculation, effective yield) as U.S. GAAP total interest income adjusted for GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net. We account for GSE CRTs purchased prior to August 24, 2015 as hybrid financial instruments, but we have elected the fair value option for GSE CRTs purchased on or after August 24, 2015. Under U.S. GAAP, coupon interest on GSE CRTs accounted for using the fair value option is recorded as interest income, whereas coupon interest on GSE CRTs accounted for as hybrid financial instruments is recorded as realized and unrealized credit derivative income (loss). We add back GSE CRT embedded derivative coupon interest to our total interest income because we consider GSE CRT embedded derivative coupon interest a current component of our total interest income irrespective of whether we elected the fair value option for the GSE CRT or accounted for the GSE CRT as a hybrid financial instrument.
We calculate effective interest expense (and by calculation, effective cost of funds) as U.S. GAAP total interest expense adjusted for net interest expense on our interest rate swaps that is recorded in gain (loss) on derivative instruments, net and the amortization of net deferred gains (losses) on de-designated interest rate swaps that is recorded as repurchase agreements interest expense. We view our interest rate swaps as an economic hedge against increases in future market interest rates on our floating rate borrowings. We add back the net payments we make on our interest rate swap agreements to our total U.S. GAAP interest expense because we use interest rate swaps to add stability to interest expense. We exclude the amortization of net deferred gains (losses) on de-designated interest rate swaps from our calculation of effective interest expense because we do not consider the amortization a current component of our borrowing costs.
We calculate effective net interest income (and by calculation, effective interest rate margin) as U.S. GAAP net interest income adjusted for net interest expense on our interest rate swaps that is recorded as gain (loss) on derivative instruments, the amortization of net deferred gains (losses) on de-designated interest rate swaps that is recorded as repurchase agreement interest expense and GSE CRT embedded derivative coupon interest that is recorded as realized and unrealized credit derivative income (loss), net.
We believe the presentation of effective interest income, effective yield, effective interest expense, effective cost of funds, effective net interest income and effective interest rate margin measures, when considered together with U.S. GAAP financial measures, provide information that is useful to investors in understanding our borrowing costs and operating performance.


 
62
 

Table of Contents

The following table reconciles total interest income to effective interest income and yield to effective yield for the following periods:
 
Years Ended December 31,
 
2016
 
2015
 
2014
$ in thousands
Reconciliation
 
Yield/Effective Yield
 
Reconciliation
 
Yield/Effective Yield
 
Reconciliation
 
Yield/Effective Yield
Total interest income
478,682

 
3.07
%
 
650,132

 
3.25
%
 
687,080

 
3.47
%
Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net
24,343

 
0.15
%
 
24,822

 
0.12
%
 
17,536

 
0.09
%
Effective interest income
503,025

 
3.22
%
 
674,954

 
3.37
%
 
704,616

 
3.56
%
Our effective interest income and effective yield for the year ended December 31, 2016 decreased from 2015 primarily due to the deconsolidation of our Residential Securitizations in December 2015. Interest income and average earning asset yield on residential loans was $110.9 million and 3.47% for the year ended December 31, 2015. In addition, our yield on average earning assets declined from 3.25% in 2015 to 3.07% in 2016. Our effective interest income and effective yield decreased for the year ended December 31, 2015 compared to 2014 was primarily attributable to portfolio reallocation to lower duration Agency RMBS.
The following table reconciles total interest expense to effective interest expense and cost of funds to effective cost of funds for the following periods:
 
Years Ended December 31,
 
2016
 
2015
 
2014
$ in thousands
Reconciliation
 
Cost of Funds / Effective Cost of Funds
 
Reconciliation
 
Cost of Funds / Effective Cost of Funds
 
Reconciliation
 
Cost of Funds / Effective Cost of Funds
Total interest expense
157,354

 
1.15
 %
 
277,973

 
1.56
 %
 
281,895

 
1.61
 %
Less: Amortization of net deferred loss on de-designated interest rate swaps
(5,154
)
 
(0.04
)%
 
(66,757
)
 
(0.37
)%
 
(85,176
)
 
(0.48
)%
Add: Contractual net interest expense on interest rate swaps recorded as gain (loss) on derivative instruments, net
104,804

 
0.76
 %
 
184,373

 
1.03
 %
 
199,783

 
1.14
 %
Effective interest expense
257,004

 
1.87
 %
 
395,589

 
2.22
 %
 
396,502

 
2.27
 %


 
63
 

Table of Contents

Our effective interest expense and effective cost of funds for the year ended December 31, 2016 decreased from 2015 primarily due to (i) the deconsolidation of our Residential Securitizations in December 2015, and (ii) a decrease in net interest expense on interest rate swaps. The impacts of the deconsolidation of our Residential Securitizations and lower interest rate swap expense were partially offset by an $18.7 million increase in interest expense on repurchase agreements outstanding due to higher borrowing rates. We incurred $82.0 million of interest expense on asset-backed securities issued by the Residential Securitizations for the year ended December 31, 2015. We did not incur any interest expense on asset-backed securities for the year ended December 31, 2016. Net interest expense on interest rate swaps decreased from $184.4 million for the year ended December 31, 2015 to $104.8 million for the year ended December 31, 2016 because we repositioned our hedging portfolio commencing in the first quarter of 2016. During the year ended December 31, 2016, we terminated swaps with a notional amount of $5.0 billion. The terminated swaps were predominately maturing in 2016 and offered little protection from rising rates. Additionally, our average earning assets and average repurchase agreement borrowings had decreased due to asset sales to facilitate stock repurchases, further reducing our need for hedging.
Our effective interest expense was relatively unchanged for the year ended December 31, 2015 compared to 2014. Our effective cost of funds decreased in 2015 versus 2014 primarily due to shifting some of our financing for purchases of our CMBS from repurchase agreement borrowing to secured loans in 2015.
The following table reconciles net interest income to effective net interest income and net interest rate margin to effective interest rate margin for the following periods:
 
Years Ended December 31,
 
2016
 
2015
 
2014
$ in thousands
Reconciliation
 
Net Interest Rate Margin / Effective Interest Rate Margin
 
Reconciliation
 
Net Interest Rate Margin / Effective Interest Rate Margin
 
Reconciliation
 
Net Interest Rate Margin / Effective Interest Rate Margin
Net interest income
321,328

 
1.92
 %
 
372,159

 
1.69
 %
 
405,185

 
1.86
 %
Add: Amortization of net deferred loss on de-designated interest rate swaps
5,154

 
0.04
 %
 
66,757

 
0.37
 %
 
85,176

 
0.48
 %
Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net
24,343

 
0.15
 %
 
24,822

 
0.12
 %
 
17,536

 
0.09
 %
Less: Contractual net interest expense on interest rate swaps recorded as gain (loss) on derivative instruments, net
(104,804
)
 
(0.76
)%
 
(184,373
)
 
(1.03
)%
 
(199,783
)
 
(1.14
)%
Effective net interest income
246,021

 
1.35
 %
 
279,365

 
1.15
 %
 
308,114

 
1.29
 %
Effective net interest income decreased from $279.4 million for the year ended December 31, 2015 to $246.0 million for the year ended December 31, 2016. The decrease in effective net interest income was primarily due to maturity and paydowns of high yielding assets, a lower overall portfolio balance and portfolio reallocation from 30 year fixed-rate Agency RMBS to 15 year fixed-rate Agency RMBS. The increase in effective interest rate margin for the year ended December 31, 2016 versus 2015 was primarily due to lower contractual net interest expense on interest rate swaps in the 2016 period. Net interest expense on interest rate swaps decreased because we repositioned our hedging portfolio commencing in the first quarter of 2016.
The decline in effective net interest income and effective interest rate margin in 2015 versus 2014 was primarily driven by lower net interest income attributable to portfolio reallocation to lower duration Agency RMBS.



 
64
 

Table of Contents

Repurchase Agreement Debt-to-Equity Ratio
The tables below show the allocation of our equity to our targeted assets, our debt-to-equity ratio, and our repurchase agreement debt-to-equity ratio as of December 31, 2016 and December 31, 2015. We present a repurchase agreement debt-to-equity ratio, a non-GAAP financial measure of leverage, because the mortgage REIT industry primarily uses repurchase agreements, which typically mature within one year, to finance investments. We believe that presenting our repurchase agreement debt-to-equity ratio, when considered together with our U.S. GAAP financial measure, provides information that is useful to investors in understanding our refinancing risks, and gives investors a comparable statistic to those other mortgage REITs who almost exclusively borrow using short-term repurchase agreements that are subject to refinancing risk.
December 31, 2016
$ in thousands
Agency RMBS
Residential Credit (1)
Commercial Credit (2)
Exchangeable Senior Notes and Other
Total
Investments
9,665,860

2,763,751

2,858,376


15,287,987

Cash and cash equivalents (3)
76,067

49,582

36,139


161,788

Derivative assets, at fair value (4)
3,085


101


3,186

Other assets
179,931

9,381

63,465

500

253,277

Total assets
9,924,943

2,822,714

2,958,081

500

15,706,238

 
 
 
 
 
 
Repurchase agreements
8,148,220

2,067,731

944,718


11,160,669

Secured loans (5)
500,150


1,149,850


1,650,000

Exchangeable senior notes



397,041

397,041

Derivative liabilities, at fair value
133,832


396


134,228

Other liabilities
52,047

21,389

14,791

5,889

94,116

Total liabilities
8,834,249

2,089,120

2,109,755

402,930

13,436,054

 
 
 
 
 
 
Total equity (allocated)
1,090,694

733,594

848,326

(402,430
)
2,270,184

Adjustments to calculate repurchase agreement debt-to-equity:
 
 
 
 
 
Net equity in unsecured assets and exchangeable senior notes (6)


(306,656
)
402,430

95,774

Collateral pledged against secured loans
(585,504
)

(1,346,078
)

(1,931,582
)
Secured loans
500,150


1,149,850


1,650,000

Equity related to repurchase agreement debt
1,005,340

733,594

345,442


2,084,376

Debt-to-equity ratio (7)
7.9

2.8

2.5

NA

5.8

Repurchase agreement debt-to-equity ratio (8)
8.1

2.8

2.7

NA

5.4

(1)
Investments in non-Agency RMBS and GSE CRT are included in residential credit.
(2)
Investments in CMBS, commercial loans and investments in unconsolidated joint ventures are included in commercial credit.
(3)
Cash and cash equivalents is allocated based on a percentage of equity for Agency RMBS, residential credit and commercial credit.
(4)
Derivative assets are allocated based on the hedging strategy for each class.
(5)
Secured loans are allocated based on amount of collateral pledged.
(6)
Net equity in unsecured assets and exchangeable senior notes includes commercial loans, investments in unconsolidated joint ventures, exchangeable senior notes and other.
(7)
Debt-to-equity ratio is calculated as the ratio of total debt (sum of repurchase agreements, secured loans and exchangeable senior notes) to total equity.
(8)
Repurchase agreement debt-to-equity ratio is calculated as the ratio of repurchase agreements to equity related to repurchase agreement debt.





 
65
 

Table of Contents

December 31, 2015
$ in thousands
Agency RMBS
Residential Credit (1)
Commercial Credit (2)
Exchangeable Senior Notes
Total
Investments
9,799,257

3,350,714

3,163,439


16,313,410

Cash and cash equivalents (3)
23,484

16,586

13,129


53,199

Derivative assets, at fair value (4)
6,795


1,864


8,659

Other assets
316,072

9,780

66,189


392,041

Total assets
10,145,608

3,377,080

3,244,621


16,767,309

 
 
 
 
 
 
Repurchase agreements
8,389,643

2,565,515

1,170,890


12,126,048

Secured loans (5)
472,983


1,177,017


1,650,000

Exchangeable senior notes



394,573

394,573

Derivative liabilities, at fair value
238,045


103


238,148

Other liabilities
46,165

22,540

17,038

5,889

91,632

Total liabilities
9,146,836

2,588,055

2,365,048

400,462

14,500,401

 
 
 
 
 
 
Total equity (allocated)
998,772

789,025

879,573

(400,462
)
2,266,908

Adjustments to calculate repurchase agreement debt-to-equity:
 
 
 
 
 
Net equity in unsecured assets and exchangeable senior notes (6)


(250,522
)
400,462

149,940

Collateral pledged against secured loans
(558,894
)

(1,390,805
)

(1,949,699
)
Secured loans
472,983


1,177,017


1,650,000

Equity related to repurchase agreement debt
912,861

789,025

415,263


2,117,149

Debt-to-equity ratio (7)
8.9

3.3

2.7

NA

6.3

Repurchase agreement debt-to-equity ratio (8)
9.2

3.3

2.8

NA

5.7

(1)
Investments in non-Agency RMBS and GSE CRT are included in residential credit.
(2)
Investments in CMBS, commercial loans and investments in unconsolidated joint ventures are included in commercial credit.
(3)
Cash and cash equivalents is allocated based on a percentage of equity for Agency RMBS, residential credit and commercial credit.
(4)
Derivative assets are allocated based on the hedging strategy for each class.
(5)
Secured loans are allocated based on amount of collateral pledged.
(6)
Net equity in unsecured assets and exchangeable senior notes includes commercial loans, investments in unconsolidated joint ventures and exchangeable senior notes.
(7)
Debt-to-equity ratio is calculated as the ratio of total debt (sum of repurchase agreements, secured loans and exchangeable senior notes) to total equity.
(8)
Repurchase agreement debt-to-equity ratio is calculated as the ratio of repurchase agreements to equity related to repurchase agreement debt.

Liquidity and Capital Resources
Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to pay dividends, fund investments, repayment of borrowings and other general business needs. Our primary sources of funds for liquidity consist of the net proceeds from our common and preferred equity offerings, net cash provided by operating activities, proceeds from repurchase agreements and other financing arrangements and future issuances of equity and/or debt securities.
We currently believe that we have sufficient liquidity and capital resources available for the acquisition of additional investments, repayments on borrowings, margin requirements and the payment of cash dividends as required for continued qualification as a REIT. We generally maintain liquidity to pay down borrowings under repurchase arrangements to reduce borrowing costs and otherwise efficiently manage our long-term investment capital. Because the level of these borrowings can be adjusted on a daily basis, the level of cash and cash equivalents carried on our consolidated balance sheets is significantly less important than our potential liquidity available under borrowing arrangements. However, there can be no assurance that we will maintain sufficient levels of liquidity to meet any margin calls.


 
66
 

Table of Contents

We held cash and cash equivalents of $161.8 million at December 31, 2016 (2015: $53.2 million). Our cash and cash equivalents increased due to normal fluctuations in cash balances related to the timing of principal and interest payments, repayments of debt, and asset purchases and sales.
Our operating activities provided net cash of approximately $329.7 million for the year ended December 31, 2016 (2015: $358.6 million; 2014: $379.7 million). Cash provided by operating activities decreased due to the decline in our average assets during the year ended December 31, 2016 as compared to the year ended December 31, 2015. Cash provided by operating activities decreased due to the decline in our average assets during the year ended December 31, 2015 as compared to the year ended December 31, 2014.
Our investing activities provided net cash of $949.0 million for the year ended December 31, 2016 (2015: provided net cash of $1.2 billion; 2014: used net cash of $912.4 million). During the year ended December 31, 2016 we utilized cash to purchase $2.7 billion of MBS and GSE CRT securities. In addition, during the year ended December 31, 2016 we originated or purchased commercial loans of $87.2 million. Cash used to fund these purchases was more than offset by proceeds from MBS and GSE CRT sales of $1.0 billion, principal payments from MBS and GSE CRT securities of $2.6 billion and principal repayments from commercial loans held-for investment of $15.0 million.
During the year ended December 31, 2015 we utilized cash to purchase $2.4 billion of MBS and GSE CRT securities and $372.3 million of residential loans. In addition, during the year ended December 31, 2015, we originated or purchased commercial loans of $158.0 million. Cash used to fund these purchases was more than offset by proceeds from MBS and GSE CRT sales of $907.2 million, principal payments from MBS and GSE CRT securities of $2.6 billion and principal payments from residential loans held-for-investment of $549.6 million and principal repayments from commercial loans held-for investment of $92.8 million.
During the year ended December 31, 2014 we utilized cash to purchase $4.3 billion of MBS and GSE CRT securities and $1.8 billion of residential loans. In addition, during the year ended December 31, 2014, we originated or purchased commercial loans of $83.5 million. Cash used to fund these purchases was partially offset by proceeds from MBS and GSE CRT sales of $3.3 billion, principal payments from MBS and GSE CRT securities of $1.9 billion and principal payments from residential loans held-for-investment of $255.7 million.
Our financing activities used net cash of $1.2 billion for the year ended December 31, 2016 (2015: used net cash of $1.7 billion; 2014: provided net cash of $486.3 million). Our financing activities for the year ended December 31, 2016 primarily consisted of net principal repayments on our repurchase agreements of $966.8 million. In addition, we paid dividends and distributions of $204.5 million and repurchased 2.1 million shares of common stock for $25.0 million.
Our financing activities for the year ended December 31, 2015 primarily consisted of net principal repayments on our repurchase agreements of $1.5 billion and net principal repayments of ABS issued by securitization trusts of $182.1 million, offset by net proceeds from our secured FHLBI advances of $400.0 million. In addition, we paid dividends and distributions of $239.4 million and repurchased 9.5 million shares of common stock for $125.6 million.
Our financing activities for the year ended December 31, 2014 primarily consisted of net principal repayments on our repurchase agreements of $1.8 billion, offset by net proceeds from our secured FHLBI advances of $1.25 billion, net proceeds from ABS issued by securitization trusts of $1.3 billion; and net proceeds of $149.9 million from our Series B Preferred Stock offering. In addition, we paid dividends and distributions of $264.5 million and repurchased $1.4 million shares of common stock for $21.1 million.
As of December 31, 2016, our wholly-owned subsidiary, IAS Services LLC, had $1.65 billion in outstanding secured advances from the FHLBI. As of December 31, 2016, the FHLBI advances were collateralized by CMBS and Agency RMBS with a fair value of $1.3 billion and $585.5 million, respectively.
As of December 31, 2016, the average margin requirement (weighted by borrowing amount), or the percentage amount by which the collateral value must exceed the loan amount (also refer to as the “haircut”) under our repurchase agreements was 5.0% for Agency RMBS, 20.6% for non-Agency RMBS, 25.3% for GSE CRT, and 18.7% for CMBS. Across our repurchase agreement facilities, the haircuts range from a low of 4% to a high of 20% for Agency RMBS, a low of 10% to a high of 50% for non-Agency RMBS, a low of 23% to a high of 30% for GSE CRT, and a low of 15% to a high of 25% for CMBS. Our effective cost of funds (non-GAAP measure) was 1.87% and 2.22% as of December 31, 2016 and 2015, respectively. Declines in the value of our securities portfolio can trigger margin calls by our lenders under our repurchase agreements. An event of default or termination event would give some of our counterparties the option to terminate all repurchase transactions existing with us and require any amount due by us to the counterparties to be payable immediately.
Our total debt-to-equity ratio, which includes longer term financing, was 5.8x as of December 31, 2016 (2015: 6.3x). We have reduced our debt-to-equity ratio over the last twelve months.


 
67
 

Table of Contents

In December 2011, our board of directors approved a share repurchase program with no stated expiration date. Shares of our common stock may be purchased in the open market, including through block purchases, or through privately negotiated transactions, or pursuant to any trading plan that may be adopted in accordance with Rules 10b5-1 and 10b-18 of the Securities Exchange Act of 1934, as amended.  The timing, manner, price and amount of any repurchases will be determined at our discretion and the program may be suspended, terminated or modified at any time for any reason. The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.
During the year ended December 31, 2016, we repurchased 2,063,451 (2015: 9,539,251) shares of our common stock at an average repurchase price of $12.12 (2015: $13.17) per share for a net cost of $25.0 million (2015: $125.6 million), including acquisition expenses. As of December 31, 2016, we had authority to purchase 18,239,082 shares of our common stock through our share repurchase program.
Effective April 1, 2016, we replaced our dividend reinvestment stock purchase plan ("DRSPP") with a direct stock purchase plan and dividend reinvestment program administered by an affiliate of our transfer agent, Computershare Trust Company. Prior to termination, we issued 3,201 (2015:12,945) shares of common stock in 2016 at an average price of $11.08 (2015: $14.75) with total proceeds of approximately $35,000 (2015: $191,000). No shares of common stock were issued under the waiver feature of the DRSPP.
Effects of Margin Requirements, Leverage and Credit Spreads
Our securities have values that fluctuate according to market conditions and, as discussed above, the market value of our securities will decrease as prevailing interest rates or credit spreads increase. When the value of the securities pledged to secure a repurchase loan decreases to the point where the positive difference between the collateral value and the loan amount is less than the haircut, our lenders may issue a “margin call,” which means that the lender will require us to pay the margin call in cash or pledge additional collateral to meet that margin call. Under our repurchase facilities, our lenders have full discretion to determine the value of the securities we pledge to them. Most of our lenders will value securities based on recent trades in the market. Lenders also issue margin calls as the published current principal balance factors change on the pool of mortgages underlying the securities pledged as collateral when scheduled and unscheduled paydowns are announced monthly.
We experience margin calls in the ordinary course of our business. In seeking to effectively manage the margin requirements established by our lenders, we maintain a position of cash and unpledged securities. We refer to this position as our liquidity. The level of liquidity we have available to meet margin calls is directly affected by our leverage levels, our haircuts and the price changes on our securities. If interest rates increase as a result of a yield curve shift or for another reason or if credit spreads widen, then the prices of our collateral (and our unpledged assets that constitute our liquidity) will decline, we will experience margin calls, and we will use our liquidity to meet the margin calls. There can be no assurance that we will maintain sufficient levels of liquidity to meet any margin calls. If our haircuts increase, our liquidity will proportionately decrease. In addition, if we increase our borrowings, our liquidity will decrease by the amount of additional haircut on the increased level of indebtedness.
We intend to maintain a level of liquidity in relation to our assets that enables us to meet reasonably anticipated margin calls but that also allows us to be substantially invested in securities. We may misjudge the appropriate amount of our liquidity by maintaining excessive liquidity, which would lower our investment returns, or by maintaining insufficient liquidity, which would force us to liquidate assets into unfavorable market conditions and harm our results of operations and financial condition.
We are subject to financial covenants in connection with our lending, derivatives and other agreements we enter into in the normal course of our business. We intend to continue to operate in a manner which complies with all of our financial covenants. Our lending and derivative agreements provide that we may be declared in default of our obligations if our leverage ratio exceeds certain thresholds and we fail to maintain stockholders’ equity or market value above certain thresholds over specified time periods.
Forward-Looking Statements Regarding Liquidity
Based upon our current portfolio, leverage rate and available borrowing arrangements, we believe that cash flow from operations and available borrowing capacity will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity requirements to fund our investment activities, pay fees under our management agreement, fund our distributions to stockholders and for other general corporate expenses.
Our ability to meet our long-term (greater than one year) liquidity and capital resource requirements will be subject to obtaining additional debt financing. We may increase our capital resources by obtaining long-term credit facilities or through public or private offerings of equity or debt securities, possibly including classes of preferred stock, common stock, and senior or subordinated notes. Such financing will depend on market conditions for capital raises and our ability to invest such offering


 
68
 

Table of Contents

proceeds. If we are unable to renew, replace or expand our sources of financing on substantially similar terms, it may have an adverse effect on our business and results of operations.
Contractual Obligations
We have entered into an agreement with our Manager pursuant to which our Manager is entitled to receive a management fee and the reimbursement of certain expenses. The management fee is calculated and payable quarterly in arrears in an amount equal to 1.50% of our stockholders’ equity, per annum. Refer to Note 12 – “Related Party Transactions” of our consolidated financial statements for a description of adjustments made to our stockholders' equity for purposes of calculating our management fee. Our Manager uses the proceeds from its management fee in part to pay compensation to its officers and personnel who, notwithstanding that certain of those individuals are also our officers, receive no cash compensation directly from us. We are required to reimburse our Manager for operating expenses related to us incurred by our Manager, including certain salary expenses and other expenses relating to legal, accounting, due diligence and other services. Our reimbursement obligation is not subject to any dollar limitation. Refer to Note 12 – “Related Party Transactions” of our consolidated financial statements for details of our reimbursements to our Manager.
As of December 31, 2016, we had the following contractual obligations:
 
Payments Due by Period
$ in thousands
Total
 
Less than 1
year
 
1-3 years
 
3-5 years
 
After 5
years
Repurchase agreements
11,160,669

 
11,160,669

 

 

 

Secured loans
1,650,000

 

 

 
400,000

 
1,250,000

Exchangeable senior notes
400,000

 

 
400,000

 

 

Total contractual obligations (1)
13,210,669

 
11,160,669

 
400,000

 
400,000

 
1,250,000

(1)
Excluded from total contractual obligations are the amounts due to our Manager under our management agreement, as those obligations do not have fixed and determinable payments.
As of December 31, 2016, we have approximately $21.5 million, $30.0 million and $91.9 million in contractual interest payments related to our repurchase agreements, exchangeable senior notes and secured loans, respectively.
Off-Balance Sheet Arrangements
We have committed to invest up to $121.6 million in unconsolidated ventures sponsored by an affiliate of our Manager. The unconsolidated ventures are structured as partnerships, and we invest in the partnerships as a limited partner. As of December 31, 2016, $106.1 million of our commitment has been called. We are committed to fund $15.5 million in additional capital to fund future investments and to cover future expenses should they occur.
As of December 31, 2016, we have unfunded commitments on our existing commercial loans of $9.7 million (2015: $2.1 million).
Stockholders’ Equity
During the year ended December 31, 2016, we issued 3,201 (2015:12,945) shares of common stock at an average price of $11.08 (2015: $14.75) under the DRSPP. We received total proceeds of approximately $35,000 (2015: $191,000).
During the year ended December 31, 2016, we repurchased 2,063,451 (2015: 9,539,251) shares of our common stock at an average repurchase price of $12.12 (2015: $13.17) per share for a net cost of $25.0 million (2015: $125.6 million), including acquisition expenses. As of December 31, 2016, we had authority to purchase 18,239,082 shares of our common stock through this program.
Share-Based Compensation
We have authorized 1,000,000 shares of common stock for issuance to our independent directors and the executive officers and employees of our Manager and its affiliates under the terms of our 2009 Equity Incentive Plan (the “Incentive Plan”). Unless terminated earlier, the Incentive Plan will terminate in 2019, but will continue to govern the unexpired awards. As of December 31, 2016, 825,641 shares of common stock remain available for future issuance under the Incentive Plan.
We recognized compensation expense of approximately $340,000 (2015: $340,000; 2014: $282,000) related to awards to our independent directors for the year ended December 31, 2016. During the year ended December 31, 2016, we issued 25,068 shares (2015: 23,776 shares; 2014: 14,632 shares) of common stock pursuant to the Incentive Plan to our independent directors.


 
69
 

Table of Contents

The fair market value of the shares granted was determined by the closing stock market price on the date of the grant. The grants vested immediately.
We recognized compensation expense of approximately $100,000 (2015: $219,000; 2014: $290,000) for the year ended December 31, 2016 related to restricted stock units awarded to employees of our Manager and its affiliates which is reimbursed by our Manager under the terms of our management agreement. At December 31, 2016 there was approximately $187,000 of total unrecognized compensation cost related to restricted stock unit awards that is expected to be recognized over a period of up to 38 months, with a weighted-average remaining vesting period of 15 months.
The following table summarizes the activity related to restricted stock units awarded to employees of our Manager and its affiliates for the year ended December 31, 2016.
 
Year Ended December 31,
 
2016
 
Restricted Stock Units
 
Weighted Average Grant Date Fair Value (1)
Unvested at the beginning of the year
40,814

 
$
17.29

Shares granted during the year
21,099

 
11.28

Shares forfeited during the year
(27,193
)
 
14.43

Shares vested during the year
(15,913
)
 
17.66

Unvested at the end of the year
18,807

 
$
14.37

(1)
The grant date fair value of restricted stock awards is based on the closing market price of our common stock at the grant date.
Dividends
We intend to continue to make regular quarterly distributions to holders of our common stock and preferred stock. U.S. federal income tax law generally requires that a REIT distribute at least 90% of its REIT taxable income annually, determined without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its taxable income. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on our repurchase agreements and other debt payable. If our cash available for distribution is less than our taxable income, we could be required to sell assets or borrow funds to make cash distributions, or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.
Inflation
Virtually all of our assets and liabilities are sensitive to interest rates. As a result, interest rates and other factors influence our performance far more than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates.
Unrelated Business Taxable Income
We have not engaged in transactions that would result in a portion of our income being treated as unrelated business taxable income.
Other Matters
We believe that we satisfied each of the asset tests in Section 856(c)(4) of the Internal Revenue Code of 1986, as amended (the "Code") at the end of each calendar quarter in 2016. We also believe that our revenue qualifies for the 75% source of income test and for the 95% source of income test rules for the period ended December 31, 2016. Consequently, we believe we met the REIT income and asset test as of December 31, 2016. We also met all REIT requirements regarding the ownership of our common stock and the distribution of dividends of our net income as of December 31, 2016. Therefore, as of December 31, 2016, we believe that we qualified as a REIT under the Code.
At all times, we intend to conduct our business so that neither we nor our Operating Partnership nor the subsidiaries of our Operating Partnership are required to register as an investment company under the 1940 Act. If we were required to register as an investment company, then our use of leverage would be substantially reduced. Because we are a holding company that conducts our business through our Operating Partnership and the Operating Partnership’s wholly-owned or majority-owned subsidiaries, the securities issued by these subsidiaries that are excepted from the definition of “investment company” under


 
70
 

Table of Contents

Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any other investment securities the Operating Partnership may own, may not have a combined value in excess of 40% of the value of the Operating Partnership’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. This requirement limits the types of businesses in which we are permitted to engage in through our subsidiaries. In addition, we believe neither we nor the Operating Partnership are considered an investment company under Section 3(a)(1)(A) of the 1940 Act because they do not engage primarily or hold themselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through the Operating Partnership’s wholly-owned or majority-owned subsidiaries, we and the Operating Partnership are primarily engaged in the non-investment company businesses of these subsidiaries. IAS Asset I LLC and certain of the Operating Partnership’s other subsidiaries that we may form in the future rely upon the exclusion from the definition of “investment company” under the 1940 Act provided by Section 3(c)(5)(C) of the 1940 Act, which is available for entities “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” This exclusion generally requires that at least 55% of each subsidiary’s portfolio be comprised of qualifying assets and at least 80% be comprised of qualifying assets and real estate-related assets (and no more than 20% comprised of miscellaneous assets). We calculate that as of December 31, 2016, we conducted our business so as not to be regulated as an investment company under the 1940 Act.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
The primary components of our market risk are related to interest rate, principal prepayment and market value. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and we seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.
Interest Rate Risk
Interest rate risk is highly sensitive to many factors, including governmental, monetary and tax policies, domestic and international economic and political considerations, and other factors beyond our control. We are subject to interest rate risk in connection with our investments and our repurchase agreements. Our repurchase agreements are typically of limited duration and will be periodically refinanced at current market rates. We mitigate this risk through utilization of derivative contracts, primarily interest rate swap agreements, TBAs and futures contracts.
Interest Rate Effect on Net Interest Income
Our operating results depend in large part upon differences between the yields earned on our investments and our cost of borrowing and interest rate hedging activities. Most of our repurchase agreements provide financing based on a floating rate of interest calculated on a fixed spread over LIBOR. The fixed spread will vary depending on the type of underlying asset which collateralizes the financing. Accordingly, the portion of our portfolio which consists of floating interest rate assets are match-funded utilizing our expected sources of short-term financing, while our fixed interest rate assets are not match-funded. During periods of rising interest rates, the borrowing costs associated with our investments tend to increase while the income earned on our fixed interest rate investments may remain substantially unchanged. This increase in borrowing costs results in the narrowing of the net interest spread between the related assets and borrowings and may even result in losses. Further, during this portion of the interest rate and credit cycles, defaults could increase and result in credit losses to us, which could adversely affect our liquidity and operating results. Such delinquencies or defaults could also have an adverse effect on the spread between interest-earning assets and interest-bearing liabilities.
Hedging techniques are partly based on assumed levels of prepayments of our RMBS. If prepayments are slower or faster than assumed, the life of the RMBS will be longer or shorter, which would reduce the effectiveness of any hedging strategies we may use and may cause losses on such transactions. Hedging strategies involving the use of derivative securities are highly complex and may produce volatile returns.
Interest Rate Effects on Fair Value
Another component of interest rate risk is the effect that changes in interest rates will have on the market value of the assets that we acquire. We face the risk that the market value of our assets will increase or decrease at different rates than those of our liabilities, including our hedging instruments.
We primarily assess our interest rate risk by estimating the duration of our assets and the duration of our liabilities. Duration measures the market price volatility of financial instruments as interest rates change. We generally calculate duration using various financial models and empirical data. Different models and methodologies can produce different duration numbers for the same securities.
The impact of changing interest rates on fair value can change significantly when interest rates change materially. Therefore, the volatility in the fair value of our assets could increase significantly in the event interest rates change materially.


 
71
 

Table of Contents

In addition, other factors impact the fair value of our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, changes in actual interest rates may have a material adverse effect on us.
Spread Risk
We employ a variety of spread risk management techniques that seek to mitigate the influences of spread changes on our book value and our liquidity to help us achieve our investment objectives. We refer to the difference between interest rates on our investments and interest rates on risk free instruments as spreads. The yield on our investments changes over time due to the level of risk free interest rates, the creditworthiness of the security, and the price of the perceived risk. The change in the market yield of our interest rate hedges also changes primarily with the level of risk free interest rates. We manage spread risk through careful asset selection, sector allocation, regulating our portfolio value-at-risk, and maintaining adequate liquidity. Changes in spreads impact our book value and our liquidity and could cause us to sell assets and to change our investment strategy in order to maintain liquidity and preserve book value.
Prepayment Risk
As we receive prepayments of principal on our investments, premiums paid on these investments are amortized against interest income. In general, an increase in prepayment rates will accelerate the amortization of purchase premiums, thereby reducing the interest income earned on the investments. Conversely, discounts on such investments are accreted into interest income. In general, an increase in prepayment rates will accelerate the accretion of purchase discounts, thereby increasing the interest income earned on the investments.
Extension Risk
We compute the projected weighted-average life of our investments based upon assumptions regarding the rate at which the borrowers will prepay the underlying mortgages. In general, when a fixed-rate or hybrid adjustable-rate security is acquired with borrowings, we may, but are not required to, enter into an interest rate swap agreement or other hedging instrument that effectively fixes our borrowing costs for a period close to the anticipated average life of the fixed-rate portion of the related assets. This strategy is designed to protect us from rising interest rates, because the borrowing costs are fixed for the duration of the fixed-rate portion of the related target asset.
However, if prepayment rates decrease in a rising interest rate environment, then the life of the fixed-rate portion of the related assets could extend beyond the term of the swap agreement or other hedging instrument. This could have a negative impact on our results from operations, as borrowing costs would no longer be fixed after the end of the hedging instrument, while the income earned on the hybrid adjustable-rate assets would remain fixed. This situation may also cause the market value of our hybrid adjustable-rate assets to decline, with little or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.
Market Risk
Market Value Risk
Our available-for-sale securities are reflected at their estimated fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income pursuant to ASC Topic 320. The estimated fair value of these securities fluctuates primarily due to changes in interest rates and other factors. Generally, in a rising interest rate environment, the estimated fair value of these securities would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of these securities would be expected to increase.
The sensitivity analysis table presented below shows the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments and net interest income, including net interest paid or received under interest rate swaps, at December 31, 2016, assuming a static portfolio. When evaluating the impact of changes in interest rates, prepayment assumptions and principal reinvestment rates are adjusted based on our Manager’s expectations. The analysis presented utilized assumptions, models and estimates of our Manager based on our Manager’s judgment and experience.


 
72
 

Table of Contents

Change in Interest Rates
 
Percentage Change
in Projected
Net Interest Income
 
Percentage
Change in
Projected
Portfolio Value
+1.00%
 
(20.86
)%
 
(1.43
)%
+0.50%
 
(5.81
)%
 
(0.53
)%
-0.50%
 
3.04
 %
 
0.83
 %
-1.00%
 
(7.38
)%
 
1.15
 %
Certain assumptions have been made in connection with the calculation of the information set forth in the foregoing interest rate sensitivity table and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. The base interest rate scenario assumes interest rates at December 31, 2016. Furthermore, while we generally expect to retain such assets and the associated interest rate risk to maturity, future purchases and sales of assets could materially change our interest rate risk profile.
Given the low interest rates at December 31, 2016, we applied a floor of 0% for all anticipated interest rates included in our assumptions. Because of this floor, we anticipate that any hypothetical interest rate shock decrease would have a limited positive impact on our funding costs; however, because prepayment speeds are unaffected by this floor, we expect that any increase in our prepayment speeds (occurring as a result of any interest rate decrease or otherwise) could result in an acceleration of our premium amortization on Agency and interest-only securities purchased at a premium, and accretion of discount on our non-Agency RMBS purchased at a discount. As a result, because this floor limits the positive impact of any interest rate decrease on our funding costs, hypothetical interest rate decreases could cause the fair value of our financial instruments and our net interest income to decline.
The information set forth in the interest rate sensitivity table above and all related disclosures constitutes forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Actual results could differ significantly from those estimated in the foregoing interest rate sensitivity table.
Real Estate Risk
Residential and commercial property values are subject to volatility and may be adversely affected by a number of factors, including, but not limited to: national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions (such as the supply of housing stock); changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; and retroactive changes to building or similar codes. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could also cause us to suffer losses.
Credit Risk
We believe that our investment strategy will generally keep our credit losses and financing costs low. However, we retain the risk of potential credit losses on all of our residential and commercial mortgage investments. We seek to manage this risk through our pre-acquisition due diligence process. In addition, we re-evaluate the credit risk inherent in our investments on a regular basis pursuant to fundamental considerations such as GDP, unemployment, interest rates, retail sales, store closings/openings, corporate earnings, housing inventory, affordability and regional home price trends. We also review key loan credit metrics including, but not limited to, payment status, current loan-to-value ratios, current borrower credit scores and debt yields. These characteristics assist in determining the likelihood and severity of loan loss as well as prepayment and extension expectations. We then perform structural analysis under multiple scenarios to establish likely cash flow profiles and credit enhancement levels relative to collateral performance projections. This analysis allows us to quantify our opinions of credit quality and fundamental value, which are key drivers of portfolio management decisions.
Foreign Exchange Rate Risk
We have an investment in a commercial loan denominated in foreign currency and an investment in an unconsolidated joint venture whose net assets and results of operations are exposed to foreign currency translation risk when translated in U.S. dollars upon consolidation. We seek to hedge our foreign currency exposures by purchasing currency forward contracts.
Risk Management
To the extent consistent with maintaining our REIT qualification, we seek to manage risk exposure to protect our investment portfolio against the effects of major interest rate changes. We generally seek to manage this risk by:
monitoring and adjusting, if necessary, the reset index and interest rate related to our target assets and our financings;


 
73
 

Table of Contents

attempting to structure our financing agreements to have a range of different maturities, terms, amortizations and interest rate adjustment periods;
using hedging instruments, primarily interest rate swap agreements but also financial futures, options, interest rate cap agreements, floors and forward sales to adjust the interest rate sensitivity of our target assets and our borrowings; and
actively managing, on an aggregate basis, the interest rate indices, interest rate adjustment periods, and gross reset margins of our target assets and the interest rate indices and adjustment periods of our financings.
Item 8. Financial Statements and Supplementary Data.
The financial statements and supplementary data are included under Item 15 of this Report.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Disclosure Controls and Procedures
Our management is responsible for establishing and maintaining disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. We have evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures as of December 31, 2016. Based upon our evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in the Exchange Act, Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of the principal executive officer and principal financial officer, management assessed the effectiveness of our internal control over financial reporting as of December 31, 2016. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (2013). Based on this assessment, management concluded that our internal control over financial reporting was effective as of December 31, 2016.
Our independent registered public accounting firm, PricewaterhouseCoopers LLP, audited the effectiveness of our internal control over financial reporting as of December 31, 2016. Their report dated February 21, 2017, which is included herein, expressed an unqualified opinion on the effectiveness of our internal control over financial reporting.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter ended December 31, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information.
None.


 
74
 

Table of Contents

PART III
Item 10. Directors, Executive Officers and Corporate Governance.
We will provide information that is responsive to certain portions of this Item 10 in our definitive proxy statement or in an amendment to this Report not later than 120 days after the end of the fiscal year covered by this Report, in either case under the captions “Information about Director Nominees,” “Information about the Executive Officers of the Company,” “Corporate Governance,” “Information about the Board and its Committees,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and possibly elsewhere therein. That information is incorporated into this Item 10 by reference.
Each year, the chief executive officer of each company listed on the New York Stock Exchange (“NYSE”) must certify to the NYSE that he or she is not aware of any violation by us of NYSE corporate governance listing standards as of the date of certification, qualifying the certification to the extent necessary. Our chief executive officer submitted this certification to the NYSE in 2016 as required pursuant to Section 303A of the NYSE Listed Company Manual and will submit a similar certification within 30 days of our 2017 annual stockholders’ meeting. In addition, we have filed, as exhibits to this Report, the certifications of our chief executive officer and chief financial officer required under Section 302 and 906 of the Sarbanes-Oxley Act of 2002.
Item 11. Executive Compensation.
We will provide information that is responsive to this Item 11 in our definitive proxy statement or in an amendment to this Report not later than 120 days after the end of the fiscal year covered by this Report, in either case under the captions “Information About the Board and Its Committees - Director Compensation,” “Executive Compensation,” “Compensation Committee Interlocks and Insider Participation,” and possibly elsewhere therein. That information is incorporated into this Item 11 by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
We will provide information that is responsive to this Item 12 in our definitive proxy statement or in an amendment to this Report not later than 120 days after the end of the fiscal year covered by this Report, in either case under the caption “Security Ownership of Principal Stockholders,” “Security Ownership of Management,” and possibly elsewhere therein. That information is incorporated into this Item 12 by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
We will provide information that is responsive to this Item 13 in our definitive proxy statement or in an amendment to this Report not later than 120 days after the end of the fiscal year covered by this Report, in either case under the captions “Corporate Governance,” “Certain Relationships and Related Transactions,” “Related Person Transaction Policy,” and possibly elsewhere therein. That information is incorporated into this Item 13 by reference.
Item 14. Principal Accounting Fees and Services.
We will provide information that is responsive to this Item 14 in our definitive proxy statement or in an amendment to this Report not later than 120 days after the end of the fiscal year covered by this Report, in either case under the captions “Fees Paid to Independent Registered Public Accounting Firm,” “Pre-Approval Process and Policy,” and possibly elsewhere therein. That information is incorporated into this Item 14 by reference.
PART IV
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements: The financial statements contained herein are set forth on pages 81-129 of this Report.
(a)(2) Financial Statement Schedules: Refer to Index to Financial Statement Schedules contained herein on page 78 of this Report.
(a)(3) Exhibits: Refer to Exhibit Index starting on page 76 of this Report.
Item 16. Form 10-K Summary.
Not applicable.



 
75
 

Table of Contents

Exhibit Index
 
Exhibit
No.
 
Description
3.1
 
Articles of Amendment and Restatement of Invesco Mortgage Capital Inc., incorporated by reference to Exhibit 3.1 to our Quarterly Report on Form 10-Q, filed with the SEC on August 12, 2009.
 
 
 
3.2
 
Articles Supplementary of 7.75% Series A Cumulative Redeemable Preferred Stock, incorporated by reference to Exhibit 3.3 to our Registration Statement on Form 8-A, filed with the SEC on July 23, 2012.
 
 
 
3.3
 
Articles Supplementary of 7.75% Fixed-to-Floating Series B Cumulative Redeemable Preferred Stock, incorporated by reference to Exhibit 3.3 to the Registrant’s Registration Statement on Form 8-A, filed with the SEC on September 8, 2014.
 
 
 
3.4
 
Amended and Restated Bylaws of Invesco Mortgage Capital Inc., incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K, filed with the SEC on February 17, 2017.
 
 
 
4.1
 
Specimen Common Stock Certificate of Invesco Mortgage Capital Inc., incorporated by reference to Exhibit 4.1 to Pre-Effective Amendment No. 8.
 
 
 
4.2
 
Specimen 7.75% Series A Cumulative Redeemable Preferred Stock Certificate, incorporated by reference to Exhibit 4.1 to our Registration Statement on Form 8-A, filed with the SEC on July 23, 2012.
 
 
 
4.3
 
Specimen 7.75% Series B Fixed-to-Floating Cumulative Redeemable Preferred Stock Certificate, incorporated by reference to Exhibit 4.1 to the Registrant’s Registration Statement on Form 8-A, filed with the SEC on September 8, 2014.
 
 
 
4.4
 
Indenture, dated March 12, 2013, by and among IAS Operating Partnership LP, as issuer, Invesco Mortgage Capital Inc., as guarantor, and The Bank of New York Mellon Trust Company, N.A., as trustee, including the form of 5.00% Exchangeable Senior Notes due 2018 and the related guarantee, incorporated by reference to Exhibit 4.1 to our Current Report on Form 8-K, filed with the SEC on March 15, 2013.
 
 
 
10.1
 
Registration Rights Agreement, dated as of July 1, 2009, among Invesco Mortgage Capital Inc. (formally known as Invesco Agency Securities Inc.), Invesco Advisers, Inc. (formally known as Invesco Institutional (N.A.), Inc.) and Invesco Investments (Bermuda) Ltd., incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q, filed with the SEC on August 12, 2009.
 
 
 
10.2
 
Registration Rights Agreement, dated March 12, 2013, among IAS Operating Partnership LP, Invesco Mortgage Capital Inc., Credit Suisse Securities (USA) LLC, Citigroup Global Markets Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated, incorporated by reference to Exhibit 4.1 to our Current Report on Form 8-K, filed with the SEC on March 15, 2013.
 
 
 
10.3
 
Management Agreement, dated as of July 1, 2009, among Invesco Advisers, Inc. (formally known as Invesco Institutional (N.A.), Inc.), Invesco Mortgage Capital Inc. and IAS Operating Partnership LP., incorporated by reference to Exhibit 10.2 to our Quarterly Report on Form 10-Q, filed with the SEC on August 12, 2009.
 
 
 
10.4
 
Amendment to Management Agreement, dated as of May 24, 2011, by and among Invesco Advisers, Inc. (formally known as Invesco Institutional (N.A.), Inc.), Invesco Mortgage Capital Inc., IAS Operating Partnership LP., and IAS Asset I LLC, incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q, filed with the SEC on August 9, 2011.
 
 
 
10.5
 
Second Amendment to Management Agreement, dated as of July 1, 2015, by and among Invesco Advisers, Inc., Invesco Mortgage Capital Inc., and IAS Operating Partnership LP., incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q, filed with the SEC on August 17, 2015.
 
 
 
10.6
 
First Amended and Restated Agreement of Limited Partnership, dated as of July 1, 2009, of IAS Operating Partnership LP., incorporated by reference to Exhibit 10.3 to our Quarterly Report on Form 10-Q, filed with the SEC on August 12, 2009.
 
 
 
10.7
 
First Amendment to First Amended and Restated Agreement of Limited Partnership of IAS Operating Partnership LP, dated as of July 23, 2012, incorporated by reference to Exhibit 10.5 to our Annual Report on Form 10-K, filed with the SEC on March 1, 2013.
 
 
 
10.8
 
Second Amendment to First Amended and Restated Agreement of Limited Partnership of IAS Operating Partnership LP, dated September 8, 2014.
 
 
 
§ 10.9
 
Invesco Mortgage Capital Inc. Amended and Restated 2009 Equity Incentive Plan, incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K, filed with the SEC on February 19, 2016.
 
 
 


 
76
 

Table of Contents

§ 10.10
 
Amendment No. 1 to Invesco Mortgage Capital Inc. 2009 Equity Incentive Plan, incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q, filed with the SEC on August 13, 2010.
 
 
 
§ 10.11
 
Form of Restricted Common Stock Award Agreement, incorporated by reference to Exhibit 4.1 to Pre-Effective Amendment No. 8.
 
 
 
§ 10.12
 
Form of Restricted Stock Unit Award Agreement, incorporated by reference to Exhibit 10.7 to our Annual Report on Form 10-K, filed with the SEC on March 24, 2010.
 
 
 
21.1
 
Subsidiaries of the Registrant.
 
 
 
23.1
 
Consent of PricewaterhouseCoopers LLP.
 
 
 
23.2
 
Consent of Grant Thornton LLP.
 
 
 
31.1
 
Certification of Richard J. King pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of Richard Lee Phegley, Jr. pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1
 
Certification of Richard J. King pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.2
 
Certification of Richard Lee Phegley, Jr. pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101
 
The following series of audited XBRL-formatted documents are collectively included herewith as Exhibit 101. The financial information is extracted from Invesco Mortgage Capital Inc.’s audited consolidated financial statements and notes that are included in this Form 10-K/A Report.
 
 
 
 
 
101.INS XBRL Instance Document
 
 
 
 
 
101.SCH XBRL Taxonomy Extension Schema Document
 
 
 
 
 
101.CAL XBRL Taxonomy Calculation Linkbase Document
 
 
 
 
 
101.LAB XBRL Taxonomy Label Linkbase Document
 
 
 
 
 
101.PRE XBRL Taxonomy Presentation Linkbase Document
 
 
 
 
 
101.DEF XBRL Taxonomy Definition Linkbase Document
§ Management contract or compensatory plan or arrangement.
(b) Exhibits: Refer to (a)(3) above.
(c) Financial Statement Schedules: Refer to (a)(2) above.


 
77
 

Table of Contents

INDEX TO FINANCIAL STATEMENTS
 
 
Page


INDEX TO FINANCIAL STATEMENT SCHEDULES

 
Page




 
78
 

Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of
Invesco Mortgage Capital Inc.

In our opinion, the accompanying consolidated balance sheet as of December 31, 2016 and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows for the year then ended present fairly, in all material respects, the financial position of Invesco Mortgage Capital Inc. and its subsidiaries at December 31, 2016, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index as of and for the year ended December 31, 2016, presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PRICEWATERHOUSECOOPERS LLP

Atlanta, Georgia
February 21, 2017





 
79
 

Table of Contents


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
Invesco Mortgage Capital Inc.

We have audited the accompanying consolidated balance sheet of Invesco Mortgage Capital Inc. (a Maryland corporation) and subsidiaries (the “Company”) as of December 31, 2015, and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows for the years ended December 31, 2015 and 2014. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Invesco Mortgage Capital Inc. and subsidiaries as of December 31, 2015, and the results of their operations and their cash flows for the years ended December 31, 2015 and 2014, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ GRANT THORNTON LLP

Iselin, New Jersey
February 22, 2016 (Except for Note 17 - Revision of Previously Issued Financial Statements, which is as of February 21, 2017)



 
80
 

Table of Contents

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
As of

December 31, 2016
 
December 31, 2015
In thousands except share amounts
 
ASSETS
 
 
 
Mortgage-backed and credit risk transfer securities, at fair value (including pledged securities of $14,422,198 and $15,553,934, respectively)
14,981,331

 
16,065,935

Commercial loans, held-for-investment
273,355

 
209,062

Cash and cash equivalents
161,788

 
53,199

Due from counterparties
86,450

 
110,009

Investment related receivable
43,886

 
154,594

Accrued interest receivable
46,945

 
50,779

Derivative assets, at fair value
3,186

 
8,659

Other assets
109,297

 
115,072

Total assets
15,706,238

 
16,767,309

LIABILITIES AND EQUITY
 
 
 
Liabilities:
 
 
 
Repurchase agreements
11,160,669

 
12,126,048

Secured loans
1,650,000

 
1,650,000

Exchangeable senior notes
397,041

 
394,573

Derivative liabilities, at fair value
134,228

 
238,148

Dividends and distributions payable
50,924

 
51,734

Investment related payable
9,232

 
167

Accrued interest payable
21,066

 
21,604

Collateral held payable
1,700

 
4,900

Accounts payable and accrued expenses
1,534

 
2,376

Due to affiliate
9,660

 
10,851

Total liabilities
13,436,054

 
14,500,401

Commitments and contingencies (See Note 16)

 

Equity:
 
 
 
Preferred Stock, par value $0.01 per share; 50,000,000 shares authorized:
 
 
 
7.75% Series A Cumulative Redeemable Preferred Stock: 5,600,000 shares issued and outstanding ($140,000 aggregate liquidation preference)
135,356

 
135,356

7.75% Fixed-to-Floating Series B Cumulative Redeemable Preferred Stock: 6,200,000 shares issued and outstanding ($155,000 aggregate liquidation preference)
149,860

 
149,860

Common Stock, par value $0.01 per share; 450,000,000 shares authorized; 111,594,595 and 113,619,471 shares issued and outstanding, respectively
1,116

 
1,136

Additional paid in capital
2,379,863

 
2,407,372

Accumulated other comprehensive income
293,668

 
318,624

Retained earnings (distributions in excess of earnings)
(718,303
)
 
(771,313
)
Total stockholders’ equity
2,241,560

 
2,241,035

Non-controlling interest
28,624

 
25,873

Total equity
2,270,184

 
2,266,908

Total liabilities and equity
15,706,238

 
16,767,309

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


 
81
 

Table of Contents

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
 
Years Ended December 31,
 
2016
 
2015
 
2014
In thousands except share amounts
 
 
Interest Income
 
 
 
 
 
Mortgage-backed and credit risk transfer securities
456,444

 
523,893

 
589,499

Residential loans (1)

 
110,908

 
88,073

Commercial loans
22,238

 
15,331

 
9,508

Total interest income
478,682

 
650,132

 
687,080

Interest Expense
 
 
 
 
 
Repurchase agreements
124,000

 
166,892

 
188,699

Secured loans
10,887

 
6,579

 
2,576

Exchangeable senior notes
22,467

 
22,461

 
22,461

Asset-backed securities (1)

 
82,041

 
68,159

Total interest expense
157,354

 
277,973

 
281,895

Net interest income
321,328

 
372,159

 
405,185

Reduction in provision for loan losses

 
(213
)
 
(142
)
Net interest income after reduction in provision for loan losses
321,328

 
372,372

 
405,327

Other income (loss)
 
 
 
 
 
Gain (loss) on investments, net
(17,542
)
 
(18,005
)
 
(84,407
)
Equity in earnings of unconsolidated ventures
2,392

 
12,630

 
6,786

Gain (loss) on derivative instruments, net
(62,815
)
 
(219,048
)
 
(487,469
)
Realized and unrealized credit derivative income (loss), net
61,143

 
19,782

 
(2,866
)
Other investment income (loss), net
(5,002
)
 
944

 
(2,045
)
Total other income (loss)
(21,824
)
 
(203,697
)
 
(570,001
)
Expenses
 
 
 
 
 
Management fee — related party
34,541

 
38,632

 
37,599

General and administrative
7,265

 
7,769

 
9,191

Consolidated securitization trusts (1)

 
8,219

 
6,076

Total expenses
41,806

 
54,620

 
52,866

Net income (loss)
257,698

 
114,055

 
(217,540
)
Net income (loss) attributable to non-controlling interest
3,287

 
1,344

 
(2,482
)
Net income (loss) attributable to Invesco Mortgage Capital Inc.
254,411

 
112,711

 
(215,058
)
Dividends to preferred stockholders
22,864

 
22,864

 
17,378

Net income (loss) attributable to common stockholders
231,547

 
89,847

 
(232,436
)
Earnings per share:
 
 
 
 
 
Net income (loss) attributable to common stockholders
 
 
 
 
 
Basic
2.07

 
0.74

 
(1.89
)
Diluted
1.98

 
0.74

 
(1.89
)
Weighted average number of shares of common stock:
 
 
 
 
 
Basic
111,973,404

 
121,377,585

 
123,104,934

Diluted
130,254,003

 
122,843,838

 
124,529,934

(1)
The consolidated statements of operations for the years ended December 31, 2015 and 2014 include income and expenses of consolidated variable interest entities ("VIEs"). We deconsolidated these VIEs in 2015. Refer to Note 2 - “Summary of Significant Accounting Policies” for further discussion.
The accompanying notes are an integral part of these consolidated financial statements.


 
82
 

Table of Contents

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
 
Years Ended December 31,
 
2016
 
2015
 
2014
In thousands
 
 
Net income (loss)
257,698

 
114,055

 
(217,540
)
Other comprehensive income (loss):
 
 
 
 
 
Unrealized gain (loss) on mortgage-backed and credit risk transfer securities, net
(37,632
)
 
(191,053
)
 
420,761

Reclassification of unrealized (gain) loss on sale of mortgage-backed and credit risk transfer securities to gain (loss) on investments, net
6,134

 
(7,484
)
 
77,898

Reclassification of amortization of net deferred (gain) loss on de-designated interest rate swaps to repurchase agreements interest expense
5,154

 
66,757

 
85,176

Currency translation adjustments on investment in unconsolidated venture
128

 
(32
)
 

Total other comprehensive income (loss)
(26,216
)
 
(131,812
)
 
583,835

Comprehensive income (loss)
231,482

 
(17,757
)
 
366,295

Less: Comprehensive (income) loss attributable to non-controlling interest
(2,939
)
 
245

 
(4,188
)
Less: Dividends to preferred stockholders
(22,864
)
 
(22,864
)
 
(17,378
)
Comprehensive income (loss) attributable to common stockholders
205,679

 
(40,376
)
 
344,729

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


 
83
 

Table of Contents

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
 
 
 
 
 
 
 
 
 
Attributable to Common Stockholders
 
 
 
 
In thousands except share amounts
Series A
Preferred Stock
 
Series B
Preferred Stock
 
 
 
Common Stock
 
Additional
Paid in
Capital
 
Accumulated
Other
Comprehensive
Income (loss)
 
Retained
Earnings
(Distributions
in excess
of earnings)
 
Total
Stockholders’
Equity
 
Non-
Controlling
Interest
 
Total
Equity
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Balance at December 31, 2013
5,600,000

 
135,356

 

 

 
124,510,246

 
1,245

 
2,552,464

 
(128,318
)
 
(184,632
)
 
2,376,115

 
27,120

 
2,403,235

Net income (loss)

 

 

 

 

 

 

 

 
(215,058
)
 
(215,058
)
 
(2,482
)
 
(217,540
)
Other comprehensive income (loss)

 

 

 

 

 

 

 
577,165

 

 
577,165

 
6,670

 
583,835

Proceeds from issuance of common stock, net of offering costs

 

 

 

 
15,505

 

 
256

 

 

 
256

 

 
256

Proceeds from issuance of preferred stock, net of offering costs

 

 
6,200,000

 
149,860

 

 

 

 

 

 
149,860

 

 
149,860

Repurchase of shares of common stock

 

 

 

 
(1,438,213
)
 
(14
)
 
(21,116
)
 

 

 
(21,130
)
 

 
(21,130
)
Stock awards

 

 

 

 
22,916

 

 

 

 

 

 

 

Common stock dividends

 

 

 

 

 

 

 

 
(240,041
)
 
(240,041
)
 

 
(240,041
)
Common unit dividends

 

 

 

 

 

 

 

 

 

 
(2,779
)
 
(2,779
)
Preferred stock dividends

 

 

 

 

 

 

 

 
(17,378
)
 
(17,378
)
 

 
(17,378
)
Amortization of equity-based compensation

 

 

 

 

 

 
526

 

 

 
526

 
6

 
532

Balance at December 31, 2014 
5,600,000

 
135,356

 
6,200,000

 
149,860

 
123,110,454

 
1,231

 
2,532,130

 
448,847

 
(657,109
)
 
2,610,315

 
28,535

 
2,638,850

Net income (loss)

 

 

 

 

 

 

 

 
112,711

 
112,711

 
1,344

 
114,055

Other comprehensive income (loss)

 

 

 

 

 

 

 
(130,223
)
 

 
(130,223
)
 
(1,589
)
 
(131,812
)
Proceeds from issuance of common stock, net of offering costs

 

 

 

 
12,945

 

 
191

 

 

 
191

 

 
191

Repurchase of shares of common stock

 

 

 

 
(9,539,251
)
 
(95
)
 
(125,500
)
 

 

 
(125,595
)
 

 
(125,595
)
Stock awards

 

 

 

 
35,323

 

 

 

 

 

 

 

Common stock dividends

 

 

 

 

 

 

 

 
(204,051
)
 
(204,051
)
 

 
(204,051
)
Common unit dividends

 

 

 

 

 

 

 

 

 

 
(2,423
)
 
(2,423
)
Preferred stock dividends

 

 

 

 

 

 

 

 
(22,864
)
 
(22,864
)
 

 
(22,864
)
Amortization of equity-based compensation

 

 

 

 

 

 
551

 

 

 
551

 
6

 
557

Balance at December 31, 2015 
5,600,000

 
135,356

 
6,200,000

 
149,860

 
113,619,471

 
1,136

 
2,407,372

 
318,624

 
(771,313
)
 
2,241,035

 
25,873

 
2,266,908

Net income (loss)

 

 

 

 

 

 

 

 
254,411

 
254,411

 
3,287

 
257,698

Other comprehensive income (loss)

 

 

 

 

 

 

 
(25,868
)
 

 
(25,868
)
 
(348
)
 
(26,216
)
Proceeds from issuance of common stock, net of offering costs

 

 

 

 
3,201

 

 
35

 

 

 
35

 

 
35

Repurchase of shares of common stock

 

 

 

 
(2,063,451
)
 
(20
)
 
(24,980
)
 

 

 
(25,000
)
 

 
(25,000
)
Stock awards

 

 

 

 
35,374

 

 

 

 

 

 

 

Common stock dividends

 

 

 

 

 

 

 

 
(178,537
)
 
(178,537
)
 

 
(178,537
)
Common unit dividends

 

 

 

 

 

 

 

 

 

 
(2,280
)
 
(2,280
)
Preferred stock dividends

 

 

 

 

 

 

 

 
(22,864
)
 
(22,864
)
 

 
(22,864
)
Amortization of equity-based compensation

 

 

 

 

 

 
434

 

 

 
434

 
6

 
440

Rebalancing of ownership percentage of non-controlling interest

 

 

 

 

 

 
(2,998
)
 
912

 

 
(2,086
)
 
2,086

 

Balance at December 31, 2016
5,600,000

 
135,356

 
6,200,000

 
149,860

 
111,594,595

 
1,116

 
2,379,863

 
293,668

 
(718,303
)
 
2,241,560

 
28,624

 
2,270,184

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


 
84
 

Table of Contents

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
In thousands
Years Ended December 31,
 
2016
 
2015
 
2014
Cash Flows from Operating Activities
 
 
 
 
 
Net income (loss)
257,698

 
114,055

 
(217,540
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
 
 
Amortization of mortgage-backed and credit risk transfer securities premiums and (discounts), net
118,248

 
117,288

 
113,932

Amortization of residential loans and asset-backed securities premiums (discounts), net

 
(656
)
 
2,761

Amortization of commercial loan origination fees
(302
)
 
(91
)
 
(9
)
Reduction in provision for loan losses

 
(213
)
 
(142
)
Unrealized (gain) loss on derivative instruments, net
(99,932
)
 
(9,597
)
 
215,499

Unrealized (gain) loss on credit derivatives, net
(42,817
)
 
4,623

 
21,753

(Gain) loss on investments, net
17,542

 
18,005

 
84,407

Realized (gain) loss on derivative instruments, net
57,943

 
44,272

 
72,187

Realized (gain) loss on credit derivatives, net
6,017

 
1,140

 

Equity in earnings of unconsolidated ventures
(2,392
)
 
(12,630
)
 
(6,786
)
Amortization of equity-based compensation
440

 
557

 
532

Amortization of deferred securitization and financing costs
2,468

 
3,146

 
3,013

Amortization of net deferred losses on de-designated interest rate swaps
5,154

 
66,757

 
85,176

Non-cash interest income capitalized in commercial loans

 

 
(768
)
(Gain) loss on foreign currency transactions, net
8,260

 
1,964

 
2,718

Changes in operating assets and liabilities:
 
 
 
 
 
Decrease in operating assets
3,966

 
5,660

 
2,473

Increase (decrease) in operating liabilities
(2,578
)
 
4,305

 
456

Net cash provided by operating activities
329,715

 
358,585

 
379,662

Cash Flows from Investing Activities
 
 
 
 
 
Purchase of mortgage-backed and credit risk transfer securities
(2,660,925
)
 
(2,352,380
)
 
(4,339,442
)
Purchase of U.S. Treasury securities
(403,105
)
 

 

Proceeds from sale of U.S. Treasury securities
524,478

 

 

(Contributions) distributions (from) to investments in unconsolidated ventures, net
7,632

 
18,183

 
7,191

Change in other assets
623

 
(12,875
)
 
(52,500
)
Principal payments from mortgage-backed and credit risk transfer securities
2,580,695

 
2,602,138

 
1,909,632

Proceeds from sale of mortgage-backed and credit risk transfer securities
1,034,295

 
907,155

 
3,266,040

Payments on sale of credit derivatives
(6,017
)
 
(1,140
)
 

Payment of premiums for interest rate swaptions

 
(1,486
)
 
(10,328
)
Payments for termination of futures, forwards, swaps, swaptions and TBAs, net
(56,458
)
 
(33,945
)
 
(48,913
)
Purchase of residential loans held-for-investment

 
(372,305
)
 
(1,816,638
)
Principal payments from residential loans held-for-investment

 
549,565

 
255,662

Principal payments from commercial loans held-for-investment
15,000

 
92,796

 
399

Origination and advances of commercial loans, net of origination fees
(87,202
)
 
(157,963
)
 
(83,483
)
Net cash provided by (used in) investing activities
949,016

 
1,237,743

 
(912,380
)
Cash Flows from Financing Activities
 
 
 
 
 
Proceeds from issuance of common stock
35

 
191

 
256

Repurchase of common stock
(25,000
)
 
(125,595
)
 
(21,130
)
Proceeds from (cost of) issuance of preferred stock

 
(36
)
 
149,896

Due from counterparties
29,445

 
(53,830
)
 
(54,679
)
Collateral held payable
(3,200
)
 
(9,990
)
 
(32,014
)
Proceeds from repurchase agreements
127,056,247

 
140,861,204

 
141,072,770

Principal repayments of repurchase agreements
(128,023,042
)
 
(142,357,783
)
 
(142,901,817
)
Proceeds from asset-backed securities

 
336,077

 
1,525,905

Principal repayments of asset-backed securities

 
(518,150
)
 
(236,210
)
Proceeds from secured loans
125,000

 
2,325,000

 
2,835,247

Principal repayments on secured loans
(125,000
)
 
(1,925,000
)
 
(1,585,247
)
Payments of deferred offering costs
(136
)
 

 
(2,199
)
Payments of dividends and distributions
(204,491
)
 
(239,361
)
 
(264,528
)
Net cash provided by (used in) financing activities
(1,170,142
)
 
(1,707,273
)
 
486,250

Net change in cash and cash equivalents
108,589

 
(110,945
)
 
(46,468
)
Cash and cash equivalents, beginning of period
53,199

 
164,144

 
210,612

Cash and cash equivalents, end of period
161,788

 
53,199

 
164,144

Supplement Disclosure of Cash Flow Information
 
 
 
 
 
Interest paid
146,840

 
211,414

 
193,275

Non-cash Investing and Financing Activities Information
 
 
 
 
 
Net change in unrealized gain (loss) on mortgage-backed and credit risk transfer securities
(31,498
)
 
(198,537
)
 
498,659

Dividends and distributions declared not paid
50,924

 
51,734

 
61,757

Net change in investment related payable (receivable)
115,304

 
(131,440
)
 
457,643

Repurchase agreements, not settled
(1,416
)
 
(50
)
 
49

Collateral held payable, not settled

 

 
(5,794
)
Change in due from counterparties
(5,886
)
 
1,425

 
(1,425
)
The accompanying notes are an integral part of these consolidated financial statements.


 
85
 

Table of Contents

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 – Organization and Business Operations
Invesco Mortgage Capital Inc. (the “Company”, “we”) is a Maryland corporation primarily focused on investing in, financing and managing residential and commercial mortgage-backed securities and mortgage loans. We are externally managed and advised by Invesco Advisers, Inc. (our "Manager"), a registered investment adviser and an indirect, wholly-owned subsidiary of Invesco Ltd. (“Invesco”), a leading independent global investment management firm. We conduct our business through IAS Operating Partnership L.P. (the “Operating Partnership”) as its sole general partner. As of December 31, 2016 we owned 98.7% of the Operating Partnership and a wholly-owned subsidiary of Invesco owned the remaining 1.3%. We have one operating segment.
We primarily invest in:
Residential mortgage-backed securities ("RMBS") that are guaranteed by a U.S. government agency such as the Government National Mortgage Association, or a federally chartered corporation such as the Federal National Mortgage Association ("Fannie Mae") or the Federal Home Loan Mortgage Corporation ("Freddie Mac") (collectively "Agency RMBS");
RMBS that are not guaranteed by a U.S. government agency (“non-Agency RMBS”);
Credit risk transfer securities that are unsecured obligations issued by government-sponsored enterprises ("GSE CRT");
Commercial mortgage-backed securities ("CMBS");
Residential and commercial mortgage loans; and
Other real estate-related financing agreements.
We 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 commencing with our taxable year ended December 31, 2009. To maintain our REIT qualification, we are generally required to distribute at least 90% of our REIT taxable income to our stockholders annually. We operate our business in a manner that permits exclusion from the "Investment Company" definition under the Investment Company Act of 1940.
Note 2 – Summary of Significant Accounting Policies
Basis of Presentation and Consolidation
In the opinion of management, the consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, which are necessary for a fair statement of our financial condition and results of operations for the periods presented. All significant intercompany transactions, balances, revenues and expenses are eliminated upon consolidation.
Our consolidated financial statements have been prepared in accordance with U.S. GAAP and consolidate the financial statements of the Company and our controlled subsidiaries. During the period from January 1, 2014 through December 9, 2015, the consolidated financial statements also include the results of operations of certain residential loan securitization trusts (the "Residential Securitizations") that meet the definition of a variable interest entity ("VIE"). On December 9, 2015, we completed the sale of certain beneficial interests in the Residential Securitizations and deconsolidated the Residential Securitizations. Refer to Note 3 - "Variable Interest Entities" for additional information regarding the impact of consolidation and deconsolidation of the Residential Securitizations.
Revision of Previously Issued Financial Statements
During the second quarter of 2016, we corrected errors in our accounting for premiums and discounts associated with non-Agency RMBS not of high credit quality. We concluded that the errors are immaterial to each of the annual and interim consolidated financial statements which were included in the Company's Annual Report on Form 10-K for the year ended December 31, 2015 and our interim report on Form 10-Q for the quarter ended March 31, 2016. We have corrected our financial statements for previous periods included in this filing on Form 10-K and will correct our previously issued financial statements for these errors as the financial statements are presented in future periodic filings.
Refer to Note 17 - "Revision of Previously Issued Financial Statements" for additional details.


 
86
 

Table of Contents

Use of Estimates
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 our 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 and credit risk transfer securities, allowance for loan losses and other-than-temporary impairment charges. Actual results may differ from those estimates.
Translation of Foreign Currencies
The functional currency of the Company and its subsidiaries is U.S. dollars. Transactions in foreign currencies are recorded at the rates of exchange prevailing on the date of the transactions. At each balance sheet date, monetary assets and liabilities that are denominated in foreign currencies are remeasured at the rates prevailing at the balance sheet date. Gains and losses arising on revaluation are included in other investment income (loss), net on the consolidated statements of operations. During the years ended December 31, 2016, 2015 and 2014, we incurred foreign currency losses of $8.2 million, $1.9 million and $2.7 million on the revaluation of our commercial loan investments denominated in Pound Sterling.
Our reporting currency is U.S. dollars. Upon consolidation, the assets and liabilities of our investment in an unconsolidated venture whose functional currency is the Euro is translated to U.S. dollars using the period-end exchange rates. Equity accounts are translated at historical rates, except for the change in retained earnings during the year, which is the result of the income statement translation process. Revenue and expense accounts are translated using the weighted average exchange rate during the period. The cumulative translation adjustments associated with the investment in the unconsolidated venture are recorded in accumulated other comprehensive income (loss), a component of consolidated stockholders’ equity.
We generally hedge interest rate and foreign currency exposure with derivative financial instruments. Refer to Note 9 - "Derivatives and Hedging Activities" for further information.
Fair Value Measurements
We report our mortgage-backed and credit risk transfer securities and derivative assets and liabilities at fair value as determined by an independent pricing service. We generally obtain one price per instrument from our primary pricing service. If the primary pricing service cannot provide a price, we will seek a value from other pricing services.
The pricing service uses two types of valuation approaches to determine the valuation of our various mortgage-backed and credit risk transfer securities: a market approach, which uses observable prices and other relevant information that is generated by market transactions involving identical or comparable assets or liabilities; and an income approach, which uses valuation techniques to convert future amounts to a single, discounted present value amount. In instances where sufficient market activity may not exist, the pricing service may utilize proprietary valuation models that may consider market transactions in comparable securities and the various relationships between securities in determining fair value and/or market characteristics to estimate relevant cash flows, which are then discounted to calculate the fair values. Observable inputs may include a combination of benchmark yields, executed trades, broker/dealer quotes, issuer spreads, bids, offers and benchmark securities. In addition, the valuation models utilized by pricing services may consider additional pool level information such as prepayment speeds, default frequencies and default severities, if applicable. We and the pricing service continuously monitor market indicators and economic events to determine whether they may have an impact on our valuations.
The pricing service values interest rate swaps and interest rate swaptions under the income approach using valuation models. The significant inputs in these models are readily available in public markets or can be derived from observable market transactions for substantially the full terms of the contracts.
The pricing service values U.S. Treasury futures, currency forward contracts and to-be-announced securities (“TBAs”) under the market approach through the use of quoted market prices available in an active market.
Overrides of prices from pricing services are rare in the current market environment for the assets we hold. Examples of instances that would cause an override include if we recently traded the same security or there is an indication of market activity that would cause the pricing service price to no longer be indicative of fair value. In the rare instance where a price is adjusted, we have a control process to monitor the reason for such adjustment.
To gain comfort that pricing service prices are representative of current market information, we compare the transaction prices of security purchases and sales to the valuation levels provided by the pricing services. Price differences exceeding pre-defined tolerance levels are identified and investigated and may be challenged. Trends are monitored over time and if there are indications that the valuations are not comparable to market activity, the pricing services are asked to provide detailed information regarding their methodology and inputs. Transparency tools are also available from the pricing services which help us understand data points and/or market inputs used for pricing securities.


 
87
 

Table of Contents

We also review daily price movements for interest rate swaps, interest rate swaptions, U.S. Treasury futures, currency forward contracts and TBAs. Price movements exceeding pre-defined tolerance levels are investigated using an alternate price from another pricing service as well as available market information. Based on our findings, the primary pricing service may be challenged, or in rare cases, overridden with an alternate pricing source.
In addition, we perform due diligence procedures on all pricing services on at least an annual basis. A questionnaire is sent to pricing services which requests information such as changes in methodologies, business recovery preparedness, internal controls and confirmation that evaluations are generated based on market data. Physical visits are also made to each pricing service's office.
As described in Note 11 - "Fair Value of Financial Instruments," we evaluate the source used to fair value our assets and liabilities and make a determination on its categorization within the fair value hierarchy. If the price of a security is obtained from quoted prices for identical instruments in active markets, the security is classified as a level 1 security. If the price of a security is obtained from quoted prices for similar instruments or model-derived valuations whose inputs are observable, the security is classified as a level 2 security. If the inputs appear to be unobservable, the security would be classified as a level 3 security. Transfers between levels, if any, are determined at the end of the reporting period.
Mortgage-Backed and Credit Risk Transfer Securities
All of our mortgage-backed securities ("MBS") and GSE CRTs are reported at fair value. Fair value is determined by obtaining valuations from an independent source. If the fair value of a security is not available from a third-party pricing service, or such data appears unreliable, we may estimate the fair value of the security using a variety of methods including other pricing services, discounted cash flow analysis, matrix pricing, option adjusted spread models and other fundamental analysis of observable market factors.
We record our purchases of MBS and GSE CRTs on the trade date. Although we generally intend to hold most of our MBS and GSE CRTs until maturity, we may sell any of its mortgage-backed and credit risk transfer securities as part of our overall management of our investment portfolio.
We have elected the fair value option for all of our MBS purchased on or after September 1, 2016. Prior to September 1, 2016, we had also elected the fair value option for our RMBS interest-only securities (“RMBS IOs”). RMBS IOs are hybrid financial instruments that contain embedded derivatives. Under the fair value option, changes in fair value are recognized in our consolidated statements of operations. In our view, this election more appropriately reflects the results of our operations because MBS fair value changes are accounted for in the same manner as fair value changes in economic hedging instruments.
Except for RMBS IOs, MBS purchased prior to September 1, 2016 are classified as available-for-sale securities. Unrealized gains or losses on available-for-sale securities are recorded in accumulated other comprehensive income, a separate component of stockholders' equity, until sale or disposition of the investment. Upon sale or disposition, the cumulative gain or loss previously reported in stockholders' equity is recognized in income. Realized gains and losses from sales of MBS are determined based upon the specific identification method.
We have elected the fair value option for GSE CRTs purchased on or after August 24, 2015. GSE CRTs are hybrid financial instruments that contain embedded derivatives. Coupon payments on the securities are based on LIBOR, and principal payments are based on prepayments, losses and defined credit events in a reference pool of mortgage loans that collateralize Agency RMBS. We elected the fair value option for these securities due to the complexities associated with bifurcation of GSE CRTs into a debt host contract and an embedded derivative. Under the fair value option, changes in fair value for GSE CRTs are recognized in our consolidated statements of operations.
GSE CRTs purchased prior to August 24, 2015 are also reported at fair value but are accounted for as hybrid financial instruments consisting of a debt host contract and an embedded derivative. Unrealized gains or losses arising from changes in fair value of the debt host contract, excluding other-than-temporary impairment, are recognized in accumulated other comprehensive income, a separate component of stockholders’ equity, until sale or disposition of the investment. Upon sale or disposition of the debt host contract, the cumulative gain or loss previously reported in stockholders’ equity is recognized in income. Realized gains and losses from sales of GSE CRTs are determined based upon the specific identification method. Realized and unrealized gains or losses arising from changes in fair value of the embedded derivative are recognized in realized and unrealized credit derivative income (loss), net in our consolidated statements of operations.
Our interest income recognition policies for MBS and GSE CRTs is described below in the Interest Income Recognition section of this Note 2 to our consolidated financial statements.
We consider our portfolio of Agency RMBS to be of high credit quality under applicable accounting guidance. For non-Agency RMBS, GSE CRTs and CMBS, we do not rely on ratings from third party agencies to determine the credit quality of the investment. We use internal models that analyze the loans underlying each security and evaluates factors including, but not


 
88
 

Table of Contents

limited to, delinquency status, loan-to-value ratios, borrower credit scores, occupancy status and geographic concentration to estimate the expected future cash flows. We place reliance on these internal models in determining credit quality.
While non-Agency RMBS, GSE CRTs and CMBS with expected future losses would generally be purchased at a discount to par, the potential for a significant adverse change in expected cash flows remains. We therefore evaluate each security in an unrealized loss position for other-than-temporary impairment at least quarterly.
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) our intent to sell the security and whether it is more likely than not that we will be required to sell the security before recovery of its amortized cost and (ii) the financial condition and near-term prospects of recovery in fair value of the security. This includes a determination of estimated future cash flows through an evaluation of the characteristics of the underlying loans and the structural features of the investment. Underlying loan characteristics reviewed include, but are not limited to, delinquency status, loan-to-value ratios, borrower credit scores, occupancy status and geographic concentration.
We recognize in earnings and reflect as a reduction in the cost basis of the security the amount of any other-than-temporary impairment related to credit losses or impairments on securities that we intend to sell or for which it is more likely than not that we will need to sell before recoveries. 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 stockholders’ equity in other comprehensive income or loss with no change to the cost basis of the security.
Commercial Loans Held-For-Investment
We carry commercial loans held-for-investment at amortized cost, net of any allowance for loan losses. An individual loan is considered impaired when it is deemed probable that the Company will not be able to recover its investment and any other anticipated future payments. We generally consider the following factors in evaluating whether a commercial loan is impaired:
Loan-to-value ratios;
The most recent financial information available for each loan and associated properties, including net operating income, debt service coverage ratios, occupancy rates, rent rolls, as well as any other factors we consider relevant, including, but not limited to, specific loan trigger events that would indicate an adverse change in expected cash flows or payment delinquency;
Economic trends, both macroeconomic as well as those directly affecting the properties associated with the loans, and the supply and demand trends in the market in which the subject property is located; and
The loan sponsor or borrowing entity’s ability to ensure that properties associated with the loan are managed and operated sufficiently.
When an individual commercial loan is deemed to be impaired, we record an allowance to reduce the carrying value of the loan to the current present value of expected future cash flows discounted at the loan’s effective interest rate or if the loan is collateral dependent, we reduce the carrying value to the estimated fair value of the collateral, with a corresponding charge to provision for loan losses on our consolidated statements of operations.
Interest Income Recognition
Mortgage-Backed Securities
Interest income on MBS is accrued based on the outstanding principal or notional balance of the securities and their contractual terms. Premiums or discounts are amortized or accreted into interest income over the life of the investment using the effective interest method.
Interest income on our MBS where we may not recover substantially all of our initial investment is based on estimated future cash flows. We estimate future expected cash flows at the time of purchase and determine the effective interest rate based on these estimated cash flows and our purchase price. Over the life of the investments, we update these estimated future cash flows and compute a revised yield based on the current amortized cost of the investment. In estimating these future cash flows, there are a number of assumptions that are subject to uncertainties and contingencies, including but not limited to the rate and timing of principal payments (prepayments, repurchases, defaults and liquidations), the pass through or coupon rate, and interest rate fluctuations. These uncertainties and contingencies are difficult to predict and are subject to future events that may impact our estimate and our interest income. Changes in our original or most recent cash flow projections may result in a prospective change in interest income recognized on these securities, or the amortized cost of these securities. For non-Agency


 
89
 

Table of Contents

RMBS not of high credit quality, when actual cash flows vary from expected cash flows, the difference is recorded as an adjustment to the amortized cost of the security and the security's yield is revised prospectively.
For Agency RMBS that cannot be prepaid in such a way that we would not recover substantially all of our initial investment, interest income recognition is based on contractual cash flows. We do not estimate prepayments in applying the effective interest method.
Credit Risk Transfer Securities
Interest income on GSE CRTs purchased prior to August 24, 2015 is accrued based on the coupon rate of the debt host contract which reflects the credit risk of GSE unsecured senior debt with a similar maturity. Premiums or discounts associated with the purchase of credit risk transfer securities are amortized or accreted into interest income over the life of the debt host contract using the effective interest method. The difference between the coupon rate on the hybrid instrument and the coupon rate on the GSE CRT debt host contract is considered premium income associated with the embedded derivative and is recorded in realized and unrealized credit derivative income (loss), net in our consolidated statements of operations. Interest income on GSE CRTs purchased on or after August 24, 2015 is based on estimated future cash flows.
Residential Loans
Prior to the deconsolidation of the Residential Securitizations, we recognized interest income from residential loans held by our consolidated VIEs on an accrual basis and amortized the related premiums and discounts into interest income using the effective interest method over the weighted average life of these loans. In estimating the weighted average life of these loans, there were a number of assumptions that were subject to estimation, including the rate and timing of principal payments, defaults, loss severity given default and other factors. Coupon interest was recognized as revenue when earned and deemed collectible or until a loan became more than 90 days past due, at which point the loan was placed on nonaccrual status. Interest previously accrued for loans that had been placed on non-accrual status was reversed against interest income in the period the loan was placed in nonaccrual status. Residential loans delinquent more than 90 days or in foreclosure were characterized as delinquent. Cash principal and interest that was advanced from servicers after a loan becomes greater than 90 days past due was recorded as a liability due to the servicer. When a delinquent loan previously placed on nonaccrual status had cured, meaning all delinquent principal and interest had been remitted by the borrower, the loan was placed back on accrual status.
Commercial Loans
We recognize interest income from commercial loans when earned and deemed collectible, or until a loan becomes past due based on the terms of the loan agreement. Any related origination fees, net of origination cost are amortized into interest income using the effective interest method over the life of the loan. Interest received after a loan becomes past due or 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, loans that have been individually impaired 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.
Cash and Cash Equivalents
We consider all highly liquid investments that have original or remaining maturity dates of three months or less when purchased to be cash equivalents. At December 31, 2016, we had cash and cash equivalents in excess of the FDIC deposit insurance limit of $250,000 per institution. We mitigate our risk of loss by actively monitoring the counterparties.
Due from Counterparties / Collateral Held Payable
Due from counterparties represents cash posted with our counterparties as collateral for our derivatives and repurchase agreements. Collateral held payable represents cash posted with us by counterparties as collateral under our derivatives and repurchase agreements. To the extent we receive collateral other than cash from its counterparties, such assets are not included in our consolidated balance sheets. Notwithstanding the foregoing, if we either sell such assets or pledge the assets as collateral pursuant to a repurchase agreement, the cash received and the corresponding liability is reflected on the consolidated balance sheets.


 
90
 

Table of Contents

Investments in Unconsolidated Ventures
Our non-controlling investments in unconsolidated ventures are included in other assets in our consolidated balance sheets and 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 the entities' operating agreements.
Repurchase Agreements
We finance our purchases of mortgage-backed and credit risk transfer securities primarily 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.
We record the mortgage-backed and credit risk transfer securities and the related repurchase agreement financing on a gross basis in our consolidated balance sheets, and the corresponding interest income and interest expense on a gross basis in our consolidated statements of operations.
Secured Loans
Our wholly-owned subsidiary, IAS Services LLC, is a member of the Federal Home Loan Bank of Indianapolis ("FHLBI"). As a member of the FHLBI, IAS Services LLC has borrowed funds from the FHLBI in the form of secured advances. FHLBI advances are treated as secured financing transactions and are carried at their contractual amounts.
Dividends and Distributions Payable
Dividends and distributions payable represent dividends declared at the balance sheet date which are payable to common stockholders, preferred stockholders, and an Invesco wholly-owned subsidiary, the non-controlling interest common unit holder of the Operating Partnership.
Earnings (Loss) per Share
We calculate basic earnings (loss) per share by dividing net income (loss) attributable to common stockholders for the period by the weighted-average number of shares of our 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"), exchangeable debt, and unvested restricted stock and uses the average share price for the period in determining the number of incremental shares that are to be added to the weighted-average number of shares outstanding.
Share-Based Compensation
We adopted an equity incentive plan under which our independent directors, as part of their compensation for serving as directors, are eligible to receive quarterly stock awards. In addition, we may compensate the officers and employees of our Manager and its affiliates under this equity incentive plan pursuant to the management agreement.
Share-based compensation arrangements include share options, restricted and non-restricted share awards, performance-based awards and share appreciation rights. For awards to our independent directors, 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. Compensation related to stock awards to employees of our Manager and its affiliates is recorded at the estimated fair value of the award over the vesting period of the award. We make 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 is earned.
Underwriting Commissions and Offering Costs
Underwriting commissions and direct costs incurred in connection with our common and preferred stock offerings are reflected as a reduction of additional paid-in-capital and preferred stock, respectively.
Comprehensive Income
Our comprehensive income consists of net income, as presented in the consolidated statements of operations, adjusted for unrealized gains and losses on MBS purchased prior to September 1, 2016 and the debt host contract associated with GSE CRTs purchased prior to August 24, 2015; reclassification of amortization of net deferred gains and losses on de-designated interest rate swaps to repurchase agreements interest expense and currency translation adjustments on an investment in an


 
91
 

Table of Contents

unconsolidated venture. Unrealized gains and losses on our MBS purchased prior to September 1, 2016 and the debt host contract associated with GSE CRTs purchased prior to August 24, 2015 are reclassified into net income upon their sale or termination.
Accounting for Derivative Financial Instruments
We record all derivatives on our consolidated balance sheets at fair value. At the inception of a derivative contract, we determine whether the instrument will be part of a qualifying hedge accounting relationship or whether we will account for the contract as a trading instrument. We have elected not to apply hedge accounting to all new derivative contracts entered into after January 1, 2014. Changes in the fair value of our derivatives are recorded in gain (loss) on derivative instruments, net in our consolidated statements of operations. Net interest paid or received under our interest rate swaps is also recognized in gain (loss) on derivative instruments, net in our consolidated statements of operations.
Prior to 2014, we applied hedge accounting to our interest rate swap agreements. Effective December 31, 2013, we voluntarily discontinued hedge accounting for our interest rate swap agreements by de-designating the interest rate swaps as cash flow hedges. As long as we expect the forecasted transactions that were being hedged (i.e., rollovers of our repurchase agreement borrowings) to still occur, the balance recorded in accumulated other comprehensive income (loss) (“AOCI”) from the interest rate swap activity up through December 31, 2013 will remain in AOCI and be recognized in our consolidated statements of operations as interest expense over the remaining term of the interest rate swaps.
We may enter into derivative contracts, such as credit default swaps, that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or we elect not to apply hedge accounting under U.S. GAAP.
We are a party to hybrid financial instruments that contain embedded derivative instruments. For securities that we did not elect the fair value option, we assess at inception, whether the economic characteristics of the embedded derivative instruments are clearly and closely related to the economic characteristics of the remaining component of the financial instrument (i.e., the debt host contract), whether the financial instrument is remeasured to fair value through earnings and whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When it is determined that (1) the embedded instrument possesses economic characteristics that are not clearly and closely related to the economic characteristics of the debt host contract, (2) the financial instrument is not remeasured to fair value through earnings and (3) a separate instrument with the same terms would qualify as a derivative instrument, the embedded instrument qualifies as an embedded derivative that is separated from the debt host contract. The embedded derivative is recorded at fair value, and changes in fair value are recorded in realized and unrealized credit derivative income (loss), net in our consolidated statements of operations.
We evaluate the terms and conditions of our holdings of swaptions, futures contracts, currency forward contracts and to-be-announced ("TBA") securities to determine if an instrument has the characteristics of an investment or should be considered a derivative under U.S. GAAP. Accordingly swaptions, futures contracts, currency forward contracts and TBAs having the characteristics of derivatives are accounted for at fair value with such changes recognized in gain (loss) on derivative instruments, net in the consolidated statements of operations. The fair value of these swaptions, futures contracts, currency forward contracts and TBAs is included in derivative assets or derivative liabilities on the consolidated balance sheets.
Income Taxes
We elected to be taxed as a REIT commencing with our taxable year ended December 31, 2009. Accordingly, we will generally not be subject to U.S. federal and applicable state and local corporate income tax to the extent that we make qualifying distributions to our common stockholders, and provided we satisfy on a continuing basis, through actual investment and operating results, the REIT requirements including certain asset, income, distribution and stock ownership tests. If we fail to qualify as a REIT and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal, state and local income taxes and may be precluded from qualifying as a REIT for the four taxable years following the year in which we lost our REIT qualification. Accordingly, our failure to qualify as a REIT could have a material adverse impact on our results of operations and amounts available for distribution to stockholders.
Our dividends paid deduction for qualifying dividends to our stockholders is computed using our REIT taxable income as opposed to net income reported on the consolidated financial statements. REIT taxable income will generally differ from net income because the determination of REIT taxable income is based on tax regulations and not financial accounting principles.
We have elected to treat one of our subsidiaries as a taxable REIT subsidiary (“TRS”). In general, a TRS may hold assets and engage in activities that we 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. Our TRS did not generate material taxable income for the years ended December 31, 2016, 2015 and 2014.
We do not have any accruals for uncertain tax positions. We would recognize interest and penalties related to uncertain tax positions, if any, as income tax expense, which would be included in general and administrative expenses.


 
92
 

Table of Contents

Reclassifications
Certain prior period reported amounts have been reclassified to be consistent with the current presentation. Such reclassifications had no impact on net income or equity attributable to common stockholders.
Accounting Pronouncements Recently Adopted and Pending Accounting Pronouncements
Effective December 31, 2016, we adopted the newly issued accounting guidance that requires management to assess and provide certain disclosures if there is substantial doubt about an entity’s ability to continue as a going concern. The newly issued guidance solely relates to financial statement disclosures and does not impact our financial condition, results of operations or cash flows.
Effective January 1, 2016, we adopted the newly issued accounting guidance for categorization of investments within the fair value hierarchy that are measured using the net asset value (“NAV”) practical expedient. We adopted the accounting standard on a retrospective basis. The newly issued guidance solely relates to financial statement disclosures and does not impact our financial condition, results of operations or cash flows.
Effective January 1, 2016, we adopted the newly issued accounting guidance for presentation of debt issuance costs. Under the new standard, debt issuance costs are required to be presented in the consolidated balance sheets as a direct deduction from the carrying value of the associated debt liability. We adopted the accounting standard on a retrospective basis, which required the restatement of our December 31, 2015 balance sheet. The adoption resulted in a $5.4 million reduction in exchangeable senior notes and a corresponding reduction in other assets.
Effective January 1, 2016, we adopted the newly issued accounting guidance for reporting entities that are required to determine whether they should consolidate certain legal entities. We did not consolidate or deconsolidate any legal entities as a result of implementing the new guidance.
In January 2016, the FASB issued guidance to improve certain aspects of classification and measurement of financial instruments, including significant revisions in accounting related to the classification and measurement of investments in equity securities and presentation of certain fair value changes for financial liabilities when the fair value option is elected. The guidance also amends certain disclosure requirements associated with the fair value of financial instruments. We are required to adopt the new guidance in the first quarter of 2018. Early adoption is permitted. We are currently evaluating the potential impact of the new guidance on our consolidated financial statements, as well as available transition methods.
In June 2016, the FASB issued an amendment to the guidance on reporting credit losses for assets measured at amortized cost and available-for-sale securities. We are required to adopt the new guidance in the first quarter of 2020. Early adoption is permitted. We are currently evaluating the potential impacts of the new guidance on our consolidated financial statements, as well as available transition methods.
In August 2016, the FASB issued new guidance that is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. We are required to adopt the new guidance in the first quarter of 2018. Early adoption is permitted, provided that all of the amendments are adopted in the same period. We are currently evaluating the potential impacts of the new guidance on our consolidated financial statements.
Note 3 – Variable Interest Entities
Our maximum risk of loss in VIEs in which we are not the primary beneficiary at December 31, 2016 is presented in the table below.
$ in thousands
Carrying
Amount
 
Company's Maximum Risk of Loss
Non-Agency RMBS
1,995,551

 
1,995,551

CMBS
2,551,720

 
2,551,720

Investments in unconsolidated ventures
33,301

 
33,301

Total
4,580,572

 
4,580,572

Refer to Note 4 - "Mortgage-Backed and Credit Risk Transfer Securities" and Note 6 - "Other Assets" for additional details regarding these investments.
On December 9, 2015, we completed the sale of certain beneficial interests (the "Securities") in the Residential Securitizations for $69.0 million (the "Transaction"). The Securities sold included the most subordinated classes of asset-backed securities issued by the Residential Securitizations. As a result of the Transaction, we no longer have the power to direct the activities of the Residential Securitizations through default oversight rights and therefore are no longer the primary


 
93
 

Table of Contents

beneficiary of the Residential Securitizations. We do not manage the Residential Securitizations or serve as or appoint the loan servicer for the Residential Securitizations. Our risk with respect to each investment in a Residential Securitization was limited to our direct ownership in the Residential Securitization. The residential loans owned by the Residential Securitizations were held solely to satisfy the liabilities of the Residential Securitizations, and the investors in the asset-backed securities issued by the Residential Securitizations had no recourse to the Company.
We deconsolidated the assets and liabilities of the Residential Securitizations as of the date of the Transaction. The following table summarizes the amounts deconsolidated from the consolidated balance sheet.
$ in thousands
As of December 9, 2015
Residential loans, held-for-investment
3,181,662

Accrued interest receivable
9,889

Deferred securitization and financing costs
4,347

Total assets
3,195,898

Accrued interest and accrued expenses payable
11,413

Asset-backed securities
2,740,797

Total liabilities
2,752,210

The deconsolidation of the Residential Securitizations did not qualify for presentation and disclosure as discontinued operations. We recorded a loss of $19.6 million on deconsolidation of the Residential Securitizations in our consolidated statement of operations as gain (loss) on investments, net. The following table presents the components of the loss on deconsolidation of VIEs.
$ in thousands
As of December 9, 2015
Gain (loss) related to derecognition of Residential Securitizations, net
(13,260
)
Gain (loss) related to remeasurement of retained interest, net
3,068

Gain (loss) on sale of the securities, net
(9,431
)
Total gain (loss) on deconsolidation of VIEs, net
(19,623
)
The following table summarizes the net income (loss) of the Residential Securitizations excluding the loss on deconsolidation.
 
Years ended December 31,
$ in thousands
2015
 
2014
Interest income - Residential loans
110,908

 
88,073

Interest expense - Asset-backed securities
82,041

 
68,159

Net interest income
28,867

 
19,914

Reduction in provision for loan losses
(213
)
 
(142
)
Net interest income after reduction in provision for loan losses
29,080

 
20,056

Expenses - Consolidated securitization trusts
8,219

 
6,076

Net income
20,861

 
13,980



 
94
 

Table of Contents

Note 4 – Mortgage-Backed and Credit Risk Transfer Securities
The following tables summarize our MBS and GSE CRT portfolio by asset type at December 31, 2016 and 2015.
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$ in thousands
Principal/ Notional
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
3,460,625

 
151,526

 
3,612,151

 
(54,223
)
 
3,557,928

 
3.11
%
 
2.19
%
 
1.99
%
30 year fixed-rate
2,780,806

 
185,521

 
2,966,327

 
15,390

 
2,981,717

 
4.37
%
 
2.61
%
 
2.57
%
ARM*
301,900

 
2,520

 
304,420

 
3,453

 
307,873

 
2.69
%
 
2.59
%
 
2.16
%
Hybrid ARM
2,423,152

 
42,360

 
2,465,512

 
8,789

 
2,474,301

 
2.70
%
 
2.52
%
 
2.02
%
Total Agency pass-through (4)
8,966,483

 
381,927

 
9,348,410

 
(26,591
)
 
9,321,819

 
3.37
%
 
2.42
%
 
2.20
%
Agency-CMO(5)
1,712,120

 
(1,368,916
)
 
343,204

 
837

 
344,041

 
2.16
%
 
3.08
%
 
2.07
%
Non-Agency RMBS(6)(7)(8)
3,838,314

 
(1,934,269
)
 
1,904,045

 
91,506

 
1,995,551

 
2.21
%
 
5.22
%
 
5.22
%
GSE CRT(9)(10)
707,899

 
24,320

 
732,219

 
35,981

 
768,200

 
2.38
%
 
1.51
%
 
1.24
%
CMBS(11)(12)
3,050,747

 
(559,857
)
 
2,490,890

 
60,830

 
2,551,720

 
3.80
%
 
4.21
%
 
4.17
%
Total
18,275,563

 
(3,456,795
)
 
14,818,768

 
162,563

 
14,981,331

 
3.05
%
 
3.05
%
 
2.87
%
*Adjustable-rate mortgage ("ARM")
(1)
Net weighted average coupon as of December 31, 2016 is presented net of servicing and other fees.
(2)
Period-end weighted average yield is based on amortized cost as of December 31, 2016 and incorporates future prepayment and loss assumptions.
(3)
Quarterly weighted average portfolio yield for the period 2.87% was calculated by dividing interest income, including amortization of premiums and discounts, by the average balance of the amortized cost of our investments. All yields are annualized.
(4)
We have elected the fair value option for Agency RMBS purchased on or after September 1, 2016 which represent 4.3% of principal/notional balance, 4.3% of amortized cost and 4.2% of fair value.
(5)
Agency collateralized mortgage obligation ("Agency-CMO") includes interest-only securities ("Agency IO"), which represent 85.5% of principal/notional balance, 26.8% of amortized cost and 27.1% of fair value.
(6)
Non-Agency RMBS held by us is 45.5% variable rate, 47.2% fixed rate and 7.3% floating rate based on fair value.
(7)
Of the total discount in non-Agency RMBS, $252.5 million is non-accretable based on estimated future cash flows of the securities.
(8)
Non-Agency RMBS includes interest-only securities, which represent 43.5% of the principal/notional balance, 1.5% of amortized cost and 1.3% of fair value.
(9)
We have elected the fair value option for GSE CRT purchased on or after August 24, 2015, which represent 19.2% of the balance based on fair value. As a result, GSE CRT accounted for under the fair value option are not bifurcated between the debt host contract and the embedded derivative.
(10)
GSE CRT weighted average coupon and weighted average yield excludes coupon interest associated with embedded derivatives not accounted for under the fair value option recorded as realized and unrealized credit derivative income (loss), net.
(11)
CMBS includes interest-only securities which represent 20.3% of principal/ notional balance, 0.8% of amortized cost and 0.9% of fair value.
(12)
We have elected the fair value option for CMBS purchased on or after September 1, 2016 which represent 0.4% of principal/notional balance, 0.6% of amortized cost and 0.5% of fair value.
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$ in thousands
Principal/ Notional
Balance
 
Unamortized
Premium
(Discount)
 
Amortized
Cost
 
Unrealized
Gain, 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
1,527,877

 
72,389

 
1,600,266

 
10,664

 
1,610,930

 
3.72
%
 
2.47
%
 
2.40
%
30 year fixed-rate
3,796,091

 
249,285

 
4,045,376

 
18,581

 
4,063,957

 
4.24
%
 
2.81
%
 
2.85
%
ARM*
417,424

 
4,625

 
422,049

 
3,976

 
426,025

 
2.72
%
 
2.58
%
 
2.26
%
Hybrid ARM
3,240,967

 
63,324

 
3,304,291

 
5,234

 
3,309,525

 
2.73
%
 
2.56
%
 
2.22
%
Total Agency pass-through
8,982,359

 
389,623

 
9,371,982

 
38,455

 
9,410,437

 
3.54
%
 
2.65
%
 
2.53
%
Agency-CMO(4)
1,774,621

 
(1,386,284
)
 
388,337

 
482

 
388,819

 
2.23
%
 
4.29
%
 
3.42
%
Non-Agency RMBS(5)(6)(7)
4,965,978

 
(2,363,799
)
 
2,602,179

 
90,308

 
2,692,487

 
2.20
%
 
5.11
%
 
4.90
%
GSE CRT(8)(9)
657,500

 
22,593

 
680,093

 
(21,865
)
 
658,228

 
1.32
%
 
0.72
%
 
0.62
%
CMBS(10)
3,429,655

 
(558,749
)
 
2,870,906

 
45,058

 
2,915,964

 
3.95
%
 
4.30
%
 
4.35
%
Total
19,810,113

 
(3,896,616
)
 
15,913,497

 
152,438

 
16,065,935

 
3.08
%
 
3.31
%
 
3.16
%
*Adjustable-rate mortgage ("ARM")
(1)
Net weighted average coupon as of December 31, 2015 is presented net of servicing and other fees.
(2)
Period-end weighted average yield is based on amortized cost as of December 31, 2015 and incorporates future prepayment and loss assumptions but excludes changes in anticipated interest rates.
(3)
Quarterly weighted average yield for the period was calculated by dividing interest income, including amortization of premiums and discounts, by the average balance of the amortized cost of our investments. All yields are annualized.


 
95
 

Table of Contents

(4)
Agency collateralized mortgage obligation ("Agency CMO") includes interest-only securities ("Agency IO"), which represent 84.4% of principal/ notional balance, 27.5% of amortized cost and 27.6% of fair value.
(5)
Non-Agency RMBS held by us is 48.4% variable rate, 45.2% fixed rate, and 6.4% floating rate based on fair value.
(6)
Of the total discount in non-Agency RMBS, $281.6 million is non-accretable based on estimated future cash flows of the securities.
(7)
Non-Agency RMBS includes interest-only securities, which represent 42.1% of principal/notional balance, 1.3% of amortized cost and 1.3% of fair value.
(8)
We have elected the fair value option for GSE CRT purchased on or after August 24, 2015, which represent 1.9% of the balance based on fair value. As a result, GSE CRT accounted for under the fair value option are not bifurcated between the debt host contract and the embedded derivative.
(9)
GSE CRT weighted average coupon and weighted average yield excludes coupon interest associated with embedded derivatives not accounted for under the fair value option recorded as realized and unrealized credit derivative income (loss), net.
(10)
CMBS includes interest-only securities and commercial real estate mezzanine loan pass-through certificates, which represent 0.9% and 0.7% of the balance based on fair value, respectively.
The following table summarizes our non-Agency RMBS portfolio by asset type as of December 31, 2016 and 2015.
$ in thousands
December 31, 2016
 
% of Non-Agency
 
December 31, 2015
 
% of Non-Agency
Prime
889,658

 
44.6
%
 
1,081,428

 
40.2
%
Alt-A
447,213

 
22.4
%
 
544,306

 
20.2
%
Re-REMIC
364,301

 
18.2
%
 
663,853

 
24.7
%
Subprime/reperforming
294,379

 
14.8
%
 
402,900

 
14.9
%
Total Non-Agency
1,995,551

 
100.0
%
 
2,692,487

 
100.0
%
The following table summarizes the credit enhancement provided to our re-securitization of real estate mortgage investment conduit ("Re-REMIC") holdings as of December 31, 2016 and 2015.
  
Percentage of Re-REMIC Holdings at Fair Value
Re-REMIC Subordination(1)
December 31, 2016
 
December 31, 2015
0% - 10%
17.6
%
 
11.0
%
10% - 20%
7.4
%
 
5.6
%
20% - 30%
13.5
%
 
12.7
%
30% - 40%
15.7
%
 
20.8
%
40% - 50%
27.0
%
 
32.8
%
50% - 60%
16.1
%
 
13.3
%
60% - 70%
2.7
%
 
3.8
%
Total
100.0
%
 
100.0
%
 
(1)
Subordination refers to the credit enhancement provided to the Re-REMIC tranche held by us by any junior Re-REMIC tranche or tranches in a resecuritization. This figure reflects the percentage of the balance of the underlying securities represented by any junior tranche or tranches at the time of resecuritization. Generally, principal losses on the underlying securities in excess of the subordination amount would result in principal losses on the Re-REMIC tranche held by us. 34.2% of our Re-REMIC holdings are not senior tranches.
The components of the carrying value of our MBS and GSE CRT portfolio at December 31, 2016 and 2015 are presented below.
$ in thousands
December 31, 2016
 
December 31, 2015
Principal/ notional balance
18,275,563

 
19,810,113

Unamortized premium
476,314

 
495,539

Unamortized discount
(3,933,109
)
 
(4,392,155
)
Gross unrealized gains
302,099

 
303,890

Gross unrealized losses
(139,536
)
 
(151,452
)
Fair value
14,981,331

 
16,065,935



 
96
 

Table of Contents

The following table summarizes our MBS and GSE CRT portfolio according to estimated weighted average life classifications as of December 31, 2016 and 2015.
$ in thousands
December 31, 2016
 
December 31, 2015
Less than one year
121,076

 
427,678

Greater than one year and less than five years
6,719,923

 
6,237,547

Greater than or equal to five years
8,140,332

 
9,400,710

Total
14,981,331

 
16,065,935

The following tables present the estimated fair value and gross unrealized losses of our MBS and GSE CRTs by length of time that such securities have been in a continuous unrealized loss position at December 31, 2016 and 2015.
December 31, 2016
Less than 12 Months
 
12 Months or More
 
Total
$ in thousands
Fair
Value
 
Unrealized
Losses
 
Number of Securities
 
Fair
Value
 
Unrealized
Losses
 
Number of Securities
 
Fair
Value
 
Unrealized
Losses
 
Number of Securities
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
2,781,777

 
(66,506
)
 
127

 
65,964

 
(1,556
)
 
17

 
2,847,741

 
(68,062
)
 
144

30 year fixed-rate
747,719

 
(15,409
)
 
45

 
547,763

 
(18,004
)
 
27

 
1,295,482

 
(33,413
)
 
72

ARM
120,540

 
(326
)
 
9

 
1,091

 
(7
)
 
1

 
121,631

 
(333
)
 
10

Hybrid ARM
1,356,687

 
(9,922
)
 
99

 
252

 
(4
)
 
2

 
1,356,939

 
(9,926
)
 
101

Total Agency pass through (1)
5,006,723

 
(92,163
)
 
280

 
615,070

 
(19,571
)
 
47

 
5,621,793

 
(111,734
)
 
327

Agency-CMO(2)
163,114

 
(3,812
)
 
28

 
22,792

 
(952
)
 
3

 
185,906

 
(4,764
)
 
31

Non-Agency RMBS
287,647

 
(7,861
)
 
42

 
497,863

 
(6,671
)
 
36

 
785,510

 
(14,532
)
 
78

GSE CRT(3)

 

 

 
35,935

 
(969
)
 
3

 
35,935

 
(969
)
 
3

CMBS(4)
401,016

 
(6,733
)
 
36

 
47,219

 
(804
)
 
6

 
448,235

 
(7,537
)
 
42

Total
5,858,500

 
(110,569
)
 
386

 
1,218,879

 
(28,967
)
 
95

 
7,077,379

 
(139,536
)
 
481

(1)
Amounts disclosed include Agency RMBS with a fair value of $149.7 million for which the fair value option has been elected. Such securities have unrealized losses of $4.0 million.
(2)
Fair value includes unrealized losses on Agency IO of $3.0 million and unrealized losses on CMO of $1.7 million.
(3)
Fair value includes unrealized losses on both the debt host contract and the embedded derivative.
(4)
Amounts disclosed include CMBS with a fair value of $13.9 million for which the fair value option has been elected. Such securities have unrealized losses of $613,000.


 
97
 

Table of Contents

December 31, 2015
Less than 12 Months
 
12 Months or More
 
Total
$ in thousands
Fair
Value
 
Unrealized
Losses
 
Number of Securities
 
Fair
Value
 
Unrealized
Losses
 
Number of Securities
 
Fair
Value
 
Unrealized
Losses
 
Number of Securities
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
600,480

 
(8,081
)
 
33

 
77,506

 
(1,482
)
 
6

 
677,986

 
(9,563
)
 
39

30 year fixed-rate
776,065

 
(14,827
)
 
32

 
1,120,391

 
(39,497
)
 
47

 
1,896,456

 
(54,324
)
 
79

ARM
200,863

 
(501
)
 
11

 

 

 

 
200,863

 
(501
)
 
11

Hybrid ARM
1,913,872

 
(17,082
)
 
111

 

 

 

 
1,913,872

 
(17,082
)
 
111

Total Agency pass through
3,491,280

 
(40,491
)
 
187

 
1,197,897

 
(40,979
)
 
53

 
4,689,177

 
(81,470
)
 
240

Agency-CMO(1)
166,754

 
(3,296
)
 
14

 
9,118

 
(6,934
)
 
9

 
175,872

 
(10,230
)
 
23

Non-Agency RMBS
872,575

 
(7,286
)
 
66

 
316,010

 
(10,699
)
 
20

 
1,188,585

 
(17,985
)
 
86

GSE CRT(2)
340,116

 
(10,050
)
 
16

 
120,877

 
(13,605
)
 
7

 
460,993

 
(23,655
)
 
23

CMBS
1,224,985

 
(17,328
)
 
85

 
31,533

 
(784
)
 
2

 
1,256,518

 
(18,112
)
 
87

Total
6,095,710

 
(78,451
)
 
368

 
1,675,435

 
(73,001
)
 
91

 
7,771,145

 
(151,452
)
 
459

(1)
Fair value includes unrealized losses on Agency IO of $8.3 million and unrealized losses on CMO of $1.9 million.
(2)
Fair value includes unrealized losses on both the debt host contract and the embedded derivative. Amounts disclosed include GSE CRT with a fair value of $12.4 million for which the fair value option has been elected. Such securities have unrealized losses of $56,000.
Gross unrealized losses on our Agency RMBS and CMO were $111.7 million and $1.7 million, respectively, at December 31, 2016. Due to the inherent credit quality of Agency RMBS and CMO, we determined that at December 31, 2016, any unrealized losses on our Agency RMBS and CMO portfolio are not other than temporary.
Gross unrealized losses on our Agency IO, non-Agency RMBS, GSE CRT and CMBS were $26.1 million at December 31, 2016. We do 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 our assessment for other-than-temporary-impairment on a quarterly basis.
We assess our investment securities for other-than-temporary impairment on 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." This analysis includes a determination of estimated future cash flows through an evaluation of the characteristics of the underlying loans and the structural features of the investment. Underlying loan characteristics reviewed include, but are not limited to, delinquency status, loan-to-value ratios, borrower credit scores, occupancy status and geographic concentration.
We recorded $8.9 million in other-temporary-impairments ("OTTI") on RMBS interest-only and non-Agency RMBS securities for the year ended December 31, 2016. As we had previously elected the fair value option for RMBS interest-only securities, the OTTI was recorded as a reclassification from an unrealized to realized loss within gain (loss) on investments, net on the consolidated statement of operations. As of December 31, 2016, we did not intend to sell the securities and determined that it was not more likely than not that we will be required to sell the securities.
The following table presents the changes in OTTI included in earnings for the year ended December 31, 2016. We did not record any OTTI for the years ended December 31, 2015 and 2014.
 
Year Ended December 31,
$ in thousands
2016
Cumulative credit loss at the beginning of the period

Additions:
 
Other-than-temporary impairments not previously recognized
8,909

Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments

Cumulative credit loss at the end of the period
8,909



 
98
 

Table of Contents

The following table summarizes the changes in accumulated other comprehensive income (loss) related to our GSE CRT debt host contracts and available-for-sale MBS for the years ended December 31, 2016, 2015 and 2014. We reclassify unrealized gains and losses from other comprehensive income to gain (loss) on investments, net when we sell our investments.
The table excludes MBS and GSE CRTs that are accounted for under the fair value option.
 
Years Ended December 31,
$ in thousands
2016
 
2015
 
2014
Accumulated other comprehensive income (loss) from MBS and GSE CRT securities:
 
 
 
 
 
Unrealized gain (loss) on MBS and GSE CRT at beginning of period
177,799

 
376,336

 
(122,323
)
Unrealized gain (loss) on MBS and GSE CRT
(37,632
)
 
(191,053
)
 
420,761

Reclassification of unrealized (gain) loss on sale of MBS and GSE CRT to gain (loss) on investments, net
6,134

 
(7,484
)
 
77,898

Balance at end of period
146,301

 
177,799

 
376,336

The following table summarizes the components of our total gain (loss) on investments, net for the years ended December 31, 2016, 2015 and 2014.
 
Years Ended December 31,
$ in thousands
2016
 
2015
 
2014
Gross realized gain on sale of investments
14,196

 
13,346

 
19,114

Gross realized loss on sale of investments
(21,635
)
 
(11,114
)
 
(95,783
)
Other-than-temporary impairment losses
(8,909
)
 

 

Net unrealized gains and losses on MBS accounted for under the fair value option
(5,791
)
 
(558
)
 
(7,738
)
Net unrealized gains and losses on GSE CRT accounted for under the fair value option
4,598

 
(56
)
 

Net unrealized gains and losses on trading securities
(1
)
 

 

Total gain (loss) on investments, net (1)
(17,542
)
 
1,618

 
(84,407
)
(1) Balance as of December 31, 2015 excludes the loss on deconsolidation of VIEs of $19.6 million. Refer to Note 3 - "Variable Interest Entities" for further discussion.
The following table presents components of interest income recognized on our MBS and GSE CRT portfolio for the years ended December 31, 2016, 2015 and 2014. GSE CRT interest income excludes coupon interest associated with embedded derivatives not accounted for under the fair value option that is recorded as realized and unrealized credit derivative income (loss), net.
For the Year ended December 31, 2016
 
 
 
 
 
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/ Discount Accretion
 
Interest
Income
Agency
346,783

 
(116,991
)
 
229,792

Non-Agency
94,206

 
13,529

 
107,735

GSE CRT
9,575

 
(3,192
)
 
6,383

CMBS
122,636

 
(11,536
)
 
111,100

Other
1,492

 
(58
)
 
1,434

Total
574,692

 
(118,248
)
 
456,444

 


 
99
 

Table of Contents

For the Year ended December 31, 2015
 
 
 
 
 
$ in thousands
Coupon
Interest
 
Net (Premium Amortization)/Discount Accretion
 
Interest
Income
Agency
372,610

 
(121,170
)
 
251,440

Non-Agency
110,885

 
18,287

 
129,172

GSE CRT
6,681

 
(3,088
)
 
3,593

CMBS
149,977

 
(11,322
)
 
138,655

Other
1,028

 
5

 
1,033

Total
641,181

 
(117,288
)
 
523,893

 
For the Year ended December 31, 2014
 
 
 
 
 
$ in thousands
Coupon
Interest
 
Net (Premium Amortization)/Discount Accretion
 
Interest
Income
Agency
403,403

 
(106,116
)
 
297,287

Non-Agency
135,178

 
22,694

 
157,872

GSE CRT
5,428

 
(3,014
)
 
2,414

CMBS
159,363

 
(27,496
)
 
131,867

Other
59

 

 
59

Total
703,431

 
(113,932
)
 
589,499


Note 5 – Commercial Loans Held-for-Investment
The following table summarizes commercial loans held-for-investment as of December 31, 2016 and 2015 that we purchased or originated.
December 31, 2016
$ in thousands
Number of
loans
 
Principal
Balance
 
Unamortized (fees)/
costs, net
 
Carrying
value
 
Weighted Average
Coupon
 
Weighted Average Years to Maturity(1)
Mezzanine loans
10

 
273,666

 
(311
)
 
273,355

 
8.14
%
 
1.60
Total
10

 
273,666

 
(311
)
 
273,355

 
8.14
%
 
1.60
December 31, 2015
$ in thousands
Number of
loans
 
Principal
Balance
 
Unamortized (fees)/
costs, net
 
Carrying
value
 
Weighted Average
Coupon
 
Weighted Average Years to Maturity(1)
Mezzanine loans
6

 
210,769

 
(1,707
)
 
209,062

 
7.97
%
 
1.75
Total
6

 
210,769

 
(1,707
)
 
209,062

 
7.97
%
 
1.75
(1)
Weighted average years to maturity is based on the contractual maturity date. Certain loans may contain either an option to prepay or an option to extend beyond their contractual maturity dates as specified in the respective loan agreements.
These loans were not impaired, and we did not record an allowance for commercial loan losses as of December 31, 2016 and 2015 based on our analysis of credit quality factors as discussed in Note 2 - Summary of Significant Accounting Policies".


 
100
 

Table of Contents

Note 6 – Other Assets
The following table summarizes our other assets as of December 31, 2016 and 2015:
$ in thousands
December 31, 2016
 
December 31, 2015
FHLBI stock
74,250

 
75,375

Investments in unconsolidated ventures
33,301

 
38,413

Prepaid expenses and other assets
1,746

 
1,284

Total
109,297

 
115,072

IAS Services LLC, our wholly-owned subsidiary, is required to purchase and hold FHLBI stock as a condition of membership in FHLBI. The stock is recorded at cost.
We have invested in unconsolidated ventures that are managed by an affiliate of our Manager. The unconsolidated ventures invest in our target assets. Refer to Note 16 - "Commitments and Contingencies" for additional details regarding our commitments to these unconsolidated ventures.


 
101
 

Table of Contents

Note 7 – Borrowings
We finance the majority of our investment portfolio through repurchase agreements, secured loans and exchangeable senior notes. The following table summarizes certain characteristics of our borrowings at December 31, 2016 and 2015. Refer to Note 8 - "Collateral Positions" for collateral pledged under our repurchase agreements and secured loans.
$ in thousands
December 31, 2016
 
Amount
Outstanding
 
Weighted
Average
Interest
Rate
 
Weighted
Average
Remaining
Maturity
(Days)
Repurchase Agreements:
 
 
 
 
 
Agency RMBS
8,148,220

 
0.93
%
 
32

Non-Agency RMBS
1,519,859

 
2.06
%
 
28

GSE CRT
547,872

 
2.25
%
 
16

CMBS
944,718

 
1.86
%
 
16

Total Repurchase Agreements
11,160,669

 
1.23
%
 
30

Secured Loans
1,650,000

 
0.74
%
 
2,682

Exchangeable Senior Notes(1)
400,000

 
5.00
%
 
439

Total Borrowings
13,210,669

 
1.28
%
 
373

$ in thousands
December 31, 2015
 
Amount
Outstanding
 
Weighted
Average
Interest
Rate
 
Weighted
Average
Remaining
Maturity
(Days)
Repurchase Agreements:
 
 
 
 
 
Agency RMBS
8,389,643

 
0.65
%
 
24

Non-Agency RMBS
2,077,240

 
1.68
%
 
32

GSE CRT
488,275

 
1.91
%
 
19

CMBS
1,170,890

 
1.49
%
 
23

Total Repurchase Agreements
12,126,048

 
0.96
%
 
25

Secured Loans
1,650,000

 
0.55
%
 
2,937

Exchangeable Senior Notes(1)
400,000

 
5.00
%
 
805

Total Borrowings
14,176,048

 
1.02
%
 
386

(1)
The carrying value of exchangeable senior notes is $397.0 million and $394.6 million as of December 31, 2016 and 2015, respectively. The carrying value is net of debt issuance costs of $3.0 million and $5.4 million as of December 31, 2016 and 2015, respectively.

The following table shows the aggregate amount of maturities of our outstanding borrowings:
$ in thousands
As of December 31,
2017
11,160,669

2018
400,000

2019

2020
300,000

2021
100,000

Thereafter
1,250,000

Total
13,210,669



 
102
 

Table of Contents

The following tables summarize certain characteristics of our repurchase agreements and secured loans at December 31, 2016 and 2015.
December 31, 2016
 
 
 
 

$ in thousands
Amount Outstanding
 
Percent of Total Amount Outstanding
 
MBS and GSE CRT Pledged as Collateral(1)
Repurchase Agreement Counterparties:
 
 
 
 
 
HSBC Securities (USA) Inc
1,401,966

 
11.2
%
 
1,468,793

ING Financial Market LLC
1,142,200

 
8.9
%
 
1,216,492

Royal Bank of Canada
1,098,631

 
8.6
%
 
1,293,336

Industrial and Commercial Bank of China Financial Services LLC
707,616

 
5.5
%
 
748,503

Mitsubishi UFJ Securities (USA), Inc.
703,382

 
5.5
%
 
740,404

Pierpont Securities LLC
681,853

 
5.3
%
 
717,663

South Street Securities LLC
675,660

 
5.3
%
 
713,330

Goldman, Sachs & Co.
486,430

 
3.8
%
 
623,400

Scotia Capital
479,105

 
3.7
%
 
500,578

JP Morgan Securities Inc.
477,947

 
3.7
%
 
554,494

KGS-Alpha Capital Markets, L.P.
441,541

 
3.4
%
 
475,858

Citigroup Global Markets Inc.
427,185

 
3.3
%
 
534,875

E D & F Man Capital Markets Inc
405,615

 
3.2
%
 
430,896

Guggenheim Liquidity Services, LLC
356,149

 
2.8
%
 
377,030

Natixis, New York Branch
336,202

 
2.6
%
 
362,432

Societe Generale
325,393

 
2.5
%
 
427,200

BNP Paribas Securities Corp.
307,641

 
2.4
%
 
346,484

All other repurchase agreement counterparties (2)
706,153

 
5.4
%
 
912,536

Total Repurchase Agreement Counterparties
11,160,669

 
87.1
%
 
12,444,304

Secured Loans Counterparty:
 
 
 
 
 
FHLBI
1,650,000

 
12.9
%
 
1,931,582

Total
12,810,669

 
100.0
%
 
14,375,886

 
(1)
Amounted pledged as collateral is measured at fair value as described in Note 2 - "Summary of Significant Accounting Policies."
(2)
Represents amounts outstanding with seven counterparties.


 
103
 

Table of Contents


December 31, 2015
 
 
 
 
 
$ in thousands
Amount Outstanding
 
Percent of Total Amount Outstanding
 
MBS and GSE CRT Pledged as Collateral(1)
Repurchase Agreement Counterparties:
 
 
 
 
 
HSBC Securities (USA) Inc
1,566,747

 
11.4
%
 
1,611,020

Royal Bank of Canada
1,148,480

 
8.3
%
 
1,383,839

ING Financial Market LLC
1,050,548

 
7.6
%
 
1,112,102

South Street Securities LLC
799,783

 
5.8
%
 
838,600

Pierpont Securities LLC
786,623

 
5.7
%
 
814,804

Industrial and Commercial Bank of China Financial Services LLC
695,933

 
5.1
%
 
730,941

Mitsubishi UFJ Securities (USA), Inc.
627,383

 
4.6
%
 
657,201

JP Morgan Securities Inc.
622,665

 
4.5
%
 
728,502

Citigroup Global Markets Inc.
585,632

 
4.3
%
 
725,882

Scotia Capital
576,137

 
4.2
%
 
598,343

BNP Paribas Securities Corp.
474,053

 
3.4
%
 
530,584

Wells Fargo Securities, LLC
463,673

 
3.4
%
 
551,667

Goldman, Sachs & Co.
428,799

 
3.1
%
 
552,549

KGS-Alpha Capital Markets, L.P.
380,286

 
2.8
%
 
400,758

Banc of America Securities LLC
380,520

 
2.8
%
 
442,801

Morgan Stanley & Co. Incorporated
273,124

 
2.0
%
 
320,484

Guggenheim Liquidity Services, LLC
265,709

 
1.9
%
 
279,345

All other counterparties (2)
999,953

 
7.1
%
 
1,180,866

Total Repurchase Agreement Counterparties:
12,126,048

 
88.0
%
 
13,460,288

Secured Loans Counterparty:
 
 
 
 
 
FHLBI
1,650,000

 
12.0
%
 
1,949,699

Total
13,776,048

 
100.0
%
 
15,409,987

(1)
Amounted pledged as collateral is measured at fair value as described in Note 2 - "Summary of Significant Accounting Policies."
(2)
Represents amount outstanding with nine counterparties.
Repurchase Agreements
Repurchase agreements bear interest at a contractually agreed upon rate and have maturities ranging from one month to twelve months. Repurchase agreements are being accounted for as secured borrowings since we maintain effective control of the financed assets. Repurchase agreements are subject to certain financial covenants. We were in compliance with these covenants at December 31, 2016.
Our repurchase agreement collateral ratio (MBS and GSE CRT pledged as collateral/Amount Outstanding) was 112% as of December 31, 2016 (December 31, 2015: 111%).
Secured Loans
Our wholly-owned captive insurance subsidiary, IAS Services LLC, is a member of the FHLBI. As a member of the FHLBI, IAS Services LLC has borrowed funds from the FHLBI in the form of secured advances.
As of December 31, 2016, IAS Services LLC, had $1.65 billion in outstanding secured advances from the FHLBI. These secured advances have fixed or floating rates. Floating rates are based on the three-month FHLB swap rate plus a spread. For the year ended December 31, 2016, IAS Services LLC had weighed average borrowings of $1.65 billion with a weighted average borrowing rate of 0.66% and a weighted average maturity of 7.35 years.
The Federal Housing Finance Agency’s ("FHFA") final rule governing Federal Home Loan Bank membership (the “FHFA Rule”) was effective on February 19, 2016. The FHFA Rule, among other provisions, excludes captive insurance companies from membership eligibility. The FHFA Rule permits existing captive insurance companies, such as IAS Services LLC, to remain members until February 2021. New advances or renewals that mature beyond February 2021 are prohibited. As


 
104
 

Table of Contents

permitted by the FHFA Rule, the FHLBI has indicated it will honor the contractual maturity dates of existing advances to IAS Services LLC that were made prior to February 19, 2016 and extend beyond February 2021. We do not expect there to be any impact to our existing FHLBI borrowings under the FHFA rule. The ability to borrow from the FHLBI is subject to our continued creditworthiness, pledging of sufficient eligible collateral to secure advances, and compliance with certain agreements with FHLBI and FHFA rules.
As discussed in Note 6 - "Other Assets," IAS Services LLC is required to purchase and hold a certain amount of FHLBI stock, which is based, in part, upon the outstanding principal balance of secured advances from the FHLBI.
Exchangeable Senior Notes
In 2013, our wholly-owned subsidiary, IAS Operating Partnership LP, issued $400.0 million in aggregate principal amount of Exchangeable Senior Notes (the “Notes”) due March 15, 2018. The Notes are reported on our consolidated balance sheets net of debt issuance costs. Debt issuance costs are amortized as an adjustment to interest expense using the effective interest method over the stated legal maturity of the Notes.
The terms of the Notes are governed by an indenture (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 our common stock at the applicable exchange rate at any time prior to the close of business on March 13, 2018. The initial exchange rate for each $1,000 aggregate principal amount of the Notes is 42.0893 shares of our common stock, equivalent to an exchange price of approximately $23.76 per share, and the maximum exchange rate is 48.4027 shares of our common stock, equivalent to an exchange price of approximately $20.66 per share. The initial and maximum exchange rates of the Notes are subject to adjustment in certain events. The Notes have not been registered under the Securities Act of 1933. Under the registration rights agreement between the initial purchasers of the Notes and us, we filed a prospectus supplement in August 2013 registering for resale 605,034 shares of common stock issuable upon exchange of the Notes. We may be required to register additional shares of common stock issuable upon exchange of the Notes at the request of holders as required by the registration rights agreement. Accrued interest payable on the Notes was approximately $5.9 million as of December 31, 2016 (2015: $5.9 million).


 
105
 

Table of Contents

Note 8 – Collateral Positions
The following table summarizes the fair value of collateral that we have pledged under our repurchase agreements, secured loans and interest rate swaps as of December 31, 2016 and 2015. Refer to Note 2 - "Summary of Significant Accounting Policies - Fair Value Measurements" for a description of how we determine fair value. RMBS, CMBS and GSE CRT collateral pledged is included in mortgage-backed and credit risk transfer securities on our consolidated balance sheets. Cash collateral pledged is classified as due from counterparties on our consolidated balance sheets.
$ in thousands
December 31, 2016
 
December 31, 2015
Repurchase Agreements:
 
 
 
Agency RMBS
8,654,233

 
8,827,976

Non-Agency RMBS
1,887,550

 
2,563,877

GSE CRT
734,212

 
640,828

CMBS
1,168,309

 
1,427,607

Cash

 
710

Total repurchase agreement collateral pledged
12,444,304

 
13,460,998

Secured Loans:
 
 
 
Agency RMBS
585,504

 
558,894

CMBS
1,346,078

 
1,390,805

Total secured loans collateral pledged
1,931,582

 
1,949,699

Interest Rate Swaps:
 
 
 
Agency RMBS
46,312

 
143,947

Cash
86,450

 
109,299

Total interest rate swaps collateral pledged
132,762

 
253,246

Total collateral pledged:


 


Mortgage-backed and GSE CRT securities
14,422,198

 
15,553,934

Cash
86,450

 
110,009

 
14,508,648

 
15,663,943

The following table summarizes the fair value of collateral that we hold under our interest rate swaps as of December 31, 2016 and 2015. Cash collateral held that is not restricted for use is included in cash and cash equivalents on our consolidated balance sheets and the liability to return the collateral is included in collateral held payable. Non-cash collateral held would be recognized if the counterparty defaults or if we sell the pledged collateral. As of December 31, 2016 and 2015, we did not recognize any non-cash collateral held.
$ in thousands
December 31, 2016
 
December 31, 2015
Interest Rate Swaps:
 
 
 
Cash
1,700

 
4,900

Non-cash collateral
536

 

Total collateral held
2,236

 
4,900

Repurchase Agreements
Collateral posted with our repurchase agreement counterparties is segregated in our books and records. The repurchase agreement counterparties have the right to resell and repledge the collateral posted but have the obligation to return the pledged collateral, or substantially the same collateral if agreed to by us, upon maturity of the repurchase agreement. Under the repurchase agreements, the respective lender retains the contractual right to mark the underlying collateral to fair value as determined by a pricing service agreed to by the respective lender and us. We would be required to provide additional collateral or fund margin calls if the value of pledged assets declines. We intend to maintain a level of liquidity that will enable us to meet margin calls.


 
106
 

Table of Contents

Secured Loans
The ability to borrow from the FHLBI is subject to our continued creditworthiness, pledging of sufficient eligible collateral to secure advances, and compliance with certain agreements with FHLBI and FHFA rules. Collateral posted with the FHLBI is held in trust for the benefit of the FHLBI and is not commingled with our other assets. The FHLBI does not have the right to resell or repledge collateral posted unless an event of default occurs. The FHLBI retains the right to mark the underlying collateral for FHLBI advances to fair value as determined by the FHLBI in its sole discretion. IAS Services LLC would be required to provide additional collateral or fund margin calls if the value of pledged assets declines.
Interest Rate Swaps
Collateral posted with our interest rate swap counterparties is segregated in our books and records. We have two types of interest rate swap arrangements: bilateral interest rate swaps that are governed by an International Swaps and Derivatives Association ("ISDA") agreement and interest rate swaps that are centrally cleared by the Chicago Mercantile Exchange ("CME") through a Futures Commission Merchant. Interest rate swaps that are governed by an ISDA agreement provide for bilateral collateral pledging based on the counterparties' market value.  The counterparties have the right to repledge the collateral posted, but have the obligation to return the pledged collateral, or substantially the same collateral, if agreed to by us, as the market value of the interest rate swaps change.  Centrally cleared swaps require initial margin and the daily posting or receipt of variation margin. CME determines the fair value of centrally cleared swaps, and we would be required to provide additional collateral if the value of our interest rate swaps decline. Centrally cleared swaps do not allow for the repledge of collateral.
Note 9 – Derivatives and Hedging Activities
Risk Management Objective of Using Derivatives
We are exposed to certain risks arising from both our business operations and economic conditions. We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity, credit and foreign exchange rate risk primarily by managing the amount, sources, and duration of our investments, debt funding, and the use of derivative financial instruments. Specifically, we enter 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. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash receipts and our known or expected cash payments principally related to our investments and borrowings.
We also utilize 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 us to synthetically assume the credit risk of a reference security, portfolio of securities or index of securities. The counterparty pays a premium to us, and we agree 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 securities and the CDS’s notional amount is recorded as a realized loss in the consolidated statements of operations.
The following table summarizes changes in the notional amount of our derivative instruments during 2016:
$ in thousands
Notional Amount as of January 1, 2016
 
Additions
 
Settlement,
Termination,
Expiration
or Exercise
 
Notional Amount as
of December 31, 2016
Interest Rate Swaps
11,450,000

 

 
(4,950,000
)
 
6,500,000

Interest Rate Swaptions
300,000

 

 
(300,000
)
 

Currency Forward Contracts
76,324

 
293,513

 
(307,529
)
 
62,308

Credit Derivatives
645,000

 

 
(75,034
)
 
569,966

Total
12,471,324

 
293,513

 
(5,632,563
)
 
7,132,274

Interest Rate Swaps
Our repurchase agreements are usually settled on a short-term basis ranging from one to twelve months. At each settlement date, we typically refinance each repurchase agreement at the market interest rate at that time. In addition, our


 
107
 

Table of Contents

secured loans have floating interest rates. As such, we are exposed to changing interest rates. Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposures to interest rate movements. To accomplish this objective, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps involve the receipt of variable-rate amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.
Effective December 31, 2013, we voluntarily discontinued cash flow hedge accounting for our interest rate swaps to gain greater flexibility in managing interest rate exposures. Amounts recorded in AOCI before we discontinued cash flow hedge accounting for our interest rate swaps are reclassified to interest expense on repurchase agreements on the consolidated statements of operations as interest is accrued and paid on the related repurchase agreements over the remaining life of the interest rate swap agreements. We reclassified $5.2 million as an increase (2015: $66.8 million as an increase) to interest expense for the year ended December 31, 2016. During the next 12 months, we estimate that $25.5 million will be reclassified as a decrease to interest expense, repurchase agreements. As of December 31, 2016, $149.1 million (December 31, 2015: $148.3 million) of unrealized gain/(loss) on discontinued cash flow hedges, net is still included in accumulated other comprehensive income.
During the year ended December 31, 2016, we terminated swaps with a notional amount of $5.0 billion and realized losses of $69.1 million. The terminated swaps were predominantly maturing in 2016 and offered little protection from rising rates. Additionally, our investment and repurchase agreement balances decreased due to asset sales to facilitate stock repurchases, further reducing our need for hedging. Our overall interest rate risk did not change materially as a result of the swap terminations.
As of December 31, 2016, we had the following interest rate derivatives outstanding: 
$ in thousands
Counterparty
Notional
 
Maturity Date
 
Fixed Interest
Rate
in Contract
ING Capital Markets LLC
350,000

 
2/24/2018
 
0.95
%
UBS AG
500,000

 
5/24/2018
 
1.10
%
ING Capital Markets LLC
400,000

 
6/5/2018
 
0.87
%
Citibank, N.A. CME Central Clearing
300,000

 
2/5/2021
 
2.50
%
The Royal Bank of Scotland Plc CME Central Clearing
300,000

 
2/5/2021
 
2.69
%
Wells Fargo Bank, N.A.
200,000

 
3/15/2021
 
3.14
%
JPMorgan Chase Bank, N.A. CME Central Clearing
500,000

 
5/24/2021
 
2.25
%
Citibank, N.A.
200,000

 
5/25/2021
 
2.83
%
HSBC Bank USA, National Association CME Central Clearing
500,000

 
6/24/2021
 
2.44
%
HSBC Bank USA, National Association
550,000

 
2/24/2022
 
2.45
%
Deutsche Bank AG CME Central Clearing
1,000,000

 
6/9/2022
 
2.21
%
The Royal Bank of Scotland Plc
500,000

 
8/15/2023
 
1.98
%
Goldman Sachs Bank USA CME Central Clearing
600,000

 
8/24/2023
 
2.88
%
HSBC Bank USA, National Association
500,000

 
12/15/2023
 
2.20
%
Morgan Stanley Capital Services, LLC Central Clearing
100,000

 
4/2/2025
 
2.04
%
Total
6,500,000

 
 
 
2.14
%
Refer to Note 8 - "Collateral Positions" for further information regarding our collateral pledged to and received from our interest rate swap counterparties.



 
108
 

Table of Contents

Interest Rate Swaptions
We purchase interest rate swaptions to help mitigate the potential impact of increases or decreases in interest rates on the performance of a portion of our investment portfolio (referred to as “convexity risk”). The interest rate swaptions provide us 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 a derivative asset in our 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 gain (loss) on derivative instruments, net in our consolidated statements of operations. If an interest rate swaption expires unexercised, the loss on the interest rate swaption would be equal to the premium paid. If we sell or exercise an interest rate swaption, the realized gain or loss on the interest rate 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.
As of December 31, 2016, we have no outstanding interest rate swaptions.
TBAs, Futures and Currency Forward Contracts
We purchase or sell certain TBAs and U.S. Treasury futures contracts to help mitigate the potential impact of changes in interest rates on the performance of our portfolio. Realized and unrealized gains and losses associated with the purchases or sales of the TBAs and U.S. Treasury futures contracts are recognized in gain (loss) on derivative instruments, net in our consolidated statements of operations.
We use currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on our investments denominated in foreign currencies. Realized and unrealized gains and losses associated with the purchases or sales of currency forward contracts are recognized in gain (loss) on derivative instruments, net in our consolidated statements of operations.
Credit Derivatives
Our GSE CRTs purchased prior to August 24, 2015 are accounted for as hybrid financial instruments consisting of a debt host contract and an embedded credit derivative. Embedded derivatives associated with GSE CRTs are recorded within mortgage-backed and credit risk transfer securities, at fair value, on the consolidated balance sheets. As of December 31, 2016 and 2015, terms of the GSE CRT embedded derivatives are:
$ in thousands
December 31, 2016
 
December 31, 2015
Fair value amount
17,095

 
(25,722
)
Notional amount
569,966

 
645,000

Maximum potential amount of future undiscounted payments
569,966

 
645,000

Tabular Disclosure of the Effect of Derivative Instruments on the Balance Sheet
The table below presents the fair value of our derivative financial instruments, as well as their classification on the consolidated balance sheets as of December 31, 2016 and 2015.
$ in thousands
 
 
 
 
 
 
 
 
 
 
Derivative Assets
 
Derivative Liabilities
 
 
As of December 31, 2016
 
As of December 31, 2015
 
 
 
As of December 31, 2016
 
As of December 31, 2015
Balance Sheet
 
Fair Value
 
Fair Value
 
Balance Sheet
 
Fair Value
 
Fair Value
Interest Rate Swaps Asset
 
3,085

 
6,795

 
Interest Rate Swaps Liability
 
133,833

 
238,045

Currency Forward Contracts
 
101

 
1,864

 
Currency Forward Contracts
 
395

 
103



 
109
 

Table of Contents

Tabular Disclosure of the Effect of Derivative Instruments on the Income Statement
The tables below present the effect of our derivative financial instruments on the consolidated statements of operations for the years ended December 31, 2016, 2015 and 2014.
$ in thousands
 
 
 
 
Derivative
not designated as
hedging instrument
 
Location of unrealized gain (loss)
recognized in income
on derivative
 
Year ended December 31,
2016
 
Year ended December 31,
2015
 
Year ended December 31,
2014
CDS Contract
 
Realized and unrealized credit derivative income (loss), net
 

 
648

 
(258
)
GSE CRT Embedded Derivatives
 
Realized and unrealized credit derivative income (loss), net
 
36,800

 
(6,411
)
 
(21,495
)
Total
 
 
 
36,800

 
(5,763
)
 
(21,753
)
The following tables summarize the effect of interest rate swaps, interest rate swaptions, TBAs, futures contracts and currency forward contracts reported in gain (loss) on derivative instruments, net on the consolidated statements of operations for the years ended December 31, 2016, 2015 and 2014.
$ in thousands
Year ended December 31, 2016
Derivative
not designated as
hedging instrument
Realized gain (loss) on derivative instruments, net
 
 Contractual
interest expense
 
Unrealized
gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
(69,090
)
 
(104,804
)
 
100,503

 
(73,391
)
Interest Rate Swaptions
(1,485
)
 

 
1,485

 

Currency Forward Contracts
12,632

 

 
(2,056
)
 
10,576

Total
(57,943
)
 
(104,804
)
 
99,932

 
(62,815
)

$ in thousands
Year ended December 31, 2015
Derivative
not designated as
hedging instrument
Realized gain (loss) on derivative instruments, net
 
 Contractual
interest expense
 
Unrealized
gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
(31,881
)
 
(184,373
)
 
(554
)
 
(216,808
)
Interest Rate Swaptions
(10,328
)
 

 
8,521

 
(1,807
)
TBAs
(2,292
)
 

 
558

 
(1,734
)
Futures Contracts
(943
)
 

 
(90
)
 
(1,033
)
Currency Forward Contracts
1,172

 

 
1,162

 
2,334

Total
(44,272
)
 
(184,373
)
 
9,597

 
(219,048
)

$ in thousands
Year ended December 31, 2014
Derivative instrument
Realized gain (loss) on derivative instruments, net
 
 Contractual
interest expense
 
Unrealized
gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
(28,758
)
 
(199,783
)
 
(223,944
)
 
(452,485
)
Interest Rate Swaptions
(23,275
)
 

 
10,906

 
(12,369
)
TBAs
(10,843
)
 

 
(558
)
 
(11,401
)
Futures Contracts
(11,489
)
 

 
(2,502
)
 
(13,991
)
Currency Forward Contracts
2,178

 

 
599

 
2,777

Total
(72,187
)
 
(199,783
)
 
(215,499
)
 
(487,469
)


 
110
 

Table of Contents

Credit-risk-related Contingent Features
We have agreements with each of our bilateral derivative counterparties. Some of those agreements contain a provision whereby if we default on any of our indebtedness, including default whereby repayment of the indebtedness has not been accelerated by the lender, we could also be declared in default on our derivative obligations.
At December 31, 2016, 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 $46.1 million. We have minimum collateral posting thresholds with certain of our derivative counterparties and have posted $46.3 million of Agency RMBS and $86.5 million of cash as collateral under these agreements as of December 31, 2016. If we had breached any of these provisions at December 31, 2016, we could have been required to settle our obligations under the agreements at their termination value.
In addition, as of December 31, 2016, we have an agreement with a central clearing counterparty. The fair value of such derivatives in a net liability position, which includes accrued interest but excludes any adjustment for non-performance risk related to this agreement, was $88.6 million.
We were in compliance with all of the financial provisions of these counterparty agreements as of December 31, 2016.

Note 10 – Offsetting Assets and Liabilities
Certain of our repurchase agreements and derivative transactions are governed by underlying agreements that generally provide for a right of offset under master netting arrangements (or similar agreements), in the event of default or in the event of bankruptcy of either party to the transactions. Assets and liabilities subject to such arrangements are presented on a gross basis in the consolidated balance sheets.
The following tables present information about the assets and liabilities that are subject to master netting arrangements (or similar agreements) and can potentially be offset on our consolidated balance sheets at December 31, 2016 and December 31, 2015.
Offsetting of Derivative Assets
As of December 31, 2016
 
 
 
 
 
 
 
Gross Amounts Not Offset in the
Consolidated Balance Sheets
 
 
$ in thousands
Description
Gross
Amounts of
Recognized
Assets
 
Gross
Amounts
Offset in the
Consolidated
Balance
Sheets
 
Net Amounts
of Assets
presented
in the
Consolidated
Balance Sheets
 
Financial
Instruments
 
Cash
Collateral
Received
 
Net Amount
Derivatives (1)(4)
3,186

 

 
3,186

 
(1,640
)
 
(1,546
)
 

Total
3,186

 

 
3,186

 
(1,640
)
 
(1,546
)
 



 
111
 

Table of Contents

Offsetting of Derivative Liabilities, Repurchase Agreements and Secured Loans
As of December 31, 2016
 
 
 
 
 
 
 
Gross Amounts Not Offset in the
Consolidated Balance Sheets
 
 
$ in thousands
Description
Gross
Amounts of
Recognized
Liabilities
 
Gross
Amounts
Offset in the
Consolidated
Balance
Sheets
 
Net Amounts
of Liabilities
presented
in the
Consolidated
Balance Sheets
 
Financial
Instruments (2)
 

Cash Collateral
Posted
 
Net Amount
Derivatives (4)
134,228

 

 
134,228

 
(45,738
)
 
(85,787
)
 
2,703

Repurchase Agreements (3)
11,160,669

 

 
11,160,669

 
(11,160,669
)
 

 

Secured Loans (5)
1,650,000

 

 
1,650,000

 
(1,650,000
)
 

 

Total
12,944,897

 

 
12,944,897

 
(12,856,407
)
 
(85,787
)
 
2,703

Offsetting of Derivative Assets
As of December 31, 2015
 
 
 
 
 
 
 
Gross Amounts Not Offset in the
Consolidated Balance Sheets
 
 
$ in thousands
Description
Gross
Amounts of
Recognized
Assets
 
Gross
Amounts
Offset in the
Consolidated
Balance
Sheets
 
Net Amounts
of Assets
presented
in the
Consolidated
Balance Sheets
 
Financial
Instruments
 
Cash
Collateral
Received
 
Net Amount
Derivatives (1)(4)
8,659

 

 
8,659

 
(4,142
)
 
(4,517
)
 

Total
8,659

 

 
8,659

 
(4,142
)
 
(4,517
)
 

Offsetting of Derivative Liabilities and Repurchase Agreements
As of December 31, 2015
 
 
 
 
 
 
 
Gross Amounts Not Offset in the
Consolidated Balance Sheets
 
 
$ in thousands
Description
Gross
Amounts of
Recognized
Liabilities
 
Gross
Amounts
Offset in the
Consolidated
Balance
Sheets
 
Net Amounts
of Liabilities
presented
in the
Consolidated
Balance Sheets
 
Financial
Instruments (2)
 
Cash
Collateral
Posted
 
Net Amount
Derivatives (4)
238,148

 

 
238,148

 
(117,240
)
 
(109,299
)
 
11,609

Repurchase Agreements (3)
12,126,048

 

 
12,126,048

 
(12,126,048
)
 

 

Secured Loans (5)
1,650,000

 

 
1,650,000

 
(1,650,000
)
 

 

 
14,014,196

 

 
14,014,196

 
(13,893,288
)
 
(109,299
)
 
11,609

 
(1)
Amounts represent derivatives in an asset position which could potentially be offset against derivatives in a liability position at December 31, 2016 and December 31, 2015, subject to a netting arrangement.
(2)
Amounts represent collateral pledged that is available to be offset against liability balances associated with repurchase agreements, secured loans and derivatives.
(3)
The fair value of securities pledged against our borrowing under repurchase agreements was $12.4 billion and $13.5 billion at December 31, 2016 and December 31, 2015, respectively.
(4)
Cash collateral received on our derivatives was $1.7 million and $4.9 million at December 31, 2016 and December 31, 2015, respectively. Non-cash collateral received on our derivatives was $536,000 and $0 at December 31, 2016 and December 31, 2015, respectively. Cash collateral posted by us on our derivatives was $86.5 million and $109.3 million at December 31, 2016 and December 31, 2015, respectively.
(5)
The fair value of securities pledged against IAS Services LLC's borrowing under secured loans was $1.9 billion and $1.9 billion at December 31, 2016 and December 31, 2015, respectively.


 
112
 

Table of Contents

Note 11 – Fair Value of Financial Instruments
A three-level valuation hierarchy exists for disclosure of fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our 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 following tables present our assets and liabilities measured at fair value on a recurring basis.
 
December 31, 2016
 
 
 
Fair Value Measurements Using:
 
 
$ in thousands
Level 1
 
Level 2
 
Level 3
 
NAV as a practical expedient
 
Total at
Fair Value
Assets:
 
 
 
 
 
 
 
 
 
Mortgage-backed and credit risk transfer securities(1) (2)

 
14,964,236

 
17,095

 

 
14,981,331

Derivative assets

 
3,186

 

 

 
3,186

Other assets (3) (4)
500

 

 

 
33,301

 
33,801

Total assets
500

 
14,967,422

 
17,095

 
33,301

 
15,018,318

Liabilities:
 
 
 
 
 
 
 
 
 
Derivative liabilities

 
134,228

 

 

 
134,228

Total liabilities

 
134,228

 

 

 
134,228

 
 
December 31, 2015
 
 
 
Fair Value Measurements Using:
 
 
$ in thousands
Level 1
 
Level 2
 
Level 3
 
NAV as a practical expedient
 
Total at
Fair Value
Assets:
 
 
 
 
 
 
 
 
 
Mortgage-backed and credit risk transfer securities(1) (2)

 
16,091,657

 
(25,722
)
 

 
16,065,935

Derivative assets

 
8,659

 

 
 
 
8,659

Other assets (3)

 

 

 
38,413

 
38,413

Total assets

 
16,100,316

 
(25,722
)
 
38,413

 
16,113,007

Liabilities:
 
 
 
 
 
 
 
 
 
Derivative liabilities

 
238,148

 

 

 
238,148

Total liabilities

 
238,148

 

 

 
238,148

 
(1)
For more detail about the fair value of our MBS and GSE CRTs, refer to Note 4 - "Mortgage-Backed and Credit Risk Transfer Securities."
(2)
Our GSE CRTs purchased prior to August 24, 2015 are accounted for as hybrid financial instruments with an embedded derivative. The hybrid instruments consist of debt host contracts classified as Level 2 and embedded derivatives classified as Level 3. As of December 31, 2016, the net embedded derivative asset position of $17.1 million includes $21.0 million of embedded derivatives in an asset position and $3.9 million of embedded derivatives in a liability position. As of December 31, 2015, the net embedded derivative liability position of $25.7 million includes $1.0 million of embedded derivatives in an asset position and $26.7 million of embedded derivatives in a liability position.
(3)
As of December 31, 2016 and December 31, 2015, $33.3 million and $38.4 million of investments in unconsolidated ventures are included in "Other assets", respectively. Investments in unconsolidated ventures are not subject to redemption, although investors may sell or transfer their interest at the approval of the general partner of the underlying


 
113
 

Table of Contents

funds. As of December 31, 2016 and December 31, 2015, the weighed average remaining term of investments in unconsolidated ventures is 1.33 years and 1.70 years, respectively.
(4)
Includes $0.5 million of investments in an exchange-traded fund as of December 31, 2016.
The following table shows a reconciliation of the beginning and ending fair value measurements of our GSE CRT embedded derivatives, which we have valued utilizing Level 3 inputs:
 
Years Ended
$ in thousands
December 31, 2016
 
December 31, 2015
Beginning balance
(25,722
)
 
(21,495
)
Sales and settlements
6,017

 
2,184

Total net gains / (losses) included in net income:
 
 
 
Realized gains/(losses), net
(6,017
)
 
(2,184
)
Unrealized gains/(losses), net (1)
42,817

 
(4,227
)
Ending balance
17,095

 
(25,722
)
(1)
Included in realized and unrealized credit derivative income (loss), net in the consolidated statements of operations are $36.2 million in net unrealized gains and $7.2 million in net unrealized losses attributable to assets still held as of December 31, 2016 and December 31, 2015, respectively. During the year ended December 31, 2016,we reversed $6.6 million (December 31, 2015: $3.0 million) in net unrealized gains on securities sold during the period.
The following table summarizes significant unobservable inputs used in the fair value measurement of our GSE CRT embedded derivatives:
 
Fair Value at
 
 
 
 
 
 
 
 
$ in thousands
December 31, 2016
 
Valuation Technique
 
Unobservable Input
 
Range
 
Weighted Average
GSE CRT Embedded Derivatives
17,095

 
Market Comparables, Vendor Pricing
 
Weighted average life
 
2.5 - 7.7
 
5.3
 
Fair Value at
 
 
 
 
 
 
 
 
$ in thousands
December 31, 2015
 
Valuation Technique
 
Unobservable Input
 
Range
 
Weighted Average
GSE CRT Embedded Derivatives
(25,722
)
 
Market Comparables
 
Prepayment Rate
 
5.72% - 14.37%
 
7.83
%
 
 
 
Vendor Pricing
 
Default Rate
 
0.10% - 0.35%
 
0.16
%
These significant unobservable inputs change according to market conditions and security performance. We estimate the weighted average life of GSE CRTs in order to identify GSE corporate debt with a similar maturity. Prior to the third quarter of 2016, we used prepayment and default rates to estimate the weighted average life. During the third quarter of 2016, we utilized weighted average life estimates obtained from a third party provider. Although weighted average life is a significant input, changes in weighted average life may not have an explicit directional impact on the fair value measurement.


 
114
 

Table of Contents

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 sheets at December 31, 2016 and December 31, 2015:
 
December 31, 2016
 
December 31, 2015
$ in thousands
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
Financial Assets:
 
 
 
 
 
 
 
Commercial loans, held-for-investment
273,355

 
275,319

 
209,062

 
209,790

Other assets
74,250

 
74,250

 
75,375

 
75,375

Total
347,605

 
349,569

 
284,437

 
285,165

Financial Liabilities:
 
 
 
 
 
 
 
Repurchase agreements
11,160,669

 
11,161,034

 
12,126,048

 
12,133,252

Secured loans
1,650,000

 
1,650,000

 
1,650,000

 
1,650,000

Exchangeable senior notes
397,041

 
400,000

 
394,573

 
376,500

Total
13,207,710

 
13,211,034

 
14,170,621

 
14,159,752

The following describes our methods for estimating the fair value for financial instruments.
The estimated fair value of commercial loans held-for-investment is a Level 3 fair value measurement. New commercial loans are carried at their unpaid principal balance until the end of the calendar year in which they were originated or purchased unless market factors indicate cost may not be a reliable indicator of fair value. Subsequent to the year of origination, commercial loan investments are valued on at least an annual basis by an independent third party valuation agent using a discounted cash flow technique.
The estimated fair value of FHLBI stock, included in "Other assets," is a Level 3 fair value measurement. FHLBI stock may only be sold back to the FHLBI at its discretion at cost. As a result, the cost of the FHLBI stock approximates its fair value.
The estimated fair value of 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 we determined best reflect current market interest rates that would be offered for repurchase agreements with similar characteristics and credit quality.
The estimated fair value of secured loans is a Level 3 fair value measurement. The secured loans have floating rates based on an index plus a spread and the spread is typically consistent with those demanded in the market. Accordingly, the interest rates on these secured loans are at market, and thus the carrying amount approximates fair value.
The fair value of exchangeable senior notes is a Level 2 fair value measurement based on a valuation obtained from a third-party pricing service.
Note 12 – Related Party Transactions
We are externally managed and advised by Invesco Advisers, Inc. (our "Manager"), a wholly-owned subsidiary of Invesco Ltd. Our Manager is at all times subject to the supervision and oversight of our Board of Directors and has only such functions and authority as we delegate to it.
Under the terms of the management agreement, our Manager and its affiliates provide us with our management team, including our officers and appropriate support personnel. Each of our officers is an employee of our Manager or one of its affiliates. We do not have any employees. Our Manager is not obligated to dedicate any of its employees exclusively to us, nor is our Manager obligated to dedicate any specific portion of time to our business. During the year ended December 31, 2016, we reimbursed our Manager $695,000 (2015: $544,000; 2014: $83,000) for costs of support personnel that are fully dedicated to our business.
We have invested $149.9 million as of December 31, 2016 (2015$47.4 million) in money market or mutual funds managed by affiliates of our Manager. The investments are reported as cash and cash equivalents on our consolidated balance sheets.
We also pay our Manager a portion of the origination and commitment fees received from borrowers in connection with purchasing and originating commercial real estate loans. For the year ended December 31, 2016, $690,000 (2015: $1.3 million; 2014: $285,000) was paid to our Manager related to such transactions.


 
115
 

Table of Contents

Management Fee
We pay our Manager a management fee equal to 1.50% of our stockholders’ equity per annum. The fee is calculated and payable quarterly in arrears. For purposes of calculating the management fee, stockholders’ 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. Stockholder's equity shall exclude (i) 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); (ii) cumulative net realized losses that are not attributable to permanently impaired investments and that relate to the investments for which market movement is accounted for in other comprehensive income; provided, however, that such adjustment shall not exceed cumulative unrealized net gains in other comprehensive income; (iii) one-time events pursuant to changes in U.S. GAAP; and (iv) certain non-cash items after discussions between our Manager and our independent directors and approval by a majority of our independent directors.
We do not pay any management fees on our investments in unconsolidated ventures that are managed by an affiliate of our Manager.
In 2016, we recorded a cumulative one-time adjustment of $2.3 million related to a prior adjustment for the accounting for premiums and discounts associated with non-Agency RMBS not of high credit quality. Refer to Note 17 – “Revision of Previously Issued Financial Statements” for further information.
Expense Reimbursement
We are required to reimburse our Manager for operating expenses incurred on our behalf, including directors and officers insurance, accounting services, auditing and tax services, filing fees, and miscellaneous general and administrative costs. Our reimbursement obligation is not subject to any dollar limitation.
The following table summarizes the costs incurred on our behalf by our Manager for the years ended December 31, 2016, 2015 and 2014.
 
Years ended December 31,
$ in thousands
2016
 
2015
 
2014
Incurred costs, prepaid or expensed
6,986

 
6,463

 
5,954

Incurred costs, charged against equity as a cost of raising capital

 
22

 
213

Incurred costs, capitalized to other assets
50

 

 

Total incurred costs, originally paid by our Manager
7,036

 
6,485

 
6,167

Termination Fee
If we terminate our management agreement, we owe our Manager a termination fee equal to three times the sum of our average annual management fee during the 24-month period before termination, calculated as of the end of the most recently completed fiscal quarter.
Note 13 – Stockholders’ Equity
Securities Convertible into Shares of Common Stock
The non-controlling interest holder of the Operating Partnership units, a wholly-owned Invesco subsidiary, has the right to cause the Operating Partnership to redeem their operating partnership ("OP Units") for cash equal to the market value of an equivalent number of shares of common stock, or at our option, we may purchase their OP Units by issuing one share of common stock for each OP Unit redeemed. We have also adopted an equity incentive plan which allows us to grant securities convertible into our common stock to our independent directors and employees of our Manager and its affiliates.


 
116
 

Table of Contents

Our Exchangeable Senior Notes are also convertible into shares of common stock. Refer to Note 7 - "Borrowings" for further discussion of the Exchangeable Senior Notes.
Registration Rights
Upon completion of our initial public offering, we entered into a registration rights agreement with regard to the common stock and OP Units owned by wholly-owned subsidiaries of Invesco and any shares of common stock that our Manager may elect to receive under the management agreement or otherwise. Under the registration rights agreement, we have granted Invesco (i) unlimited demand registration rights to have the common stock and OP Units owned by Invesco and any shares of common stock granted to our Manager registered for resale and (ii) in certain circumstances, the right to “piggy-back” these shares in registration statements we might file in connection with any future public offering so long as we retain our Manager under the management agreement.
On March 12, 2013, we also entered into a registration rights agreement with the initial purchasers of our Exchangeable Senior Notes. Under the registration rights agreement, we initially designated our automatic shelf registration statement filed on April 2, 2013 (“2013 Shelf”) to be used for resales of the common stock, if any, issuable upon exchange of the Notes. We filed a supplement to the underlying prospectus in the 2013 Shelf to cover resales of the common stock by one noteholder. We filed a new automatic shelf registration statement on March 29, 2016 (“2016 Shelf”) prior to the expiration of the 2013 Shelf and have agreed to file prospectus supplements if requested by noteholders to add such noteholders as selling securityholders. If the 2016 Shelf ceases to be effective, additional interest will accrue on the Notes, subject to certain exceptions.
Preferred Stock
Holders of our Series A Preferred Stock are entitled to receive dividends at an annual rate of 7.75% of the liquidation preference of $25.00 per share or $1.9375 per share per annum. These dividends are cumulative and payable quarterly in arrears.
Holders of our Series B Preferred Stock are entitled to receive dividends at an annual rate of 7.75% of the liquidation preference of $25.00 per share or $1.9375 per share per annum until December 27, 2024. After December 27, 2024, holders are entitled to receive dividends at a floating rate equal to three-month LIBOR plus a spread of 5.18% of the $25.00 liquidation preference per annum. These dividends are cumulative and payable quarterly in arrears.
We may elect to redeem shares of preferred stock at our option after July 26, 2017 (with respect to the Series A Preferred Stock) and after December 27, 2024 (with respect to the Series B Preferred Stock) for $25.00 per share, plus any accumulated and unpaid dividends through the date of the redemption. These shares are not redeemable, convertible into or exchangeable for any other property or any other securities of the Company prior to those times, except under circumstances intended to preserve our qualification as a REIT or upon the occurrence of a change in control.
Common Stock
Prior to April 1, 2016, we had a dividend reinvestment and stock purchase plan (the “DRSPP”) that allowed participating stockholders to purchase shares of common stock directly from us. DRSPP participants also had the ability to automatically reinvest all or a portion of their dividends in exchange for additional shares of common stock.
During the years ended December 31, 2016, 2015 and 2014, we issued 3,201 (2015: 12,945; 2014: 1,770,106) shares of common stock at an average price of $11.08 (2015: $14.75; 2014: $16.52) under the DRSPP. We received total proceeds of approximately $35,000 (2015: $191,000; 2014: $256,000). Effective April 1, 2016, we terminated our DRSPP and replaced the DSRPP program with a direct stock purchase plan and dividend reinvestment program administered by an affiliate of our transfer agent.
Accumulated Other Comprehensive Income
The following table presents the components of accumulated other comprehensive income at December 31, 2016 and December 31, 2015, respectively. The table excludes MBS and GSE CRT that are accounted for under the fair value option.


 
117
 

Table of Contents

 
December 31, 2016
$ in thousands
Equity method investments
 
Available-for-sale securities
 
Derivatives and hedging
 
Total
Other comprehensive income/(loss), net
 
 
 
 
 
 
 
Unrealized gain (loss) on mortgage-backed and credit risk transfer securities, net

 
(37,632
)
 

 
(37,632
)
Reclassification of unrealized (gain) loss on sale of mortgage-backed and credit risk transfer securities to gain (loss) on investments, net

 
6,134

 

 
6,134

Reclassification of amortization of net deferred (gain) loss on de-designated interest rate swaps to repurchase agreements interest expense

 

 
5,154

 
5,154

Currency translation adjustments on investment in unconsolidated venture
128

 

 

 
128

Other comprehensive income/(loss), net
128

 
(31,498
)
 
5,154

 
(26,216
)
 
 
 
 
 
 
 
 
Balance at beginning of period
(32
)
 
170,383

 
148,273

 
318,624

Other comprehensive income/(loss), net
128

 
(31,498
)
 
5,154

 
(26,216
)
Other comprehensive income/(loss) attributable to non-controlling interest
(1
)
 
412

 
(63
)
 
348

Rebalancing of ownership percentage of non-controlling interest

 
5,161

 
(4,249
)
 
912

Balance at end of period
95

 
144,458

 
149,115

 
293,668


 
December 31, 2015
$ in thousands
Equity method investments
 
Available-for-sale securities
 
Derivatives and hedging
 
Total
Other comprehensive income/(loss), net
 
 
 
 
 
 
 
Unrealized gain (loss) on mortgage-backed and credit risk transfer securities, net

 
(191,053
)
 

 
(191,053
)
Reclassification of unrealized (gain) loss on sale of mortgage-backed and credit risk transfer securities to gain (loss) on investments, net

 
(7,484
)
 

 
(7,484
)
Reclassification of amortization of net deferred (gain) loss on de-designated interest rate swaps to repurchase agreements interest expense

 

 
66,757

 
66,757

Currency translation adjustments on investment in unconsolidated venture
(32
)
 

 

 
(32
)
Other comprehensive income/(loss), net
(32
)
 
(198,537
)
 
66,757

 
(131,812
)
 
 
 
 
 
 
 
 
Balance at beginning of period

 
366,556

 
82,291

 
448,847

Other comprehensive income/(loss), net
(32
)
 
(198,537
)
 
66,757

 
(131,812
)
Other comprehensive income/(loss) attributable to non-controlling interest

 
2,364

 
(775
)
 
1,589

Balance at end of period
(32
)
 
170,383

 
148,273

 
318,624

Effective December 31, 2013, we voluntarily discontinued cash flow hedge accounting for our interest rate swaps to gain greater flexibility in managing interest rate exposures. Amounts recorded in AOCI before we discontinued cash flow hedge accounting for our interest rate swaps are reclassified to interest expense on repurchase agreements on the consolidated statements of operations as interest is accrued and paid on the related repurchase agreements over the remaining original life of the interest rate swap agreements.
Share Repurchase Program
In December 2011, our board of directors approved a share repurchase program with no stated expiration date.


 
118
 

Table of Contents

During the year ended December 31, 2016, we repurchased and concurrently retired 2,063,451 (2015: 9,539,251) shares of our common stock at a weighted average repurchase price of $12.12 (2015: $13.17) per share for a net cost of $25.0 million (2015: $125.6 million), including acquisition expenses. As of December 31, 2016, we had authority to purchase 18,239,082 additional shares of our common stock through the share repurchase program.
Share-Based Compensation
We established the 2009 Equity Incentive Plan for grants of common stock and other equity based awards to our independent directors and officers and employees of our Manager and its affiliates (the “Incentive Plan”). Under the Incentive Plan, a total of 1,000,000 shares of common stock are authorized for issuance. Unless terminated earlier, the Incentive Plan will terminate in 2019, but will continue to govern the unexpired awards. As of December 31, 2016, 825,641 shares of common stock remain available for future issuance under the Incentive Plan.
We recognized compensation expense of approximately $340,000 (2015: $340,000; 2014: $282,000) related to awards to our independent directors for the year ended December 31, 2016. During the year ended December 31, 2016, we issued 25,068 shares (2015: 23,776 shares; 2014: 14,632 shares) of common stock pursuant to the Incentive Plan to our independent directors. The fair market value of the shares granted was determined by the closing stock market price on the date of the grant. The grants vested immediately.
We recognized compensation expense of approximately $100,000 (2015: $219,000; 2014: $290,000) for the year ended December 31, 2016 related to restricted stock units awarded to employees of our Manager and its affiliates which is reimbursed by our Manager under the management agreement. At December 31, 2016 there was approximately $187,000 of total unrecognized compensation cost related to restricted stock unit awards that is expected to be recognized over a period of up to 38 months, with a weighted-average remaining vesting period of 15 months.
The following table summarizes the activity related to restricted stock units awarded to employees of our Manager and its affiliates for the year ended December 31, 2016.
 
Year Ended December 31,
 
2016
 
Restricted Stock Units
 
Weighted Average Grant Date Fair Value (1)
Unvested at the beginning of the year
40,814

 
$
17.29

Shares granted during the year
21,099

 
11.28

Shares forfeited during the year
(27,193
)
 
14.43

Shares vested during the year
(15,913
)
 
17.66

Unvested at the end of the year
18,807

 
$
14.37

(1)
The grant date fair value of restricted stock unit awards is based on the closing market price of our common stock at the grant date.
Dividends
The following table sets forth the dividends declared per share of our common stock.
Date Declared
Dividends Declared Per Share
 
Amount
 
Date of Payment
2016
 
 
 
December 15, 2016
$
0.40

 
January 26, 2017
September 14, 2016
$
0.40

 
October 26, 2016
June 15, 2016
$
0.40

 
July 26, 2016
March 15, 2016
$
0.40

 
April 26, 2016
2015
 
 
 
December 15, 2015
$
0.40

 
January 26, 2016
September 15, 2015
$
0.40

 
October 27, 2015
June 15, 2015
$
0.45

 
July 28, 2015
March 17, 2015
$
0.45

 
April 28, 2015


 
119
 

Table of Contents

The following table sets forth the dividends declared per share of our Series A Preferred Stock.
Date Declared
Dividends Declared Per Share
 
Amount
 
Date of Payment
2016
 
 
 
December 15, 2016
$
0.4844

 
January 25, 2017
September 14, 2016
$
0.4844

 
October 25, 2016
June 15, 2016
$
0.4844

 
July 25, 2016
March 15, 2016
$
0.4844

 
April 25, 2016
2015
 
 
 
December 15, 2015
$
0.4844

 
January 25, 2016
September 15, 2015
$
0.4844

 
October 26, 2015
June 15, 2015
$
0.4844

 
July 27, 2015
March 17, 2015
$
0.4844

 
April 27, 2015
The following table sets forth the dividends declared per share of our Series B Preferred Stock.
Date Declared
Dividends Declared Per Share
 
Amount
 
Date of Payment
2016
 
 
 
December 15, 2016
$
0.4844

 
March 27, 2017
September 15, 2016
$
0.4844

 
December 27, 2016
June 15, 2016
$
0.4844

 
September 27, 2016
March 17, 2016
$
0.4844

 
June 27, 2016
2015
 
 
 
December 15, 2015
$
0.4844

 
March 28, 2016
September 15, 2015
$
0.4844

 
December 28, 2015
June 15, 2015
$
0.4844

 
September 28, 2015
March 17, 2015
$
0.4844

 
June 29, 2015
The following table sets forth the dividends declared per share of our preferred and common stock and their related tax characterization for the fiscal tax years ended December 31, 2016 and 2015.
 
 
 
Tax Characterization of Dividends
Fiscal Tax Year
Dividends Declared
 
Ordinary Dividends
 
Capital Gain Distribution
 
Carry Forward
Series A Preferred Stock Dividends
 
 
 
 
 
 
 
Fiscal tax year 2016(1)
1.937600

 
1.937600

 

 

Fiscal tax year 2015(2)
1.937600

 
1.937600

 

 

 
 
 
 
 
 
 
 
Series B Preferred Stock Dividends
 
 
 
 
 
 
 
Fiscal tax year 2016(3)
1.937600

 
1.937600

 

 

Fiscal tax year 2015(4)
1.937600

 
1.937600

 

 

 
 
 
 
 
 
 
 
Common Stock Dividends
 
 
 
 
 
 
 
Fiscal tax year 2016 (5)
1.600000

 
1.857840

 

 

Fiscal tax year 2015 (5)
1.700000

 
1.615469

 

 
0.257840

(1)
Excludes preferred stock dividend of $0.4844 per share declared on December 15, 2016 having a record date of January 1, 2017, which for federal income tax purposes is a fiscal tax year 2016 dividend.
(2)
Excludes preferred stock dividend of $0.4844 per share declared on December 15, 2015 having a record date of January 1, 2016, which for federal income tax purposes is a fiscal tax year 2015 dividend.


 
120
 

Table of Contents

(3)
Excludes preferred stock dividend of $0.4844 per share declared on December 15, 2016 having a record date of March 5, 2017, which for federal income tax purposes is a fiscal tax year 2016 dividend.
(4)
Excludes preferred stock dividend of $0.4844 per share declared on December 15, 2015 having a record date of March 5, 2016, which for federal income tax purposes is a fiscal tax year 2015 dividend.
(5)
Ordinary dividends include $0.257840 of spillover dividend carried-forward from fiscal tax year 2015.
Note 14 – Earnings per Common Share
Earnings per share for the years ended December 31, 2016, 2015 and 2014 is computed as follows:
$ and share amounts in thousands
Years Ended December 31,
 
2016
 
2015
 
2014
Numerator (Income)
 
 
 
 
 
Basic Earnings:
 
 
 
 
 
Net income (loss) available to common stockholders
231,547

 
89,847

 
(232,436
)
Effect of dilutive securities:
 
 
 
 
 
Income allocated to exchangeable senior notes
22,467

 

 

Income (loss) allocated to non-controlling interest
3,287

 
1,344

 
(2,482
)
Dilutive net income (loss) available to stockholders
257,301

 
91,191

 
(234,918
)
Denominator (Weighted Average Shares)
 
 
 
 
 
Basic Earnings:
 
 
 
 
 
Shares available to common stockholders
111,973

 
121,378

 
123,105

Effect of dilutive securities:
 
 
 
 
 
Restricted stock awards
20

 
41

 

OP Units
1,425

 
1,425

 
1,425

Exchangeable senior notes
16,836

 

 

Dilutive Shares
130,254

 
122,844

 
124,530

The following potential common shares were excluded from diluted earnings per common share for the year ended December 31, 2015 as the effect would be anti-dilutive: 16,835,720 for the exchangeable senior notes. The following potential common shares were excluded from diluted earnings per common share for the year ended December 31, 2014 as the effect would be anti-dilutive: 16,835,720 for the exchangeable senior notes and 44,421 for restricted stock awards.


 
121
 

Table of Contents

Note 15 – Non-controlling Interest – Operating Partnership
Non-controlling interest represents the aggregate ownership interest of a wholly-owned Invesco subsidiary in our 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 common stockholders. Since an OP unit is generally redeemable for cash or Shares at our option, it is deemed to be a Share equivalent. Therefore, such transactions are treated as capital transactions and result in an allocation between stockholders’ equity and non-controlling interest in the accompanying consolidated balance sheets. As of December 31, 2016, non-controlling interest related to the outstanding 1,425,000 OP Units represented a 1.3% interest (2015: 1.2%) in the Operating Partnership. During the fourth quarter of 2016, we recorded a cumulative out-of-period adjustment to rebalance equity in our Operating Partnership. The effect of the entry was to reduce additional paid-in capital by $3.0 million and increase non-controlling interest and AOCI by $2.1 million and $0.9 million, respectively. The adjustment reallocates total equity between total stockholders’ equity and non-controlling interest to account for changes in ownership due to repurchases and issuances of common stock and did not have any impact on our consolidated statement of operations.
Income allocated to the non-controlling interest is based on the Unit Holders’ ownership percentage of the Operating Partnership. The following table presents the net income (loss) allocated and distributions paid to the Operating Partnership non-controlling interest for the years ended December 31, 2016, 2015 and 2014.
 
Years ended December 31,
$ in thousands
2016
 
2015
 
2014
Net income (loss) allocated
3,287

 
1,344

 
(2,482
)
Distributions paid
2,280

 
2,494

 
2,850

As of December 31, 2016, distributions payable to the non-controlling interest were approximately $570,000 (2015: $570,000; 2014: $641,000).
Note 16 – Commitments and Contingencies
Commitments and contingencies may arise in the ordinary course of business. Our material off balance sheet commitments as of December 31, 2016 are discussed below.
As discussed in Note 6 - "Other Assets", we have invested in unconsolidated ventures that are sponsored by an affiliate of our Manager. The unconsolidated ventures are structured as partnerships, and we invest in the partnerships as a limited partner. The entities are structured such that capital commitments are to be drawn down over the life of the partnership as investment opportunities are identified. At December 31, 2016, our undrawn capital and purchase commitments were $15.5 million (2015: $21.1 million).
As discussed in Note 5 - “Commercial Loans Held-for-Investment”, we purchase and originate commercial loans. As of December 31, 2016, we have unfunded commitments on commercial loans held-for-investment of $9.7 million (2015: $2.1 million).
We have entered into agreements with financial institutions to guarantee certain obligations of our subsidiaries.  We would be required to perform under these guarantees in the event of certain defaults. We have not had prior claims or losses pursuant to these contracts and expect the risk of loss to be remote.


 
122
 

Table of Contents

Note 17 – Revision of Previously Issued Financial Statements
During the second quarter of 2016, we corrected errors in our accounting for premiums and discounts associated with non-Agency RMBS not of high credit quality. Premiums and discounts are amortized and recorded as interest income in our financial statements based on estimated future cash flows. We determined that the future cash flow assumptions used to develop our estimated premium amortization and discount accretion did not support our reported interest income. We revised our future cash flow estimates and also corrected our financial statements to account for the difference between actual and expected future cash flows as an adjustment to the amortized cost of the security and a prospective adjustment to the security's yield. We concluded that the errors are immaterial to each of the annual and interim consolidated financial statements which were included in our Annual Report on Form 10-K for the year ended December 31, 2015 and our interim report on Form 10-Q for the quarter ended March 31, 2016.  We have revised our consolidated financial statements as of December 31, 2015 and for the years ended December 31, 2015, and 2014 presented in this Report on Form 10-K and will revise our previously issued financial statements to correct these errors when the financial statements are presented in future periodic filings.
The following changes have been made to our Consolidated Balance Sheet as of December 31, 2015:
$ in thousands
December 31, 2015
 
As Reported
 
Adjustment
 
As Revised
Accumulated other comprehensive income
303,110

 
15,514

 
318,624

Retained earnings (distributions in excess of earnings)
(755,799
)
 
(15,514
)
 
(771,313
)
The following changes have been made to our Consolidated Statements of Operations for the years ended December 31, 2015 and 2014:
$ in thousands
Year Ended December 31, 2015
 
As Reported
 
Adjustment
 
As Revised
Interest Income
 
 
 
 
 
Mortgage-backed and credit risk transfer securities
518,256

 
5,637

 
523,893

Other income (loss)
 
 
 
 
 
Gain (loss) on investments, net
(21,212
)
 
3,207

 
(18,005
)
Net income (loss)
105,211

 
8,844

 
114,055

Net income (loss) attributable to non-controlling interest
1,241

 
103

 
1,344

Net income (loss) attributable to Invesco Mortgage Capital Inc.
103,970

 
8,741

 
112,711

Net income (loss) attributable to common stockholders
81,106

 
8,741

 
89,847

Earnings per share:
 
 
 
 
 
Net income (loss) attributable to common stockholders
 
 
 
 
 
   Basic
0.67

 
0.07

 
0.74

   Diluted
0.67

 
0.07

 
0.74



 
123
 

Table of Contents

$ in thousands
Year Ended December 31, 2014
 
As Reported
 
Adjustment
 
As Revised
Interest Income
 
 
 
 
 
Mortgage-backed and credit risk transfer securities
579,062

 
10,437

 
589,499

Other Income
 
 
 
 
 
Gain (loss) on investments, net
(87,168
)
 
2,761

 
(84,407
)
Net income (loss)
(230,738
)
 
13,198

 
(217,540
)
Net income (loss) attributable to non-controlling interest
(2,632
)
 
150

 
(2,482
)
Net income (loss) attributable to Invesco Mortgage Capital Inc.
(228,106
)
 
13,048

 
(215,058
)
Net income (loss) attributable to common stockholders
(245,484
)
 
13,048

 
(232,436
)
Earnings per share:
 
 
 
 
 
Net income (loss) attributable to common stockholders
 
 
 
 
 
   Basic
(1.99
)
 
0.10

 
(1.89
)
   Diluted
(1.99
)
 
0.10

 
(1.89
)
The following changes have been made to our Consolidated Statements of Comprehensive Income for the years ended December 31, 2015 and 2014:
 
Year Ended December 31, 2015
 
As Reported
 
Adjustment
 
As Revised
Net income (loss)
105,211

 
8,844

 
114,055

Unrealized gain (loss) on mortgage-backed and credit risk transfer securities, net
(185,416
)
 
(5,637
)
 
(191,053
)
Reclassification of unrealized (gain) loss on sale of mortgage-backed and credit risk transfer securities to gain (loss) on investments, net
(4,277
)
 
(3,207
)
 
(7,484
)
Total other comprehensive income (loss)
(122,968
)
 
(8,844
)
 
(131,812
)
$ in thousands
Year Ended December 31, 2014
 
As Reported
 
Adjustment
 
As Revised
Net income (loss)
(230,738
)
 
13,198

 
(217,540
)
Unrealized gain (loss) on mortgage-backed and credit risk transfer securities, net
431,198

 
(10,437
)
 
420,761

Reclassification of unrealized (gain) loss on sale of mortgage-backed and credit risk transfer securities to gain (loss) on investments, net
80,659

 
(2,761
)
 
77,898

Total other comprehensive income (loss)
597,033

 
(13,198
)
 
583,835

The following changes have been made to our Consolidated Statements of Cash Flows for the years ended December 31, 2015 and 2014:
$ in thousands
Year Ended December 31, 2015
 
As Reported
 
Adjustment
 
As Revised
Cash Flows from Operating Activities
 
 
 
 
 
Net income (loss)
105,211

 
8,844

 
114,055

Amortization of mortgage-backed and credit risk transfer securities premiums and (discounts), net
122,925

 
(5,637
)
 
117,288

(Gain) loss on investments, net
21,212

 
(3,207
)
 
18,005

Non-cash Investing and Financing Activities Information
 
 
 
 
 
Net change in unrealized gain on mortgage-backed and credit risk transfer securities
(189,693
)
 
(8,844
)
 
(198,537
)


 
124
 

Table of Contents

$ in thousands
Year Ended December 31, 2014
 
As Reported
 
Adjustment
 
As Revised
Cash Flows from Operating Activities
 
 
 
 
 
Net income (loss)
(230,738
)
 
13,198

 
(217,540
)
Amortization of mortgage-backed and credit risk transfer securities premiums and (discounts), net
124,369

 
(10,437
)
 
113,932

(Gain) loss on investments, net
87,168

 
(2,761
)
 
84,407

Non-cash Investing and Financing Activities Information
 
 
 
 
 
Net change in unrealized gain on mortgage-backed and credit risk transfer securities
511,857

 
(13,198
)
 
498,659



 
125
 

Table of Contents

Note 18 – Summarized Quarterly Results of Operations (Unaudited)
The following is a presentation of selected unaudited results of operations for the quarters ended.
$ in thousands except share amounts
Q4 16
 
Q3 16
 
Q2 16
 
Q1 16
 
Q4 15
 
Q3 15
 
Q2 15
 
Q1 15
Interest Income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed and credit risk transfer securities
108,871

 
112,467

 
112,860

 
122,246

 
128,049

 
128,305

 
128,491

 
139,048

Residential loans

 

 

 

 
22,907

 
28,380

 
30,247

 
29,374

Commercial loans
5,718

 
5,680

 
5,947

 
4,893

 
3,982

 
3,743

 
4,491

 
3,115

Total interest income
114,589

 
118,147

 
118,807

 
127,139

 
154,938

 
160,428

 
163,229

 
171,537

Interest Expense
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Repurchase agreements
26,048

 
24,892

 
31,260

 
41,800

 
41,348

 
41,303

 
40,931

 
43,310

Secured loans
2,738

 
2,746

 
2,688

 
2,715

 
1,940

 
1,622

 
1,553

 
1,464

Exchangeable senior notes
5,620

 
5,620

 
5,614

 
5,613

 
5,621

 
5,620

 
5,613

 
5,607

Asset-backed securities

 

 

 

 
17,128

 
20,686

 
22,329

 
21,898

Total interest expense
34,406

 
33,258

 
39,562

 
50,128

 
66,037

 
69,231

 
70,426

 
72,279

Net interest income
80,183

 
84,889

 
79,245

 
77,011

 
88,901

 
91,197

 
92,803

 
99,258

Reduction in provision for loan losses

 

 

 

 

 
(81
)
 
(70
)
 
(62
)
Net interest income after reduction in provision for loan losses
80,183

 
84,889

 
79,245

 
77,011

 
88,901

 
91,278

 
92,873

 
99,320

Other income (loss)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gain (loss) on investments, net
(23,402
)
 
(7,155
)
 
1,414

 
11,601

 
(29,024
)
 
(1,967
)
 
10,896

 
2,090

Equity in earnings of unconsolidated ventures
400

 
729

 
202

 
1,061

 
3,499

 
1,894

 
1,231

 
6,006

Gain (loss) on derivative instruments, net
230,713

 
35,378

 
(90,363
)
 
(238,543
)
 
68,296

 
(220,602
)
 
56,003

 
(122,745
)
Realized and unrealized credit derivative income (loss), net
3,579

 
31,926

 
17,228

 
8,410

 
(5,122
)
 
2,928

 
614

 
21,362

Other investment income (loss), net
(1,385
)
 
(554
)
 
(2,745
)
 
(318
)
 
(574
)
 
739

 
1,673

 
(894
)
Total other income (loss)
209,905

 
60,324

 
(74,264
)
 
(217,789
)
 
37,075

 
(217,008
)
 
70,417

 
(94,181
)
Expenses
10,745

 
8,555

 
10,957

 
11,549

 
13,074

 
14,697

 
13,551

 
13,298

Net income (loss)
279,343

 
136,658

 
(5,976
)
 
(152,327
)
 
112,902

 
(140,427
)
 
149,739

 
(8,159
)
Net income (loss) attributable to non-controlling interest
3,522

 
1,723

 
(75
)
 
(1,883
)
 
1,354

 
(1,628
)
 
1,712

 
(94
)
Net income (loss) attributable to Invesco Mortgage Capital Inc.
275,821

 
134,935

 
(5,901
)
 
(150,444
)
 
111,548

 
(138,799
)
 
148,027

 
(8,065
)
Dividends to preferred stockholders
5,716

 
5,716

 
5,716

 
5,716

 
5,716

 
5,716

 
5,716

 
5,716

Net income (loss) attributable to common stockholders
270,105

 
129,219

 
(11,617
)
 
(156,160
)
 
105,832

 
(144,515
)
 
142,311

 
(13,781
)
Earnings (loss) per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss) attributable to common stockholders
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
2.42

 
1.16

 
(0.10
)
 
(1.38
)
 
0.90

 
(1.18
)
 
1.16

 
(0.11
)
Diluted
2.15

 
1.05

 
(0.10
)
 
(1.38
)
 
0.83

 
(1.18
)
 
1.06

 
(0.11
)



 
126
 

Table of Contents

The tables below present the reconciliation of amounts previously reported on our consolidated statements of operations to corresponding revised amounts for those quarters not previously included in our periodic reports on Form 10-Q for the quarters ended June 30, 2016 and September 30, 2016. For further information, see Note 17 - "Revision of Previously Issued Financial Statements".
 
Three Months Ended
 
March 31, 2016
$ in thousands
As Reported
 
Adjustment
 
As Revised
Interest Income:
 
 
 
 
 
Mortgage-backed and credit risk transfer securities
121,087

 
1,159

 
122,246

Other income (loss):
 
 
 
 
 
Gain (loss) on investments, net
11,601

 

 
11,601

Net income (loss)
(153,486
)
 
1,159

 
(152,327
)
Net income (loss) attributable to non-controlling interest
(1,897
)
 
14

 
(1,883
)
Net income (loss) attributable to Invesco Mortgage Capital, Inc.
(151,589
)
 
1,145

 
(150,444
)
Net income (loss) attributable to common stockholders
(157,305
)
 
1,145

 
(156,160
)
Earnings per share:
 
 
 
 
 
Net income (loss) attributable to common stockholders
 
 
 
 
 
Basic
(1.39
)
 
0.01

 
(1.38
)
Diluted
(1.39
)
 
0.01

 
(1.38
)
 
Three Months Ended
 
December 31, 2015
$ in thousands
As Reported
 
Adjustment
 
As Revised
Interest Income:
 
 
 
 
 
Mortgage-backed and credit risk transfer securities
127,633

 
416

 
128,049

Other income (loss):
 
 
 
 
 
Gain (loss) on investments, net
(31,302
)
 
2,278

 
(29,024
)
Net income (loss)
110,208

 
2,694

 
112,902

Net income (loss) attributable to non-controlling interest
1,321

 
33

 
1,354

Net income (loss) attributable to Invesco Mortgage Capital, Inc.
108,887

 
2,661

 
111,548

Net income (loss) attributable to common stockholders
103,171

 
2,661

 
105,832

Earnings per share:
 
 
 
 
 
Net income (loss) attributable to common stockholders
 
 
 
 
 
Basic
0.88

 
0.02

 
0.90

Diluted
0.81

 
0.02

 
0.83





 
127
 

Table of Contents

 
Three Months Ended
 
March 31, 2015
$ in thousands
As Reported
 
Adjustment
 
As Revised
Interest Income:
 
 


 
 
Mortgage-backed and credit risk transfer securities
135,265

 
3,783

 
139,048

Other income (loss):
 
 


 
 
Gain (loss) on investments, net
2,172

 
(82
)
 
2,090

Net income (loss)
(11,860
)
 
3,701

 
(8,159
)
Net income (loss) attributable to non-controlling interest
(136
)
 
42

 
(94
)
Net income (loss) attributable to Invesco Mortgage Capital, Inc.
(11,724
)
 
3,659

 
(8,065
)
Net income (loss) attributable to common stockholders
(17,440
)
 
3,659

 
(13,781
)
Earnings per share:
 
 


 
 
Net income (loss) attributable to common stockholders
 
 


 
 
Basic
(0.14
)
 
0.03

 
(0.11
)
Diluted
(0.14
)
 
0.03

 
(0.11
)
Note 19 – Subsequent Events
We have reviewed subsequent events occurring through the date that these consolidated financial statements were issued, and determined that no subsequent events occurred that would require accrual or additional disclosure.




 
128
 

Table of Contents

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
Schedule IV
Mortgage Loans on Real Estate
As of December 31, 2016
$ in thousands
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Asset Type
 
Description
 
Number of loans
 
Interest Rate
 
Maturity Date
 
Periodic Payment Terms(1)
 
Prior Liens
 
Face Amount of Mortgages
 
Carrying Amount of Mortgages
 
Principal Amount of Loans Subject to Delinquent Principal or Interest
Mezzanine Loans
 
Various
 
10

 
LIBOR+6.75% to 9.35% or 7.5% Fixed
 
04/22/2017 to 03/31/2019
 
I
 

 
273,666

 
273,355

 

 
 
 
 
 
 
 
 
 
 
 
 

 
273,666

 
273,355

 

(1) Interest ("I") only until stated maturity of the loan.
 
Reconciliation of Carrying Value of Mortgage Loans on Real Estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2016
 
2015
 
2014
Beginning balance
 
 
 
 
 
 
 
 
 
 
 
209,062

 
3,510,759

 
1,874,861

Additions:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal amount of new loans
 
 
 
 
 
 
 
 
 
 
 
87,474

 
530,399

 
1,887,391

Premium (discount) on new loans
 
 
 
 
 
 
 
 
 
(272
)
 
(131
)
 
12,730

Capitalized interests
 
 
 
 
 
 
 
 
 

 

 
768

Amortization of premium (discount)
 
 
 
 
 
 
 
 
 
302

 
(6,204
)
 
(6,368
)
Deductions:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Collection of principal
 
 
 
 
 
 
 
 
 
 
 
15,000

 
642,361

 
256,061

(Reduction in) provision for loan losses
 
 
 
 
 
 
 
 
 
 
 

 
(213
)
 
(142
)
Loss on foreign currency revaluation
 
 
 
 
 
 
 
 
 
8,211

 
1,951

 
2,704

Deconsolidation of VIEs
 
 
 
 
 
 
 
 
 
 
 

 
3,181,662

 

Ending balance
 
 
 
 
 
 
 
 
 
 
 
 
 
273,355

 
209,062

 
3,510,759




 
129
 

Table of Contents

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
Invesco Mortgage Capital Inc.
 
 
 
 
By:
/s/ Richard J. King
 
 
Richard J. King
President and Chief Executive Officer
 
Date:
February 21, 2017
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
 
Signatures
 
Title
 
Date
 
 
 
 
 
 
By:
/s/ Richard J. King
 
President and Chief Executive Officer
 
February 21, 2017
 
Richard J. King
 
(principal executive officer)
 
 
 
 
 
 
 
 
By:
/s/ Richard Lee Phegley, Jr.
 
Chief Financial Officer
 
February 21, 2017
 
Richard Lee Phegley, Jr.
 
(principal financial and accounting officer)
 
 
 
 
 
 
 
 
By:
/s/ James S. Balloun
 
Director
 
February 21, 2017
 
James S. Balloun
 
 
 
 
 
 
 
 
 
 
By:
/s/ John S. Day
 
Director
 
February 21, 2017
 
John S. Day
 
 
 
 
 
 
 
 
 
 
By:
/s/ Karen Dunn Kelley
 
Director
 
February 21, 2017
 
Karen Dunn Kelley
 
 
 
 
 
 
 
 
 
 
By:
/s/ Edward J. Hardin
 
Director
 
February 21, 2017
 
Edward J. Hardin
 
 
 
 
 
 
 
 
 
 
By:
/s/ James R. Lientz, Jr.
 
Director
 
February 21, 2017
 
James R. Lientz, Jr.
 
 
 
 
 
 
 
 
 
 
By:
/s/ Gregory G. McGreevey
 
Director
 
February 21, 2017
 
Gregory G. McGreevey
 
 
 
 


 
130