form10q-051410.htm
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-Q

 (Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2010
 
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
 

 
INVESCO MORTGAGE CAPITAL INC.
(Exact Name of Registrant as Specified in Its Charter)

 
Maryland
26-2749336
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
 
1555 Peachtree Street, N.E., Suite 1800
Atlanta, Georgia
 
 
30309
(Address of Principal Executive Offices)
(Zip Code)
 
(404) 892-0896
(Registrant’s Telephone Number, Including Area Code) 

 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 and Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes  ¨    No  ¨
 
Indicate by check mark whether the registrant is a large accelerated filed, 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  ¨                                                      Accelerated filer  ¨
 
          Non-Accelerated filer x                                              Smaller reporting company   ¨
 
          (Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  ¨    No  x

As of May 14, 2010, there were 25,938,046 outstanding shares of common stock of Invesco Mortgage Capital Inc.
 

 
INVESCO MORTGAGE CAPITAL INC.
TABLE OF CONTENTS
 
 
PART I.                      FINANCIAL INFORMATION
Page
Item 1.
Consolidated Financial Statements
 
     
 
Consolidated Balance Sheets as of March 31, 2010 (unaudited) and December 31, 2009
1
     
 
Unaudited Consolidated Statements of Operations for the three months ended March 31, 2010 and 2009
2
     
 
Unaudited Consolidated Statement of Shareholders’ Equity and Comprehensive Income for the three months ended March 31, 2010
3
     
 
Unaudited Consolidated Statements of Cash Flows for the three months ended March 31, 2010 and 2009
4
     
 
Notes to Consolidated Financial Statements
5
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
20
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
33
     
Item 4T.
Controls and Procedures
35
     
PART II.                      OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
36
     
Item 1A.
Risk Factors
36
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
36
     
Item 3.
Defaults Upon Senior Securities
36
     
Item 4.
Reserved
36
     
Item 5.
Other Information
36
     
Item 6.
Exhibits
38

 
 

 
PART I
ITEM 1.                      FINANCIAL STATEMENTS


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS



$ in thousands, except per share amounts
           
ASSETS
 
March 31,
2010
   
December 31,
2009
 
   
(Unaudited)
       
 
Mortgage-backed securities, at fair value
    1,436,005       802,592  
Cash
    9,186       24,041  
Restricted cash
    30,614       14,432  
Principal paydown receivable
    12,287       2,737  
Investments in unconsolidated limited partnerships, at fair value
    28,683       4,128  
Accrued interest receivable
    6,270       3,518  
Derivative asset, at fair value
    44        
Prepaid insurance
    335       681  
Deferred offering costs
          288  
Other assets
    504       983  
Total assets
    1,523,928       853,400  
                 
LIABILITIES AND EQUITY
               
Liabilities:
               
Repurchase agreements
    961,163       545,975  
TALF financing
    151,819       80,377  
Derivative liability, at fair value
    9,197       3,782  
Dividends and distributions payable
    14,323       10,828  
Payable for investment securities purchased
    12,357        
Accrued interest payable
    977       598  
Accounts payable and accrued expenses
    820       665  
Due to affiliate
    1,296       865  
Total liabilities
    1,151,952       643,090  
                 
Equity:
               
Preferred Stock: par value $0.01 per share; 50,000,000 shares authorized, 0 shares issued and outstanding
           
Common Stock: par value $0.01 per share; 450,000,000 shares authorized, 16,938,046 and 8,887,212 shares issued and outstanding, at March 31, 2010 and December 31, 2009, respectively
    170       89  
Additional paid in capital
    334,904       172,385  
Accumulated other comprehensive income
    7,533       7,721  
Retained earnings (deficit)
    (843 )     320  
Total shareholders’ equity
    341,764       180,515  
                 
Non-controlling interest
    30,212       29,795  
Total equity
    371,976       210,310  
                 
Total liabilities and equity
    1,523,928       853,400  


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

 

 

INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
  
$ in thousands, except per share data
 
For the Three Months Ended March 31, 2010
   
For the Three Months Ended March 31, 2009
 
Revenues
           
Interest income
    18,010        
Interest expense
    3,652        
Net interest income
    14,358        
                 
Other income (loss)
Gain on sale of investments
    733        
Equity in earnings and fair value change in unconsolidated limited partnerships
    446        
Loss on other-than-temporarily impaired securities
    (124 )      
Unrealized loss on interest rate swaps
    (25 )      
Total other income
    1,030        
                 
Expenses
               
Management fee – related party
    1,284        
General and administrative
    182       45  
Insurance
    346        
Professional Fees
    409       3  
Total expenses
    2,221       48  
Net income (loss)
    13,167       (48 )
                 
Net income attributable to non-controlling interest
    1,118        
Net income (loss) attributable to common shareholders
    12,049       (48 )
Earnings per share:
               
Net income attributable to common shareholders (basic/diluted)
    0.77    
NM
 
Dividends declared per common share
    0.78        
Weighted average number of shares of common stock:
               
Basic
    15,685    
NM
 
Diluted
    17,111    
NM
 
                 

NM = not meaningful

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

  2
 

 


 
INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
For the three months ended March 31, 2010
(Unaudited)

   
Attributable to Common Shareholders
                   
$ in thousands, except per share amounts
 
Common Stock
Shares Amount
   
Additional Paid in Capital
   
Accumulated Other Comprehensive Income (Loss)
   
Retained Earnings (Deficit)
   
Total Shareholders
Equity
   
Non-Controlling Interest
   
Total Equity
   
Comprehensive Income (Loss)
 
Balance at January 1, 2010
    8,887,212       89       172,385       7,721       320       180,515       29,795       210,310       26,470  
Net income
                            12,049       12,049       1,118       13,167       13,167  
Comprehensive income
                                                                       
Change in net unrealized gains and losses on available for sale securities
                      4,531             4,531       1,035       5,566       5,566  
Change in net unrealized gains and losses on derivatives
                      (4,719 )           (4,719 )     (627 )     (5,346 )     (5,346 )
Total comprehensive income
                                                                    39,857  
Net proceeds from common stock, net of offering costs
    8,050,000       81       162,501                   162,582             162,582          
Stock awards to directors
    834                                                    
Common stock dividends
                            (13,212 )     (13,212 )           (13,212 )        
Common unit dividends
                                        (1,112 )     (1,112 )        
Amortization of equity-based compensation
                18                   18       3       21          
Balance at March 31, 2010
    16,938,046       170       334,904       7,533       (843 )     341,764       30,212       371,976          


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

 

 
 
 
INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
$ in thousands
 
Three Months Ended March 31, 2010
   
Three Months Ended March 31, 2009
 
Cash Flows from Operating Activities
           
Net income (loss)
    13,167       (48 )
Adjustments to reconcile net income to net cash provided by operating activities
               
Amortization of mortgage-backed securities premiums and discounts, net
    (1,925 )      
Unrealized loss on derivatives
    25        
Gain on sale of mortgage-backed securities
    (733 )      
Loss on other-than-temporarily impaired securities
    124        
Equity in earnings and fair value change in unconsolidated limited partnerships
    (446 )      
Amortization of equity-based compensation
    21        
Changes in operating assets and liabilities
               
Increase in accrued interest
    (2,752 )      
(Increase) decrease in prepaid insurance
    346        
(Increase) decrease in deferred offering costs
    20       (235 )
Increase in other assets
    480        
Increase in accrued interest payable
    379        
Increase in due to affiliate
    529       283  
Increase (decrease) in accounts payable and accrued expenses
    324        
Net cash provided by operating activities
    9,559        
                 
Cash Flows from Investing Activities
               
Purchase of mortgage-backed securities
    (775,561 )      
Investment in PPIP
    (11,771 )      
Principal payments of mortgage-backed securities
    65,868        
Proceeds from sale of mortgage-backed securities
    74,849        
Net cash used in investing activities
    (646,615 )      
                 
Cash Flows from Financing Activities
               
Proceeds from issuance of common stock
    162,582        
Restricted cash
    (16,182 )      
Proceeds from repurchase agreements
    2,527,880        
Principal repayments of repurchase agreements
    (2,112,692 )      
Proceeds from TALF financing
    71,525        
Principal payments of TALF financing
    (84 )      
Payments of dividends and distributions
    (10,828 )      
Net cash provided by financing activities
    622,201        
                 
Net change in cash
    (14,855 )      
Cash, Beginning of Period
    24,041       1  
                 
Cash, End of Period
    9,186       1  
Supplement disclosure of cash flow information
               
Interest paid
    3,273        
                 
Non-cash investing and financing activities information
               
Net change in unrealized gain (loss) on available-for-sale securities and derivatives
    220        
Net change in investment in PPIP
    12,339        
 
Dividends and distributions declared not paid
     14,323        
                 

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

4  
 

 

 
INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
Note 1 – Organization and Business Operations

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

The Company conducts its business through IAS Operating Partnership LP (the “Operating Partnership”) as its sole general partner. As of March 31, 2010, the Company owned 92.2% of the Operating Partnership and Invesco Investments (Bermuda) Ltd., a direct, wholly-owned subsidiary of Invesco, owned the remaining 7.8%.
 
The Company finances its Agency RMBS and Non-Agency RMBS and some of its CMBS investments, through short-term borrowings structured as repurchase agreements. The Manager has secured commitments for the Company with a number of repurchase agreement counterparties. In addition, the Company has financed its CMBS portfolio with financings under the Term Asset-Backed Securities Lending Facility (“TALF”). The Company has also financed, and may do so again in the future, investments in CMBS under private equity sources.  The Company also finances its investments in certain Non-Agency RMBS, CMBS and residential and commercial mortgage loans by contributing capital to a partnership that invests in public-private investment funds (“PPIF”) managed by the Company’s Manager. In addition, the Company may use other sources of financing including committed borrowing facilities and other private financing.

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

Note 2 – Summary of Significant Accounting Policies

Basis of Quarterly Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial position and the results of operations of the Company for the interim periods presented have been included. The interim consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2009 which was filed with the Securities and Exchange Commission (the “SEC”) on March 24, 2010 and amended on April 29, 2010. The results of operations for the interim period ended March 31, 2010 are not necessarily indicative of the results to be expected for the full year or any other future period.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany balances and transactions have been eliminated.

 
 

5
 

 

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

The Company considers all highly liquid investments that have original or remaining maturity dates of three months or less when purchased to be cash equivalents. At March 31, 2010, the Company had cash and cash equivalents, including amounts restricted, in excess of the Federal Deposit Insurance Corporation deposit insurance limit of $250,000 per institution. The Company mitigates its risk by placing cash and cash equivalents with major financial institutions.

Deferred Offering Costs
 
The Company records costs associated with stock offerings as a reduction in additional paid in capital.  At December 31, 2009, deferred offering costs consisted of legal and other costs of approximately $288,000 related to the follow-on public offering completed on January 15, 2010 (the “January Offering”).

Underwriting Commissions and Costs

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

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

In instances where the Company acquires Agency RMBS, Non-Agency RMBS or CMBS through repurchase agreements with the same counterparty from whom the Agency RMBS, Non-Agency RMBS or CMBS were purchased, the Company accounts for the purchase commitment and repurchase agreement on a net basis and records a forward commitment to purchase Agency RMBS, Non-Agency RMBS or CMBS as a derivative instrument if the transaction does not comply with the criteria for gross presentation. All of the following criteria must be met for gross presentation in the circumstance where the repurchase assets are financed with the same counterparty as follows:
 
·  
the initial transfer of and repurchase financing cannot be contractually contingent;
·  
the repurchase financing entered into between the parties provides full recourse to the transferee and the repurchase price is fixed;
·  
the financial asset has an active market and the transfer is executed at market rates; and
·  
the repurchase agreement and financial asset do not mature simultaneously.

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

If the transaction complies with the criteria for gross presentation, the Company records the assets and the related financing on a gross basis on its balance sheet, and the corresponding interest income and interest expense in its statements of operations. Such forward commitments are recorded at fair value with subsequent changes in fair value recognized in income. Additionally, the Company records the cash portion of its investment in Agency RMBS and Non-Agency RMBS as a mortgage related receivable from the counterparty on its balance sheet.
 

 

 

 
Fair Value Measurements
 
In January 2010, the FASB updated guidance entitled, “Improving Disclosures about Fair Value Measurements.” The guidance required a number of additional disclosures regarding fair value measurements. Specifically, entities should disclose: (1) the amount of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers; (2) the reasons for any transfers in or out of Level 3; and (3) information in the reconciliation of recurring Level 3 measurements about purchases, sales, issuances and settlements on a gross basis. Except for the requirement to disclose information about purchases, sales, issuances, and settlements in the reconciliation of recurring Level 3 measurements on a gross basis, all the amendments are effective for interim and annual reporting periods beginning after December 15, 2009. The Company adopted these provisions in preparing the Consolidated Financial Statements for the period ended March 31, 2010.  The adoption of these provisions only affected the disclosure requirements for fair value measurements and as a result had no impact on the Company’s consolidated statements of operations and consolidated balance sheets.

The Company discloses the fair value of its financial instruments according to a fair value hierarchy (levels 1, 2, and 3, as defined). In accordance with US GAAP, the Company is required to provide enhanced disclosures regarding instruments in the level 3 category (which require significant management judgment), including a separate reconciliation of the beginning and ending balances for each major category of assets and liabilities.
 
Additionally, US GAAP permits entities to choose to measure many financial instruments and certain other items at fair value (the “fair value option”). Unrealized gains and losses on items for which the fair value option has been elected are irrevocably recognized in earnings at each subsequent reporting date.

During 2009, the Company elected the fair value option for its investments in unconsolidated limited partnerships. The Company has the one-time option to elect fair value for these financial assets on the election date. The changes in the fair value of these instruments are recorded in equity in earnings and fair value change in unconsolidated limited partnerships in the consolidated statements of operations.

Securities

The Company designates securities as held-to-maturity, available-for-sale, or trading depending on its ability and intent to hold such securities to maturity. Trading and securities available-for-sale are reported at fair value, while securities held-to-maturity are reported at amortized cost. Although the Company generally intends to hold most of its RMBS and CMBS until maturity, the Company may, from time to time, sell any of its RMBS or CMBS as part of its overall management of its investment portfolio and as such will classify its RMBS and CMBS as available-for-sale securities.
 
All securities classified as available-for-sale are reported at fair value, based on market prices from third-party sources, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity.  When applicable, included with available-for-sale securities are forward purchase commitments on to be announced securities (“TBA”).  The Company records TBA purchases on the trade date and the corresponding payable is recorded as an outstanding liability in payable for investments purchased until the settlement date of the transaction.

The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. The determination of whether a security is other-than-temporarily impaired involves judgments and assumptions based on subjective and objective factors. Consideration is given to (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of recovery, in fair value of the security, and (iii) the Company’s intent and ability to retain its investment in the security for a period of time sufficient to allow for any anticipated recovery in fair value. For debt securities, the amount of the other-than-temporary impairment related to a credit loss or impairments on securities that the Company has the intent or for which it is more likely than not that the Company will need to sell before recovery are recognized in earnings and reflected as a reduction in the cost basis of the security. The amount of the other-than-temporary impairment on debt securities related to other factors is recorded consistent with changes in the fair value of all other available-for-sale securities as a component of consolidated shareholders’ equity in other comprehensive income or loss with no change to the cost basis of the security. 
 
 
 

 
 

 


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

Investments in Unconsolidated Limited Partnerships

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

The Company elected the fair value option for investments in unconsolidated limited partnerships. The election for investments in unconsolidated limited partnerships was made upon their initial recognition in the financial statements. The Company has elected the fair value option for the investments in unconsolidated limited partnerships for the purpose of enhancing the transparency of its financial condition.

The Company measures the fair value of the investments in unconsolidated limited partnerships on the basis of the net asset value per share of the investments as permitted in guidance effective for the interim and annual periods ended after December 15, 2009.

Dividends and Distributions Payable

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

Earnings per Share
 
The Company calculates basic earnings per share by dividing net income for the period by weighted-average shares of the Company’s common stock outstanding for that period. Diluted income per share takes into account the effect of dilutive instruments, such as units of limited partnership interest in the Operating Partnership (“OP Units”), stock options and unvested restricted stock, but 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.   For the three months ended March 31, 2009, earnings per share is not presented because it is not a meaningful measure of the Company’s performance.

Comprehensive Income

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

 

 


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

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

Income Taxes
 
The Company intends to elect and qualify to be taxed as a REIT, commencing with the Company’s taxable year ended December 31, 2009. Accordingly, the Company will generally not be subject to U.S. federal and applicable state and local corporate income tax to the extent that the Company makes qualifying distributions to its shareholders, and provided the Company satisfies on a continuing basis, through actual investment and operating results, the REIT requirements including certain asset, income, distribution and stock ownership tests. If the Company fails to qualify as a REIT, and does not qualify for certain statutory relief provisions, it will be subject to U.S. federal, state and local income taxes and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year in which the Company lost its REIT qualification. Accordingly, the Company’s failure to qualify as a REIT could have a material adverse impact on its results of operations and amounts available for distribution to its shareholders.
 
A REIT’s dividend paid deduction for qualifying dividends to the Company’s shareholders is computed using its taxable income as opposed to net income reported on the consolidated financial statements. Taxable income, generally, will differ from net income reported on the consolidated financial statements because the determination of taxable income is based on tax regulations and not financial accounting principles.
 
The Company may elect to treat certain of its future subsidiaries as taxable REIT subsidiaries (“TRS”). In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate-related business. A TRS is subject to U.S. federal, state and local corporate income taxes.
 
While a TRS will generate net income, a TRS can declare dividends to the Company which will be included in its taxable income and necessitate a distribution to its shareholders. Conversely, if the Company retains earnings at a TRS level, no distribution is required and the Company can increase book equity of the consolidated entity. The Company has no adjustments regarding its tax accounting treatment of any uncertainties. The Company expects to recognize interest and penalties related to uncertain tax positions, if any, as income tax expense, which will be included in general and administrative expense.

  9
 

 


Share-Based Compensation
 
Share-based compensation arrangements include share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Compensation cost relating to share-based payment transactions are recognized in the consolidated financial statements, based on the fair value of the equity or liability instruments issued on the date of grant, for awards to the Company’s independent directors. Compensation related to stock awards to officers and employees of the Manager are recorded at the estimate fair value of the award during the vesting period. The Company makes an upward or downward adjustment to compensation expense for the difference in the fair value at the date of grant and the date the award was earned.
 
On July 1, 2009, the Company adopted an equity incentive plan under which its independent directors, as part of their compensation for serving as directors, are eligible to receive quarterly restricted stock awards. In addition, the Company may compensate its officers and employees of the Manager under this plan pursuant to the management agreement.
 
Note 3 – Mortgage-Backed Securities

    All of the Company’s MBS are classified as available-for-sale and, as such, are reported at fair value, determined by obtaining valuations from an independent source. If the fair value of a security is not available from a dealer or third-party pricing service, or such data appears unreliable, the Company may estimate the fair value of the security using a variety of methods including other pricing services, repurchase agreement pricing, discounted cash flow analysis, matrix pricing, option adjusted spread models and other fundamental analysis of observable market factors. At March 31, 2010, all of the Company’s MBS values were based on third-party values. The following tables present certain information about the Company’s investment portfolio at March 31, 2010 and December 31, 2009.  
 
 
March 31, 2010
 
$ in thousands
 
Principal Balance
   
Unamortized Premium (Discount)
   
Amortized Cost
   
Unrealized
Gain/
(Loss)
   
Fair
Value
   
Net Weighted Average Coupon (1)
   
Average Yield (2)
 
Agency RMBS:
                                         
15 year fixed-rate
    292,729       11,512       304,241       3,276       307,517       4.86 %     3.54 %
30 year fixed-rate
    342,080       22,672       364,752       870       365,622       5.90 %     3.94 %
ARM
    9,377       208       9,585       (257 )     9,328       3.08 %     2.53 %
Hybrid ARM
    128,763       6,027       134,790       (353 )     134,437       4.98 %     2.78 %
Total Agency
    772,949       40,419       813,368       3,536       816,904       5.32 %     3.58 %
                                                         
MBS – CMO
    23,411       739       24,150       575       24,725       6.33 %     4.88 %
Non-Agency MBS
    613,798       (241,270 )     372,528       6,804       379,332       3.80 %     11.58 %
CMBS
    209,512       (1,861 )     207,651       7,393       215,044       5.07 %     5.27 %
Total
    1,619,670       (201,973 )     1,417,697       18,308       1,436,005       4.72 %     5.95 %
 
 

 
December 31, 2009
 
$ in thousands
 
Principal Balance
   
Unamortized Premium (Discount)
   
Amortized Cost
   
Unrealized
Gain/
(Loss)
   
Fair
Value
   
Net Weighted Average Coupon (1)
   
Average Yield (2)
 
Agency RMBS:
                                         
15 year fixed-rate
    251,752       9,041       260,793       1,023       261,816       4.82 %     3.80 %
30 year fixed-rate
    149,911       10,164       160,075       990       161,065       6.45 %     5.02 %
     ARM
    10,034       223       10,257       (281 )     9,976       2.52 %     1.99 %
     Hybrid ARM
    117,163       5,767       122,930       597       123,527       5.14 %     3.55 %
Total Agency
    528,860       25,195       554,055       2,329       556,384       5.31 %     4.07 %
                                                         
MBS – CMO
    27,819       978       28,797       936       29,733       6.34 %     4.83 %
Non-Agency MBS
    186,682       (79,341 )     107,341       7,992       115,333       4.11 %     17.10 %
CMBS
    104,512       (4,854 )     99,658       1,484       101,142       4.93 %     5.97 %
Total
    847,873       (58,022 )     789,851       12,741       802,592       5.03 %     6.10 %
_____________________
(1) Net weighted average coupon (“WAC”) is presented net of servicing and other fees.
(2) Average yield incorporates future prepayment and loss assumptions.

10 
 

 


The components of the carrying value of the Company’s investment portfolio at March 31, 2010 and December 31, 2009 are presented below.

$ in thousands
 
March 31, 2010
   
December 31, 2009
 
Principal balance
    1,619,670       847,873  
Unamortized premium
    43,549       26,174  
Unamortized discount
    (245,522 )     (84,196 )
Gross unrealized gains
    28,133       14,595  
Gross unrealized losses
    (9,825 )     (1,854 )
Fair value
    1,436,005       802,592  

 
The following table summarizes certain characteristics of the Company’s investment portfolio, at fair value, according to estimated weighted average life classifications as of March 31, 2010:
 
$ in thousands
 
March 31, 2010
   
December 31, 2009
 
Less than one year
    1,382        
Greater than one year and less than five years
    813,500       483,540  
Greater than or equal to five years
    621,123       319,052  
Total
    1,436,005       802,592  

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

 During the three months ended March 31, 2010, the trustees of certain non-Agency RMBS notified the Company that due to the deterioration in the credit quality of the underlying collateral in these securitizations, a portion of the principal of these securities had no value. Accordingly, the Company recognized a $124,000 loss on other-than-temporarily impaired securities in the consolidated statement of operations for the three months ended March 31, 2010, which had been included in accumulated other comprehensive income.

The following tables present the gross unrealized losses and estimated fair value of the Company’s RMBS by length of time that such securities have been in a continuous unrealized loss position at March 31, 2010 and December 31, 2009, respectively:

March 31, 2010
 
Less than 12 Months
   
12 Months or More
   
Total
 
$ in thousands
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
Agency RMBS:
                                   
15 year fixed-rate
    26,814       (70 )                 26,814       (70 )
30 year fixed-rate
    182,629       (1,277 )                 182,629       (1,277 )
ARM
    9,328       (257 )                 9,328       (257 )
Hybrid ARM
    66,962       (706 )                 66,962       (706 )
Total Agency
    285,733       (2,310 )                 285,733       (2,310 )
                                                 
MBS – CMO
    8,111       (50 )                 8,111       (50 )
Non-Agency MBS
    225,759       (7,131 )                 225,759       (7,131 )
CMBS
    41,159       (334 )                 41,159       (334 )
Total
    560,762       (9,825 )                 560,762       (9,825 )
 
 
 
 
 
 
 
 
 

11 
 

 

 

 
December 31, 2009
 
Less than 12 Months
   
12 Months or More
   
Total
 
$ in thousands
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
Agency RMBS:
                                   
15 year fixed-rate
    42,446       (82 )                 42,446       (82 )
30 year fixed-rate
    22,195       (70 )                 22,195       (70 )
ARM
    9,976       (281 )                 9,976       (281 )
Hybrid ARM
                                   
Total Agency
    74,617       (433 )                 74,617       (433 )
                                                 
MBS – CMO
                                   
Non-Agency MBS
    13,499       (1,044 )                 13,499       (1,044 )
CMBS
    18,281       (376 )                 18,281       (376 )
Total
    106,397       (1,853 )                 106,397       (1,853 )

 
Note 4 – Investments in Unconsolidated Limited Partnerships

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

The Company invested in certain Non-Agency RMBS, CMBS and residential and commercial mortgage loans by contributing equity capital to a legacy securities PPIF established and managed by the Manager or one of its affiliates, Invesco Mortgage Recovery Feeder Fund, L.P. (the “Fund”) that receives financing under the U.S. government’s Public-Private Investment Program (“PPIP”). In addition the Manager identified a whole loan transaction, which resulted in the Company being admitted into an alternative investment vehicle, the Invesco Mortgage Recovery Loans AIV, L.P. (an “AIV”). The Company’s initial commitment in the Fund and AIV was $25.0 million. The Fund and AIV limited partnership agreements provided for additional subscriptions of limited partners within six months of the initial closing. During 2009 and 2010 the Fund and AIV accepted additional subscriptions and the Company increased its overall commitment to $100.0 million which effectively increased the Company’s initial ownership interest in the Fund and AIV. In connection with the increase of the Company’s interest in the Fund and AIV, the Company is committed to fund approximately $12.1 million of additional capital at March 31, 2010. The Company realized approximately $230,000 of equity in earnings and $216,000 of unrealized appreciation from these investments for the three months ended March 31, 2010.

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

Note 5 – Borrowings

Repurchase Agreements

The Company has entered into repurchase agreements to finance a portion of its portfolio of investments. The repurchase agreements bear interest at a contractually agreed rate. The repurchase obligations mature and reinvest every thirty to ninety days and have a weighted average aggregate interest rate of 0.47% and 0.26% at March 31, 2010 and December 31, 2009, respectively. These repurchase agreements are being accounted for as secured borrowings since the Company maintains effective control of the financed assets.  The following table summarizes certain characteristics of the Company’s repurchase agreements at March 31, 2010 and December 31, 2009:
 
 
$ in thousands
 
March 31, 2010
   
December 31, 2009
 
   
Amount Outstanding
   
Weighted Average
   
Amount Outstanding
   
Weighted Average
 
Agency RMBS
    773,490       0.24 %     545,975       0.26 %
Non-Agency RBS
    169,534       1.49 %            
CMBS
    18,139       1.05 %            
Total
    961,163       0.47 %     545,975       0.26 %


  12
 

 


Under the repurchase agreements, the respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets would require the Company to provide additional collateral or fund margin calls.

The following tables summarize certain characteristics of the Company’s repurchase agreements at March 31, 2010 and December 31, 2009:
 
March 31, 2010
$ in thousands
Purchase
A greement
Counterparties
 
Amount Outstanding
   
Percent of Total Amount Outstanding
   
 
 
Company MBS Held as Collateral
 
Credit Suisse
    362,426       38 %     422,698  
Barclay's Bank
    59,581       6 %     62,610  
RBS Securities
    127,199       13 %     157,560  
Deutsche Bank
    77,279       8 %     82,236  
Goldman Sachs
    173,260       18 %     182,031  
BNP Paribas
    70,265       7 %     72,613  
Wells Fargo
    60,605       7 %     62,960  
Nomura
    30,548       3 %     32,158  
Total
    961,163       100 %     1,074,866  
 
December 31, 2009
$ in thousands
Purchase
Agreement
Counterparties
 
Amount Outstanding
   
Percent of Total Amount Outstanding
   
 
 
 
Company MBS Held as Collateral
 
Credit Suisse
    109,697       20 %     110,501  
Barclay's Bank
    62,279       12 %     64,228  
RBS Securities
    83,093       15 %     86,503  
Deutsche Bank
    115,764       21 %     113,804  
Goldman Sachs
    175,142       32 %     182,731  
Total
    545,975       100 %     557,767  

Cash collateral held by the counterparties at March 31, 2010 and December 31, 2009 were $29.5 million and $14.0 million, respectively.

TALF Financing

Under the TALF, the Federal Reserve made non-recourse loans to borrowers to fund purchases of asset-backed securities (“ABS”).  The TALF facility ceased making loans collateralized by newly issued and legacy ABS on March 31, 2010.  The Company has secured borrowings of $151.8 million under the TALF at a weighted average interest rate of 3.56% and 3.82% at March 31, 2010 and December 31, 2009, respectively. The TALF loans are non-recourse. However, they are secured by $194.6 million of CMBS, and mature in February 2013, July 2014, August 2014, December 2014 and January 2015.

At March 31, 2010, the TALF financing agreements had the following remaining maturities:
 
$ in thousands
 
March 31, 2010
 
2011
     
2012
     
2013
    33,764  
2014
    80,342  
2015
    37,713  
Thereafter
     
Total
    151,819  


  13
 

 

Note 6 Derivatives and Hedging Activities

Risk Management Objective of Using Derivatives

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

Cash Flow Hedges of Interest Rate Risk

The Company finances its activities primarily through repurchase agreements, which are generally settled on a short-term basis, usually from one to three months. At each settlement date, the Company refinances each repurchase agreement at the market interest rate at that time. Since the interest rate on its repurchase agreements change on a monthly basis, the Company is exposed to changing interest rates. The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

The effective portion of changes in the fair value of derivatives designated and qualifying as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three months ended March 31, 2010, the Company recorded $25,000 of unrealized swap losses in earnings as hedge ineffectiveness attributable primarily to differences in the reset dates on the Company’s swaps versus the refinancing dates of certain of its repurchase agreements.
 
Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest is accrued and paid on the Company’s repurchase agreements. During the next twelve months, the Company estimates that an additional $13.0 million will be reclassified as an increase to interest expense.
 
The Company is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of 64 months.
 
As of March 31, 2010, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:
 
 
 
Counterparty
 
Notional Amount $ - in thousands
 
 
Maturity Date
 
Fixed Interest Rate in Contract
 
The Bank of New York Mellon
    175,000  
8/5/2012
    2.07 %
SunTrust Bank
    100,000  
7/15/2014
    2.79 %
Credit Suisse International
    100,000  
2/24/2015
    3.26 %
Credit Suisse International
    100,000  
3/24/2015
    2.76 %
The Bank of New York Mellon
    100,000  
5/24/2013
    1.83 %
Wells Fargo Bank, N.A.
    100,000  
7/15/2015
    2.85 %
Total/Weighted Average
    675,000         2.54 %

 
At March 31, 2010, the Company’s counterparties held approximately $1.1 million of cash margin deposits and approximately $13.2 million of RMBS as collateral against its swap contracts.  The cash is classified as restricted cash and the agency RMBS is included in the total mortgage-backed securities on our consolidated balance sheet.
 
 


  14
 

 


 
The table below presents the fair value of the Company’s derivative financial instruments, as well as their classification on the balance sheet as of March 31, 2010 and December 31, 2009.

$ in thousands
Asset Derivatives
 
Liability Derivatives
As of March 31, 2010
 
As of December 31, 2009
 
As of March 31, 2010
 
As of December 31, 2009
Balance Sheet
 
Fair Value
 
Balance Sheet
 
Fair Value
 
Balance Sheet
 
Fair Value
 
Balance Sheet
 
Fair Value
Interest rate swap asset
 
44
 
Interest rate swap asset
 
 
Interest rate swap liability
 
9,197
 
Interest rate swap liability
 
3,782

Tabular Disclosure of the Effect of Derivative Instruments on the Income Statement
 
The table below presents the effect of the Company’s derivative financial instruments on the statement of operations for the three months ended March 31, 2010.

$ in thousands
Derivative
type for
cash flow
hedge
  
Amount of loss recognized
in OCI on derivative
(effective portion)
  
Location of loss
reclassified from
accumulated
OCI into
income
(effective
portion)
  
Amount of loss
reclassified from
accumulated OCI into
income (effective
portion)
  
Location of loss
recognized in
income on
derivative
(ineffective
portion)
  
Amount of loss
recognized in income
on derivative
(ineffective portion)
Interest Rate Swap
  
7,145
 
  
Interest Expense
  
1,799
 
  
Other Expense
  
 
25

Credit-risk-related Contingent Features

The Company has agreements with each of its derivative counterparties. Some of those agreements contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.
 
The Company has an agreement with one of its derivative counterparties that contains a provision where if the Company’s net asset value declines by certain percentages over specified time periods, then the Company could be declared in default on its derivative obligations. The Company also has an agreement with one of its derivative counterparties that contains a provision where if the Company’s shareholders’ equity declines by certain percentages over specified time periods, then the Company could be declared in default on its derivative obligations.

The Company has an agreement with one of its derivative counterparties that contains a provision where if the Company fails to maintain a minimum shareholders’ equity or market value of $80 million, then the Company could be declared in default on its derivative obligations.

As of March 31, 2010, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $9.7 million. The Company has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of approximately $1.1 million of cash and $13.2 million of RMBS. If the Company had breached any of these provisions at March 31, 2010, it could have been required to settle its obligations under the agreements at their termination value.

Note 7 – Financial Instruments

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

Valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions. These inputs into the following hierarchy:

15 
 

 


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

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

·  
Level 3 Inputs – Instruments with primarily unobservable value drivers.

The fair values at March 31, 2010 and December 31, 2009, on a recurring basis, of the Company’s MBS and interest rate hedges based on the level of inputs are summarized below:

   
March 31, 2010
       
   
Fair Value Measurements Using:
       
$ in thousands
 
Level 1
   
Level 2
   
Level 3
   
Total at
Fair Value
 
Assets
                       
Mortgage-backed securities (1)
          1,436,005             1,436,005  
Investments in unconsolidated
limited partnerships
                28,683       28,683  
Derivatives
          44             44  
Total
          1,436,049       28,638       1,464,732  
 
Liabilities
                               
Derivatives
          9,197             9,197  
Total
          9,197             9,197  
 

   
December 31, 2009
       
   
Fair Value Measurements Using:
       
$ in thousands
 
Level 1
   
Level 2
   
Level 3
   
Total at
Fair Value
 
Assets
                       
Mortgage-backed securities (1)
          802,592             802,592  
Investments in unconsolidated
 limited partnerships
                4,128       4,128  
Total
          802,592       4,128       806,720  
 
Liabilities
                               
Derivatives
          3,782             3,782  
Total
          3,782             3,782  
_____________________
(1)  For more detail about the fair value of our MBS and type of securities, see Note 3 in the unaudited consolidated financial statements.

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

$ in thousands
 
March 31, 2010
   
December 31, 2009
 
Beginning balance
    4,128        
Purchases, sales and settlements, net
    24,109       4,057  
Total net gains / (losses) included in net income
               
Realized gains/(losses), net
    230       63  
Unrealized gains/(losses), net
    216       8  
Unrealized gain/(losses), net included in other comprehensive income
           
Ending balance
    28,683       4,128  

The fair value of the TALF debt and repurchase agreements are based on an expected present value technique. This method discounts future estimated cash flows using rates the Company determined best reflect current market interest rates that would be offered for loans with similar characteristics and credit quality. At March 31, 2010, the TALF debt had a fair value of $152.4 million and a carrying value of $151.8 million and the repurchase agreements had a fair value of $961.5 million and a carrying value of $961.2 million.  At December 31, 2009, the TALF debt had a fair value of $80.0 million and a carrying value of $80.4 million and the repurchase agreements had a fair value of $546.1 million and a carrying value of $546.0 million.

  16
 

 


Note 8 – Related Party Transactions
 
The Company is externally managed and advised by the Manager. Pursuant to the terms of the management agreement, effective July 1, 2009, the Manager provides the Company with its management team, including its officers, along with appropriate support personnel. Each of the Company’s officers is an employee of Invesco or one of Invesco’s affiliates. The Company does not have any employees. With the exception of the Company’s Chief Financial Officer, the Manager is not obligated to dedicate any of its employees exclusively to the Company, nor is the Manager or its employees obligated to dedicate any specific portion of its or their time to the Company’s business. The Manager is at all times subject to the supervision and oversight of the Company’s board of directors and has only such functions and authority as the Company delegates to it.
 
Management Fee

The Company pays the Manager a management fee equal to 1.50% of the Company’s shareholders’ equity per annum, which is calculated and payable quarterly in arrears. For purposes of calculating the management fee, shareholders’ equity is equal to the sum of the net proceeds from all issuances of equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus retained earnings at the end of the most recently completed calendar quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less any amount paid to repurchase common stock since inception, and excluding any unrealized gains, losses or other items that do not affect realized net income (regardless of whether such items are included in other comprehensive income or loss, or in net income). This amount will be adjusted to exclude one-time events pursuant to changes in US GAAP, and certain non-cash items after discussions between the Manager and the Company’s independent directors and approval by a majority of the Company’s independent directors.

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

The Manager has agreed to reduce (but not below zero) the management fee payable by the Company under the management agreement with respect to any equity investment the Company may make in the Fund managed by the Manager or any of its affiliates.  In addition, the Company may include any stock-based compensation awarded to personnel of the Manager as a component of the Manger’s compensation.

For the three months ended March 31, 2010, the Company incurred management fees of approximately $1.3 million, of which all was accrued but had not been paid.

Expense Reimbursement

Pursuant to the management agreement, the Company is required to reimburse the Manager for operating expenses related to the Company incurred by the Manager, including certain salary expenses and other expenses related to legal, accounting, due diligence and other services. The Company’s reimbursement obligation is not subject to any dollar limitation.

The Company incurred costs, originally paid by Invesco, of approximately $581,000 and $283,000 for the three months ended March 31, 2010 and 2009, respectively.  Approximately $344,000 and $48,000 was expensed for the three months ended March 31, 2010 and 2009, respectively, and approximately $237,000 was charged against equity as a cost of raising capital for the three months ended March 31, 2010.  During the three months ended March 31, 2009, $235,000 of costs were capitalized as deferred offering costs.


  17
 

 


Note 9 – Shareholders’ Equity (Deficit)

Securities Convertible into Shares of Common Stock

As of the completion of the Company’s IPO on July 1, 2009, (i) the limited partners who hold units of the Operating Partnership (“OP Units”) have the right to cause the Operating Partnership to redeem their OP Units for cash equal to the market value of an equivalent number of shares of common stock, or at the Company’s option, the Company may purchase their OP Units by issuing one share of common stock for each OP Unit redeemed, and (ii) the Company adopted an equity incentive plan which includes the ability for the Company to grant securities convertible into the Company’s common stock to the independent directors and the executive officers of the Company and the personnel of the Manager.

Registration Rights
 
The Company entered into a registration rights agreement with regard to the common stock and OP Units owned by the Manager and Invesco Investments (Bermuda) Ltd., respectively, upon completion of the Company’s IPO and any shares of common stock that the Manager may elect to receive under the management agreement or otherwise. Pursuant to the registration rights agreement, the Company has granted to the Manager and Invesco Investments (Bermuda) Ltd., (i) unlimited demand registration rights to have the shares purchased by the Manager or granted to it in the future and the shares that the Company may issue upon redemption of the OP Units purchased by Invesco Investments (Bermuda) Ltd. registered for resale, and (ii) in certain circumstances, the right to “piggy-back” these shares in registration statements the Company might file in connection with any future public offering so long as the Company retains the Manager under the management agreement. The registration rights of the Manager and Invesco Investments (Bermuda) Ltd., with respect to the common stock and OP Units that they purchased simultaneously with the Company’s IPO, will apply on and after June 25, 2010.

Public Offering

On January 15, 2010, the Company completed a public offering of 7,000,000 shares of common stock and an issuance of an additional 1,050,000 shares of common stock pursuant to the underwriters’ full exercise of their over-allotment option at $21.25 per share. Net proceeds to the Company were $162.6 million, net of issuance costs of approximately $8.5 million.

Share-Based Compensation

The Company established the 2009 Equity Incentive Plan for grants of restricted common stock and other equity based awards to the independent directors and the executive officers of the Company and personnel of the Manager (the “Incentive Plan”). Under the Incentive Plan, a total of 1,000,000 shares are currently reserved for issuance. Unless terminated earlier, the Incentive Plan will terminate in 2019, but will continue to govern the unexpired awards. The Company recognized compensation expense of approximately $19,000 for the three months ended March 31, 2010.  During the three months ended March 31, 2010, the Company issued 834 shares of restricted stock pursuant to this plan to the Company’s non-executive directors.  The fair market value of the shares granted was determined by the closing stock market price on the date of grant.

On March 17, 2010, the Company awarded 5,725 restricted stock units to the executive officers of the Company who are employees of the Manager.  The restricted stock units vest equally in four installments on the anniversary date of each award. Compensation related to stock awards to officers and employees of the Manager are recorded at the estimated fair value of the award during the vesting period. The Company makes an upward or downward adjustment to compensation expense for the difference in the fair value at the date of grant and the date the award was earned. The Company recognized compensation expense of approximately $2,000 for the three months ended March 31, 2010 related to awards to officers and employees of the Manager.

Dividends

On March 18, 2010, the Company declared a dividend of $0.78 per share of common stock. The dividend was paid on April 22, 2010 to shareholders of record as of the close of business on March 31, 2010.
 

  18
 

 

Note 10 – Earnings per Share

Earnings per share for the three months ended March 31, 2010 is computed as follows:

$ in thousands
 
Three Months Ended
March 31, 2010
 
Numerator (Income)
     
Basic Earnings
     
Net income available to common shareholders
    12,049  
Effect of dilutive securities:
       
Income allocated to non-controlling interest
    1,118  
Dilutive net income available to shareholders
    13,167  
         
Denominator (Weighted Average Shares)
       
Basic Earnings:
       
Shares available to common shareholders
    15,685  
Effect of dilutive securities:
       
OP Units
    1,426  
Dilutive Shares
    17,111  
         
 
                 For the three months ended March 31, 2009, earnings per share is not presented because it is not a meaningful measure of the Company’s performance.

Note 11 – Non-controlling Interest - Operating Partnership

Non-controlling interest represents the aggregate OP Units in the Operating Partnership held by limited partners (the “Unit Holders”). Income allocated to the non-controlling interest is based on the Unit Holders ownership percentage of the Operating Partnership. The ownership percentage is determined by dividing the number of OP Units held by the Unit Holders by the total number of dilutive shares of common stock. The issuance of common stock (“Share” or “Shares”) or OP Units changes the percentage ownership of both the Unit Holders and the holders of common stock.  Since an OP unit is generally redeemable for cash or Shares at the option of the Company, it is deemed to be equivalent to a Share. Therefore, such transactions are treated as capital transactions and result in an allocation between shareholders’ equity and non-controlling interest in the accompanying consolidated balance sheet to account for the change in the ownership of the underlying equity in the Operating Partnership. As of March 31, 2010, non-controlling interest related to the outstanding 1,425,000 OP units represented a 7.76% interest in the Operating Partnership. Income allocated to the Operating Partnership non-controlling interest for the three months ended March 31, 2010 was approximately $1.1 million. Distributions paid and payable to the non-controlling interest were approximately $1.5 million and $1.1 million, respectively.

Note 12 – Subsequent Events

On May 3, 2010, the Company completed a follow-on public offering of 9,000,000 shares of common stock at $20.75 per share. The net proceeds to the Company were $177.5 million, net of issuance costs of approximately $9.2 million.  The underwriters have the option to purchase an additional 1,350,000 shares of common stock pursuant to an over-allotment option for 30 days.

19 
 

 


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

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

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

Forward-Looking Statements
 
We make forward-looking statements in this Report and other filings we make with the SEC within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and such statement 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, 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, we intend to identify forward-looking statements.  Factors that could cause actual results to differ from those expressed in the Company’s forward-looking statements include, but are not limited to:

·  
actions and initiatives of the U.S. government and changes to U.S. government policies;

·  
our ability to obtain additional financing arrangements;

·  
financing and advance rates for our target assets;

·  
changes to our expected leverage;

·  
general volatility of the securities markets in which we invest;

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

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

·  
changes in prepayment rates on 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 volatility;

·  
changes in governmental regulations, tax law and rates, and similar matters;

·  
our ability to qualify as a REIT for U.S. federal income tax purposes;
 
 
 

20
 

 


·  
our ability to maintain our exclusion from the definition of “investment company” under the 1940 Act;

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

·  
availability of qualified personnel;

·  
our understanding of our competition; and

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

 
These forward-looking statements are based upon information presently available to our management and are inherently subjective, uncertain and subject to change. There can be no assurance that actual results will not differ materially from our expectations. We caution investors not to rely unduly on any forward-looking statements and urge you to carefully consider the risks identified under the captions “Risk Factors,” “Forward-Looking Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Report and the most recent Form 10-K, as amended, which is available on the SEC’s website at www.sec.gov.
 
All written or oral forward-looking statements that we make, or that are attributable to us, are expressly qualified by this cautionary notice. We expressly disclaim any obligation to update the information in any public disclosure if any forward-looking statement later turns out to be inaccurate, except as may otherwise be required by law.

Overview

We are a Maryland corporation 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”), which is an indirect, wholly-owned subsidiary of Invesco Ltd. (NYSE:IVZ) (“Invesco”). We intend to qualify to be taxed as a REIT commencing with our taxable year ended December 31, 2009. Accordingly, we generally will not be subject to U.S. federal income taxes on our taxable income that we distribute currently to our shareholders as long as we maintain our qualification as a REIT. We operate our business in a manner that will permit us to maintain our exemption from registration under the Investment Company Act of 1940, as amended (the “1940 Act”).
 
Our objective is to provide attractive risk-adjusted returns to our shareholders, primarily through dividends and secondarily through capital appreciation. To achieve this objective, we invest in the following securities:

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

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

·  
CMBS, which are commercial mortgage-backed securities; and

·  
Residential and commercial mortgage loans.
 
We finance our investments in Agency RMBS and non-Agency RMBS primarily through short-term borrowings structured as repurchase agreements. In addition, we have financed our investments in CMBS with financing under the Term Asset-Backed Securities Loan Facility (“TALF”). We have also financed, and may do so again in the future, our investments in CMBS with private financing sources. We have also financed our investments in certain non-Agency RMBS, CMBS and residential and commercial mortgage loans by contributing capital to one or more of the legacy securities public-private investment funds (“PPIFs”) that receive financing under the U.S. government’s Public-Private Investment Program (“PIPP”), established and managed by our Manager or one of its affiliates (the “Invesco PPIP Fund”), which, in turn, invests in our target assets.
 
 

21
 

 

Recent Developments

On May 3, 2010, we completed a follow-on public offering of 9,000,000 shares of common stock at $20.75 per share. The net proceeds to us were $177.5 million, net of issuance costs of approximately $9.2 million.  The underwriters have the option to purchase an additional 1,350,000 shares of common stock pursuant to an over-allotment option for 30 days.

On January 15, 2010, we completed a follow-on public offering of 7,000,000 shares of common stock and an issuance of an additional 1,050,000 shares of common stock pursuant to the underwriters’ full exercise of their over-allotment option at $21.25 per share. The net proceeds to us were $162.6 million, net of issuance costs of approximately $8.5 million.

We have actively worked to deploy the proceeds from our follow-on offering. As of March 31, 2010:

·  
We invested the net proceeds from our follow-on public offering, as well as monies that we borrowed under repurchase agreements and TALF, to increase our investment portfolio to approximately $1.4 billion, which consisted of $816.9 million in Agency RMBS, $379.3 million in Non-Agency RMBS, $215.0 million in CMBS and $24.7 million in CMOs.

·  
We borrowed an aggregate $961.2 million (an increase of $415.2 million during the first quarter 2010) under our master repurchase agreements at a weighted average rate of 0.47%, of which $773.5 million was used to purchases Agency RMBS at a weighted average of rate of 0.24%, $170.0 million for Non-Agency RMBS at a weighted average rate of 1.49% and $18.1 million for CMBS at a weighted average rate of 1.05%.

·  
We entered into three additional interest rate swap agreements, for a notional amount of $300.0 million, increasing our holdings to six interest rate swap agreements and total notional amount to $675.0 million. The interest rate swap agreements are designed to mitigate the effects of increases in interest rates under a portion of our repurchase agreements.

·  
We increased our borrowings by $71.4 million under the TALF to $151.8 million at a weighted average interest rate of 3.56%.

·  
We increased our commitment from $25.0 million to invest up to $100.0 million in the Invesco PPIP Fund which, in turn, invests in our target assets.  As of March 31, 2010, $28.4 million has been called, which is an increase of $24.3 million from December 31, 2009.
 
 
 
 
 
 
 
 
 
 

 
  22
 

 

Factors Impacting Our Operating Results

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

Market Conditions

Beginning in the summer of 2007, significant adverse changes in financial market conditions resulted in a deleveraging of the entire global financial system. As part of this process, residential and commercial mortgage markets in the United States experienced a variety of difficulties, including loan defaults, credit losses and reduced liquidity. As a result, many lenders tightened their lending standards, reduced lending capacity, liquidated significant portfolios or exited the market altogether, and therefore, financing with attractive terms was generally unavailable. In response to these unprecedented events, the U.S. government has taken a number of actions to stabilize the financial markets and encourage lending. Significant measures include the enactment of the Emergency Economic Stabilization Act of 2008 to, among other things, establish the Troubled Asset Relief Program, or TARP, the enactment of the Housing and Economic Recovery Act of 2008, which established a new regulator for Fannie Mae and Freddie Mac and the establishment of the TALF and the PPIP. Some of these programs are beginning to expire and the impact of the wind-down of these programs on the financial sector and on the economic recovery is unknown.

The Federal Reserve initiated a program to purchase agency securities issued or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae on January 5, 2009, and completed the purchase program in March 2010. The termination of the purchase program may cause a decrease in demand for agency securities, which could reduce their market price.

We have elected to participate in programs established by the U.S. government, including the TALF and the PPIP, in order to increase our ability to acquire our target assets and to provide a source of financing for such acquisitions. The TALF was intended to make credit available to consumers and businesses on more favorable terms by facilitating the issuance of asset-backed securities and improving the market conditions for asset-backed securities generally. The Federal Reserve Bank of New York, or FRBNY, made up to $200 billion of loans under the TALF. The facility will cease making loans collateralized by newly issued CMBS on June 30, 2010 and ceased making loans collateralized by newly issued asset-backed securities backed by consumer and business loans and legacy CMBS on March 31, 2010. As a result, we are no longer able to obtain additional TALF loans as a source of financing for investments in legacy CMBS.

The PPIP is designed to encourage the transfer of certain illiquid legacy real estate-related assets off of the balance sheets of financial institutions, restarting the market for these assets and supporting the flow of credit and other capital into the broader economy. As of March 31, 2010, the Invesco PPIP Fund no longer accepts investment subscriptions and the fund is now deemed closed.

Investment Activities

As of March 31, 2010, 26.4% of our equity was invested in Agency RMBS, 56.9% in non-Agency RMBS, 12.3% in CMBS, 7.7% in the Invesco PPIP Fund. We use leverage on our target assets to achieve our return objectives. For our investments in Agency RMBS, we focus on securities we believe provide attractive returns when levered approximately 6 to 8 times. For our investments in non-Agency RMBS, we invest in securities that provide attractive returns leveraged 1 to 2 times.

As of March 31, 2010, we had approximately $365.6 million in 30-year fixed rate securities that offered higher coupons and call protection based on the collateral attributes. We balanced this with approximately $307.5 million in 15-year fixed rate, approximately $134.4 million in hybrid adjustable-rate mortgages (“ARMs”) and approximately $9.3 million in ARMs we believe to have similar durations based on prepayment speeds. As of March 31, 2010, we had purchased approximately $379.3 million non-Agency RMBS.
 
 

23
 

 

Our investments in CMBS are securities for which we were able to obtain financing under the TALF.  We have also financed, and may do so again in the future, our investments in CMBS through repurchase agreements and private financing sources. Our primary focus is on investing in AAA-rated securities issued prior to 2008. As of March 31, 2010, we had purchased approximately $215.0 million in CMBS and financed such purchases with a $151.8 million TALF loan and $18.1 million under repurchase agreements. In addition, as of March 31, 2010, we had purchased approximately $24.7 million in CMOs.

Investment Portfolio

                 The following table summarizes certain characteristics of our investment portfolio as of March 31, 2010:

$ in thousands
 
Principal Balance
   
Unamortized
Premium (Discount)
   
Amortized Cost
   
Unrealized
Gain/
(Loss)
   
Fair
Value
   
Net
Weighted Average Coupon (1)
   
Average
Yield (2)
 
Agency RMBS:
                                         
15 year fixed-rate
    292,729       11,512       304,241       3,276       307,517       4.86 %     3.54 %
30 year fixed-rate
    342,080       22,672       364,752       870       365,622       5.90 %     3.94 %
ARM
    9,377       208       9,585       (257 )     9,328       3.08 %     2.53 %
Hybrid ARM
    128,763       6,027       134,790       (353 )     134,437       4.98 %     2.78 %
Total Agency
    772,949       40,419       813,368       3,536       816,904       5.32 %     3.58 %
                                                         
MBS-CMO
    23,411       739       24,150       575       24,725       6.33 %     4.88 %
Non-Agency MBS
    613,798       (241,270 )     372,528       6,804       379,332       3.80 %     11.58 %
CMBS
    209,512       (1,861 )     207,651       7,393       215,044       5.07 %     5.27 %
Total
    1,619,670       (201,973 )     1,417,697       18,308       1,436,005       4.72 %     5.95 %
_____________________
(1)           Net weighted average coupon is presented net of servicing and other fees.
(2)           Average yield incorporates future prepayment assumptions.

The following table summarizes certain characteristics of our investment portfolio, at fair value, according to their estimated weighted average life classifications as of March 31, 2010:

$ in thousands
 
March 31, 2010
 
Less than one year
    1,382  
Greater than one year and less than five years
    813,500  
Greater than or equal to five years
    621,123  
Total
    1,436,005  

The following table presents certain information about the carrying value of our available for sale MBS at March 31, 2010:

$ in thousands
 
March 31, 2010
 
Principal balance
    1,619,670  
Unamortized premium
    43,549  
Unamortized discount
    (245,522 )
Gross unrealized gains
    28,133  
Gross unrealized losses
    (9,825 )
Carrying value/estimated fair value
    1,436,005  

Financing and Other Liabilities. We enter into repurchase agreements to finance the majority of our Agency RMBS, Non-Agency RMBS and some CMBS. These agreements are secured by our Agency RMBS, Non-Agency RMBS and CMBS and bear interest at rates that have historically moved in close relationship to the London Interbank Offer Rate (“LIBOR”). As of March 31, 2010, we had entered into repurchase agreements totaling $961.2 million. In addition, we funded most of our CMBS portfolio with borrowings of $151.8 million under the TALF. The TALF loans are non-recourse and mature in February 2013, July 2014, August 2014, December 2014 and January 2015. Finally, we committed to invest up to $100.0 million in the Invesco PPIP fund, which, in turn, invests in our target assets.  As of March 31, 2010, $28.4 million of our commitment to the Invesco Fund has been called.

Hedging Instruments. We generally hedge as much of our interest rate 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 interest rate risk that we are required to hedge.
 
 

24
 

 
 
    Interest rate 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 hedge may not match the duration of the related liability;

·  
the party owing money in the hedging transaction may default on its obligation to pay;

·  
the credit quality of the party 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 value of derivatives used for hedging may be adjusted from time to time in accordance with accounting rules to reflect changes in fair value. Downward adjustments (“mark-to-market losses”) would reduce our shareholders’ equity.

As of March 31, 2010, we have entered into interest rate swap agreements designed to mitigate the effects of increases in interest rates under a portion of our repurchase agreements. These swap agreements provide for fixed interest rates indexed off of one-month LIBOR and effectively fix the floating interest rates on $675.0 million of borrowings under our repurchase agreements as of March 31, 2010. We intend to continue to add interest rate hedge positions according to our hedging strategy.

The following table summarizes our hedging activity as of March 31, 2010:

 
 
Counterparty
 
Notional Amount $ - in thousands
 
 
Maturity Date
 
Fixed Interest
Rate in
Contract
 
The Bank of New York Mellon
    175,000  
8/5/2012
    2.07 %
SunTrust Bank
    100,000  
7/15/2014
    2.79 %
Credit Suisse International
    100,000  
2/24/2015
    3.26 %
Credit Suisse International
    100,000  
3/24/2015
    2.76 %
The Bank of New York Mellon
    100,000  
5/24/2013
    1.83 %
Wells Fargo Bank, N.A.
    100,000  
7/15/2015
    2.85 %
Total/Weighted Average
    675,000         2.54 %

Book Value per Share

Our book value was $20.26 and $20.39 as of March 31, 2010 and December 31, 2009, respectively, on a fully diluted basis after giving effect to our units of limited partnership interest in our operating partnership, which may be converted to common shares at the sole election of the Company.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with US GAAP, which requires the use of estimates and assumptions that involve the exercise of judgment and use of assumptions as to future uncertainties. Our most critical accounting policies involve decisions and assessments that could affect our reported assets and liabilities, as well as our reported revenues and expenses. We believe that all of the decisions and assessments upon which our consolidated financial statements are based are reasonable at the time made and based upon information available to us at that time. We rely upon independent pricing of our assets at each quarter’s end to arrive at what we believe to be reasonable estimates of fair market value.  The complete listing of our Critical Accounting Policies was disclosed in our 2009 annual report on Form 10-K, as filed with the SEC on March 24, 2010, as amended, and there have been no material changes to our Critical Accounting Policies as disclosed therein.

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Results of Operations

The table below presents certain information from our Consolidated Statement of Operations for the three month periods ending March 31, 2010 and March 31, 2009:
 
   
For the Three Months Ended
 
$ in thousands, except per share data
 
March 31, 2010
   
March 31, 2009
 
   
(unaudited)
 
Revenues
           
Interest income
    18,010        
Interest expense
    3,652        
Net interest income
    14,358        
                 
Other income (loss)
Gain on sale of investments
    733        
Equity in earnings and fair value change in unconsolidated
     limited partnerships
    446        
Loss on other-than-temporarily impaired securities
    (124 )      
Unrealized loss on interest rate swaps
    (25 )      
Total other income
    1,030        
                 
Expenses
               
Management fee – related party
    1,284        
General and administrative
    182       45  
Insurance
    346        
Professional Fees
    409       3  
Total expenses
    2,221       48  
Net income (loss)
    13,167       (48 )
                 
Net income loss attributable to non-controlling interest
    1,118        
Net income attributable to common shareholders
    12,049       (48 )
Earnings per share:
               
Net income attributable to (basic/diluted)
    0.77    
NM
 
Dividends declared per common share
    0.78        
Weighted average number of shares of common stock:
               
Basic
    15,685    
NM
 
Diluted
    17,111    
NM
 

NM = not meaningful
 
Net Income Summary
 
For the three months ended March 31, 2010, our net income was $13.2 million or $0.77 basic income per weighted average share available to common shareholders compared to $10.5 million or $1.02 basic income per weighted average share available to common shareholders for the three months ended December 31, 2009.  The increase to net income is primarily attributable to the growth in our income portfolio resulting from our follow-on public offering in January 2010.

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Interest Income and Average Earning Asset Yield
 
Our primary source of income is interest earned on our portfolio of mortgage-backed securities.  We had average earning assets of $1.2 billion and $861.9 million and earned interest income of $18.0 million and $12.6 million for the three months ended March 31, 2010 and three months ended December 31, 2009, respectively.  The yield on our average investment portfolio was 5.88% and 5.82% for the respective periods.   The change in our average assets and the portfolio yield was primarily the result of the increase in our investment portfolio after our January follow-on common stock offering.