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Invesco Mortgage Capital Inc. - Quarter Report: 2015 September (Form 10-Q)

Table of Contents


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

(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  ý    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): 
Large Accelerated filer
 
ý
 
  
Accelerated filer
 
o
Non-Accelerated filer
 
o
(Do not check if a smaller reporting company)
  
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o    No  ý
As of October 28, 2015, there were 119,455,302 outstanding shares of common stock of Invesco Mortgage Capital Inc.

Table of Contents


INVESCO MORTGAGE CAPITAL INC.
TABLE OF CONTENTS
 
 
 
Page
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.

Table of Contents


PART I
ITEM 1.
FINANCIAL STATEMENTS
INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
  
As of
 In thousands except share amounts
September 30, 2015
 
December 31, 2014 
 (As Restated)
 
(Unaudited)
 
 
ASSETS
 
Mortgage-backed and credit risk transfer securities, at fair value
16,814,961

 
17,248,895

Residential loans, held-for-investment (1)
3,307,249

 
3,365,003

Commercial loans, held-for-investment
187,038

 
145,756

Cash and cash equivalents
76,658

 
164,144

Due from counterparties
174,741

 
57,604

Investment related receivable
24,897

 
38,717

Accrued interest receivable
69,064

 
66,044

Derivative assets, at fair value
1,308

 
24,178

Deferred securitization and financing costs
10,689

 
13,080

Other investments
113,297

 
106,498

Other assets
1,444

 
1,098

Total assets (1)
20,781,346

 
21,231,017

LIABILITIES AND EQUITY
 
 
 
Liabilities:
 
 
 
Repurchase agreements
12,912,131

 
13,622,677

Secured loans
1,675,000

 
1,250,000

Asset-backed securities issued by securitization trusts (1)
2,859,423

 
2,929,820

Exchangeable senior notes
400,000

 
400,000

Derivative liabilities, at fair value
343,897

 
254,026

Dividends and distributions payable
54,067

 
61,757

Investment related payable
54,996

 
17,008

Accrued interest payable
37,296

 
29,670

Collateral held payable
—

 
14,890

Accounts payable and accrued expenses
3,910

 
2,439

Due to affiliate
11,259

 
9,880

Total liabilities (1)
18,351,979

 
18,592,167

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

 
135,356

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

 
149,860

Common Stock, par value $0.01 per share; 450,000,000 shares authorized; 119,453,846 and 123,110,454 shares issued and outstanding, respectively
1,195

 
1,231

Additional paid in capital
2,482,742

 
2,532,130

Accumulated other comprehensive income
446,857

 
424,592

Retained earnings (distributions in excess of earnings)
(813,520
)
 
(632,854
)
Total stockholders’ equity
2,402,490

 
2,610,315

Non-controlling interest
26,877

 
28,535

Total equity
2,429,367

 
2,638,850

Total liabilities and equity
20,781,346

 
21,231,017

(1)
The condensed consolidated balance sheets include assets of consolidated variable interest entities (“VIEs”) that can only be used to settle obligations and liabilities of the VIEs for which creditors do not have recourse to the Company. As of September 30, 2015 and December 31, 2014, total assets of the consolidated VIEs were $3,331,942 and $3,380,597, respectively, and total liabilities of the consolidated VIEs were $2,876,059 and $2,938,512, respectively. Refer to Note 3 - "Variable Interest Entities" for further discussion.
The accompanying notes are an integral part of these condensed consolidated financial statements.

 
1
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
In thousands, except share amounts
2015
 
2014 
 (As Restated)
 
2015
 
2014 
 (As Restated)
Interest Income

 

 

 

Mortgage-backed and credit risk transfer securities
129,260

 
139,419

 
390,623

 
436,019

Residential loans (1)
28,380

 
22,713

 
88,001

 
60,888

Commercial loans
3,743

 
2,649

 
11,349

 
6,329

Total interest income
161,383

 
164,781

 
489,973

 
503,236

Interest Expense

 

 

 

Repurchase agreements
41,303

 
45,756

 
125,544

 
142,649

Secured loans
1,622

 
1,223

 
4,639

 
1,399

Exchangeable senior notes
5,620

 
5,620

 
16,840

 
16,840

Asset-backed securities (1)
20,686

 
17,660

 
64,913

 
47,421

Total interest expense
69,231

 
70,259

 
211,936

 
208,309

Net interest income
92,152

 
94,522

 
278,037

 
294,927

(Reduction in) provision for loan losses
(81
)
 
(209
)
 
(213
)
 
(52
)
Net interest income after (reduction in) provision for loan losses
92,233

 
94,731

 
278,250

 
294,979

Other Income (loss)

 

 

 

Gain (loss) on investments, net
(2,958
)
 
(48,364
)
 
10,090

 
(86,333
)
Equity in earnings of unconsolidated ventures
1,894

 
1,145

 
9,131

 
5,480

Gain (loss) on derivative instruments, net
(220,602
)
 
(3,704
)
 
(287,344
)
 
(322,832
)
Realized and unrealized credit derivative income (loss), net
2,928

 
(28,613
)
 
24,904

 
20,929

Other investment income (loss), net
739

 
(1,358
)
 
1,518

 
(1,358
)
Total other income (loss)
(217,999
)
 
(80,894
)
 
(241,701
)
 
(384,114
)
Expenses
 
 
 
 
 
 
 
Management fee – related party
10,058

 
9,214

 
28,816

 
27,876

General and administrative
2,507

 
2,519

 
6,186

 
6,906

Consolidated securitization trusts (1)
2,132

 
1,560

 
6,544

 
4,108

Total expenses
14,697

 
13,293

 
41,546

 
38,890

Net income (loss)
(140,463
)
 
544

 
(4,997
)
 
(128,025
)
Net income (loss) attributable to non-controlling interest
(1,629
)
 
6

 
(80
)
 
(1,456
)
Net income (loss) attributable to Invesco Mortgage Capital Inc.
(138,834
)
 
538

 
(4,917
)
 
(126,569
)
Dividends to preferred stockholders
5,716

 
2,713

 
17,148

 
8,138

Undeclared cumulative dividends to preferred stockholders
—

 
661

 
—

 
661

Net income (loss) attributable to common stockholders
(144,550
)
 
(2,836
)
 
(22,065
)
 
(135,368
)
Earnings (loss) per share:


 


 


 


Net income (loss) attributable to common stockholders

 

 

 

Basic
(1.18
)
 
(0.02
)
 
(0.18
)
 
(1.10
)
Diluted
(1.18
)
 
(0.02
)
 
(0.18
)
 
(1.10
)
Dividends declared per common share
0.40

 
0.50

 
1.30

 
1.50

(1)
The condensed consolidated statements of operations include income and expenses of consolidated VIEs. Refer to Note 3 - “Variable Interest Entities” for further discussion.
The accompanying notes are an integral part of these condensed consolidated financial statements.

 
2
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
In thousands
2015
 
2014 
 (As Restated)
 
2015
 
2014 
 (As Restated)
Net income (loss)
(140,463
)
 
544

 
(4,997
)
 
(128,025
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized gain (loss) on mortgage-backed and credit risk transfer securities, net
41,978

 
(81,267
)
 
(25,390
)
 
325,045

Reclassification of unrealized (gain) loss on sale of mortgage-backed and credit risk transfer securities to gain (loss) on investments, net
1,380

 
49,169

 
(3,223
)
 
81,653

Reclassification of amortization of net deferred losses on de-designated interest rate swaps to repurchase agreements interest expense
15,724

 
21,227

 
51,182

 
64,055

Currency translation adjustments on investment in unconsolidated venture
(33
)
 
—

 
(33
)
 
—

Total other comprehensive income (loss)
59,049

 
(10,871
)
 
22,536

 
470,753

Comprehensive income (loss)
(81,414
)
 
(10,327
)
 
17,539

 
342,728

Less: Comprehensive income (loss) attributable to non-controlling interest
942

 
117

 
(191
)
 
(3,919
)
Less: Dividends to preferred stockholders
(5,716
)
 
(2,713
)
 
(17,148
)
 
(8,138
)
Less: Undeclared cumulative dividends to preferred shareholders
—

 
(661
)
 
—

 
(661
)
Comprehensive income (loss) attributable to common stockholders
(86,188
)
 
(13,584
)
 
200

 
330,010

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


 
3
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF EQUITY
For the nine months ended September 30, 2015
(Unaudited)
 
 
 
 
 
 
 
Attributable to Common Stockholders
 
 
 
 
 
 
 
 
 
 
 
 
 
Additional
Paid in
Capital
 
Accumulated
Other
Comprehensive
Income (loss)
 
Retained
Earnings
(Distributions
in excess of
earnings)
 
Total
Stockholders’
Equity
 
Non-
Controlling
Interest
 
 
 
Series A
Preferred Stock
 
Series B
Preferred Stock
 
 
 
 
In thousands except
 share amounts
 
 
Common Stock
 
Total
Equity
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
Balance at January 1, 2015 (As Restated)
5,600,000

 
135,356

 
6,200,000

 
149,860

 
123,110,454

 
1,231

 
2,532,130

 
424,592

 
(632,854
)
 
2,610,315

 
28,535

 
2,638,850

Net income (loss)
—

 
—

 
—

 
—

 


 


 
—

 
—

 
(4,917
)
 
(4,917
)
 
(80
)
 
(4,997
)
Other comprehensive income
—

 
—

 
—

 
—

 
—

 
—

 
—

 
22,265

 
—

 
22,265

 
271

 
22,536

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

 
—

 
—

 
—

 
10,317

 
—

 
158

 
—

 
—

 
158

 
—

 
158

Repurchase of shares of common stock
—

 
—

 
—

 
—

 
(3,695,368
)
 
(36
)
 
(49,963
)
 
—

 
—

 
(49,999
)
 
—

 
(49,999
)
Stock awards
—

 
—

 
—

 
—

 
28,443

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Common stock dividends
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(158,601
)
 
(158,601
)
 


 
(158,601
)
Common unit dividends
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(1,854
)
 
(1,854
)
Preferred stock dividends
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(17,148
)
 
(17,148
)
 
—

 
(17,148
)
Amortization of equity-based compensation
—

 
—

 
—

 
—

 
—

 
—

 
417

 
—

 


 
417

 
5

 
422

Balance at September 30, 2015
5,600,000

 
135,356

 
6,200,000

 
149,860

 
119,453,846

 
1,195

 
2,482,742

 
446,857

 
(813,520
)
 
2,402,490

 
26,877

 
2,429,367

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


 
4
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
  
Nine Months Ended September 30,
In thousands
2015
 
2014 
 (As Restated)
Cash Flows from Operating Activities
 
 
 
Net income (loss)
(4,997
)
 
(128,025
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Amortization of mortgage-backed and credit risk transfer securities premiums and (discounts), net
96,121

 
99,698

Amortization of residential loans and asset-backed securities premiums (discount), net
(639
)
 
2,195

Amortization of commercial loan origination fees
(51
)
 
(1
)
(Reduction in) provision for loan losses
(213
)
 
(52
)
Unrealized (gain) loss on derivative instruments, net
104,546

 
133,863

Unrealized (gain) loss on credit derivatives, net
(7,923
)
 
(8,121
)
(Gain) loss on investments, net
(10,090
)
 
86,333

Realized (gain) loss on derivative instruments, net
44,394

 
34,877

Realized (gain) loss on credit derivatives, net
2,184

 
—

Equity in earnings of unconsolidated ventures
(9,131
)
 
(5,480
)
Amortization of equity-based compensation
422

 
378

Amortization of deferred securitization and financing costs
2,391

 
2,220

Reclassification of amortization of net deferred losses on de-designated interest rate swaps to repurchase agreements interest expense
51,182

 
64,055

Non-cash interest income capitalized in commercial loans
—

 
(768
)
(Gain) loss on foreign currency transactions, net
619

 
1,479

Changes in operating assets and liabilities:
 
 
 
(Increase) decrease in operating assets
(3,289
)
 
1,790

Increase (decrease) in operating liabilities
10,512

 
(6,174
)
Net cash provided by operating activities
276,038

 
278,267

Cash Flows from Investing Activities
 
 
 
Purchase of mortgage-backed and credit risk transfer securities
(1,821,811
)
 
(3,752,261
)
Distributions from investment in unconsolidated ventures, net
15,174

 
7,602

Change in other investments
(12,875
)
 
(52,500
)
Principal payments from mortgage-backed and credit risk transfer securities
1,910,904

 
1,422,082

Proceeds from sale of mortgage-backed and credit risk transfer securities
290,561

 
3,069,978

Payments on sale of credit derivatives
(2,184
)
 
—

Payment of premiums for interest rate swaptions
(1,485
)
 
(10,328
)
Payments for termination of futures/currency forward contracts, swaps, swaptions and TBAs
(34,066
)
 
(11,604
)
Purchase of residential loans held-for-investment
(372,305
)
 
(1,417,864
)
Principal payments from residential loans held-for-investment
424,644

 
120,930

Principal payments from commercial loans held-for-investment
63,132

 
400

Origination and advances of commercial loans, net of origination fees
(104,965
)
 
(81,201
)
Net cash provided by (used in) investing activities
354,724

 
(704,766
)
Cash Flows from Financing Activities
 
 
 
Proceeds from issuance of common stock
158

 
191

Repurchase of common stock
(49,999
)
 
(21,130
)
Cost of issuance of preferred stock
(36
)
 
150,096

Due from counterparties
(118,562
)
 
(26,999
)
Collateral held payable
(14,890
)
 
(13,771
)
Proceeds from repurchase agreements
105,832,915

 
108,739,181

Principal repayments of repurchase agreements
(106,543,411
)
 
(110,638,714
)
Proceeds from asset-backed securities issued by securitization trusts
336,077

 
1,213,405

Principal repayments of asset-backed securities issued by securitization trusts
(400,207
)
 
(109,587
)
Proceeds from secured loans
2,100,000

 
2,835,247

Principal repayments on secured loans
(1,675,000
)
 
(1,585,247
)
Payments of deferred costs
—

 
(1,811
)
Payments of dividends and distributions
(185,293
)
 
(196,030
)
Net cash (used in) provided by financing activities
(718,248
)
 
344,831

Net change in cash and cash equivalents
(87,486
)
 
(81,668
)
Cash and cash equivalents, beginning of period
164,144

 
210,612

Cash and cash equivalents, end of period
76,658

 
128,944

Supplement Disclosure of Cash Flow Information
 
 
 
Interest paid
162,906

 
146,209

Non-cash Investing and Financing Activities Information
 
 
 
Net change in unrealized gain on mortgage-backed and credit risk transfer securities
(28,613
)
 
406,698

Dividends and distributions declared not paid
54,067

 
64,976

(Receivable) / payable for mortgage-backed and credit risk transfer securities, net
53,089

 
457,049

Repurchase agreements, not settled
(50
)
 
19,747

Collateral held payable, not settled
—

 
(3,481
)
Net change in due from counterparties
1,425

 
—

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

 
5
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 – Organization and Business Operations
Invesco Mortgage Capital Inc. (the “Company”) is a Maryland corporation primarily focused on investing in, financing and managing residential and commercial mortgage-backed securities and 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 leading independent global investment management firm.
The Company conducts its business through IAS Operating Partnership LP (the “Operating Partnership”) as its sole general partner. As of September 30, 2015, the Company owned 98.8% of the Operating Partnership, and a wholly-owned subsidiary of Invesco owned the remaining 1.2%. The Company has one operating segment.
The Company primarily invests in:
•
Residential mortgage-backed securities ("RMBS") that are guaranteed by a U.S. government agency such as the Government National Mortgage Association, or a federally chartered corporation such as the Federal National Mortgage Association ("Fannie Mae") or the Federal Home Loan Mortgage Corporation ("Freddie Mac") (collectively "Agency RMBS");
•
RMBS that are not guaranteed by a U.S. government agency (“non-Agency RMBS”);
•
Credit risk transfer securities that are unsecured obligations issued by government-sponsored enterprises ("GSE CRT");
•
Commercial mortgage-backed securities ("CMBS");
•
Residential and commercial mortgage loans; and
•
Other real estate-related financing agreements.
The Company generally finances its investments through short- and long-term borrowings structured as repurchase agreements and secured loans. The Company finances its residential loans held-for-investment through asset-backed securities ("ABS") issued by consolidated securitization trusts. The Company has also financed investments through the issuances of debt and equity and may utilize other forms of financing in the future.
The Company elected to be taxed as a real estate investment trust (“REIT”) for U.S. federal income tax purposes under the provisions of the Internal Revenue Code of 1986, as amended, 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 REIT taxable income to its stockholders annually. The Company operates its business in a manner that permits exclusion from the "Investment Company" definition under the Investment Company Act of 1940, as amended.
Note 2 – Summary of Significant Accounting Policies
Restatement Background
On August 9, 2015, the Audit Committee of the Board of Directors of the Company concluded, based on the recommendation of management, that each of the Company’s previously issued (i) consolidated financial statements as of and for the years ended December 31, 2013 and 2014, which were included in its Annual Report on Form 10-K for the year ended December 31, 2014, and (ii) interim consolidated financial statements as of and for the quarter ended March 31, 2013 and for all subsequent quarters through the quarter ended March 31, 2015 needed to be restated and should no longer be relied upon. The Company filed Amendment No. 1 to its Annual Report on Form 10-K for the year ended December 31, 2014 ("Form 10-K/A") and Amendment No. 1 to its Quarterly Report on Form 10-Q for the quarter ended March 31, 2015 ("Form 10-Q/A") on August 17, 2015. Additional information regarding the restatement is contained in those filings. Prior period financial information in this Form 10-Q has been amended where necessary to reflect the restatement. Therefore, this Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2014.
Basis of Presentation and Consolidation
Certain disclosures included in the Company’s Form 10-K/A are not required to be included on an interim basis in the Company’s quarterly reports on Form 10-Q. The Company has condensed or omitted these disclosures. Therefore, this Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2014.

 
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In the opinion of management, the condensed consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, which are necessary for a fair presentation of the financial condition and results of operations for the periods presented. All significant intercompany transactions, balances, revenues and expenses are eliminated upon consolidation.
The condensed consolidated financial statements have been prepared in accordance with U.S. GAAP and consolidate the financial statements of the Company and its controlled subsidiaries. The condensed consolidated financial statements also include the consolidation of certain securitization trusts that meet the definition of a variable interest entity ("VIE") because the Company has been deemed to be the primary beneficiary of the securitization trusts. These securitization trusts hold pools of residential mortgage loans and issue series of asset-backed securities payable from the cash flows generated by the underlying pools of residential mortgage loans. The securitizations are non-recourse financing for the residential mortgage loans held-for-investment. Generally, a portion of the asset-backed securities issued by the securitization trusts is sold to unaffiliated third parties and the balance is purchased by the Company. The Company classifies the underlying residential mortgage loans owned by the securitization trusts as residential loans held-for-investment in its condensed consolidated balance sheets. The asset-backed securities issued to third parties are recorded as liabilities on the Company's condensed consolidated balance sheets. The Company records interest income on the residential loans held-for-investment, interest expense on the asset-backed securities issued to third parties and direct operating expenses incurred by the securitization trusts in the Company's condensed consolidated statements of operations. The Company eliminates all intercompany balances and transactions between itself and the consolidated securitization trusts. The Company records the initial underlying assets and liabilities of the consolidated securitization trusts at their fair value upon consolidation into the Company and, as such, no gain or loss is recorded upon consolidation. Refer to Note 3 - "Variable Interest Entities" for additional information regarding the impact of consolidation of securitization trusts.
The consolidated securitization trusts are VIEs because the securitization trusts do not have equity that meets the definition of U.S. GAAP equity at risk. In determining if a securitization trust should be consolidated, the Company evaluates whether it has both (i) the power to direct the activities of the securitization trust that most significantly impact its economic performance and (ii) the right to receive benefits from the securitization trust or the obligation to absorb losses of the securitization trust that could be significant. The Company's determination of whether it is the primary beneficiary of a securitization trust includes both a qualitative and quantitative analysis. The Company determined that it was the primary beneficiary of certain securitization trusts because it was involved in certain aspects of the design of the securitization trusts and has certain default oversight rights on defaulted residential loans. In addition, the Company owns the most subordinated class of asset-backed securities issued by the securitization trusts and has the obligation to absorb losses and right to receive benefits from the securitization trust that could potentially be significant to the securitization trust. The Company assesses modifications to VIEs on an ongoing basis to determine if a significant reconsideration event has occurred that would change the Company's initial consolidation assessment.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Examples of estimates include, but are not limited to, estimates of the fair values of financial instruments, interest income on mortgage-backed and credit risk transfer securities, allowance for loan losses and other-than-temporary impairment charges. Actual results may differ from those estimates.
Significant Accounting Policies
A summary of the Company's significant accounting policies is included in Note 2 to the consolidated financial statements of the Company’s 2014 Annual Report on Form 10-K/A. A summary of additional accounting policies that are significant to the Company's consolidated financial condition and results of operations for the three and nine months ended September 30, 2015 is provided below.
Translation of Foreign Currencies
The functional currency of the Company and its subsidiaries is U.S. dollars. Transactions in foreign currencies are recorded at the rates of exchange prevailing on the date of the transactions. At each balance sheet date, monetary assets and liabilities that are denominated in foreign currencies are remeasured at the rates prevailing at the balance sheet date. Gains and losses arising on revaluation are included in the condensed consolidated statements of operations.
The Company's reporting currency is U.S. dollars. Upon consolidation, the assets and liabilities of the Company’s investment in an unconsolidated venture whose functional currency is the Euro is translated to U.S. dollars using the period-end exchange rates. Equity accounts are translated at historical rates, except for the change in retained earnings during the year,

 
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which is the result of the income statement translation process. Revenue and expense accounts are translated using the weighted average exchange rate during the period. The cumulative translation adjustments associated with the investment in the unconsolidated venture are recorded in accumulated other comprehensive income (loss), a component of condensed consolidated stockholders’ equity.
The Company generally hedges interest rate and foreign currency exposure with derivative financial instruments. Refer to Note 8 - "Derivatives and Hedging Activities" for further information.
Fair Value Measurements
The Company discloses the fair value of its financial instruments according to a fair value hierarchy (Levels 1, 2, and 3, as defined). In accordance with U.S. GAAP, the Company is required to provide enhanced disclosures regarding instruments in the Level 3 category (which require significant management judgment), including a separate reconciliation of the beginning and ending balances for each major category of assets and liabilities.
To determine fair value of its financial instruments, the Company generally obtains one price per instrument from its primary valuation service. If this service cannot provide a price, the Company will seek a value from other vendors. The valuation services use various observable inputs which may include a combination of benchmark yields, trades, broker/dealer quotes, issuer spreads, bids, offers and benchmark securities to determine prices. Both the Company and the pricing vendor continuously monitor market indicators and economic events to determine if any may have an impact on the valuations.
Overrides of prices from pricing vendors are rare in the current market environment for the assets the Company holds. Examples of instances that would cause an override include if the Company recently traded the same security or there is an indication of market activity that would cause the vendor price to be unreliable. In the rare instance where a price is adjusted, the Company has a control process to monitor the reason for such adjustment.
To gain comfort that vendor prices are representative of current market information, the Company compares the transaction prices of security purchases and sales to the valuation levels provided by the vendors. Price differences exceeding pre-defined tolerance levels are identified and investigated and may be challenged. Trends are monitored over time and if there are indications that the valuations are not comparable to market activity, the vendors are asked to provide detailed information regarding their methodology and inputs. Transparency tools are also available from the vendors which help the Company understand data points and/or market inputs used for pricing securities.
In addition, the Company performs due diligence procedures on all vendors on at least an annual basis. A questionnaire is sent to vendors which requests information such as changes in methodologies, business recovery preparedness, internal controls and confirmation that evaluations are generated based on market data. Physical visits are also made to each vendor’s office.
As described in Note 10 - "Fair Value of Financial Instruments," the Company evaluates the source used to provide the market price for each security and makes a determination on its categorization within the fair value hierarchy. If the price of a security is obtained from quoted prices for identical instruments in active markets, the security is classified as a level 1 security. If the price of a security is obtained from quoted prices for similar instruments or model-derived valuations whose inputs are observable, the security is classified as a level 2 security. If the inputs appear to be unobservable, the security would be classified as a level 3 security. Transfers between levels, if any, are determined by the Company at the end of the reporting period.
Mortgage-Backed and Credit Risk Transfer Securities
All of the Company’s mortgage-backed securities ("MBS") except for Agency interest-only securities ("Agency MBS IOs"), are classified as available-for-sale and reported at fair value. Fair value is determined by obtaining valuations from an independent source. If the fair value of a security is not available from a third-party pricing service, or such data appears unreliable, the Company may estimate the fair value of the security using a variety of methods including other pricing services, discounted cash flow analysis, matrix pricing, option adjusted spread models and other fundamental analysis of observable market factors.
The Company records its purchases of mortgage-backed and credit risk transfer securities on the trade date. Although the Company generally intends to hold most of its mortgage-backed and credit risk transfer securities until maturity, the Company may, from time to time, sell any of its mortgage-backed and credit risk transfer securities as part of its overall management of its investment portfolio.
Unrealized gains or losses on all MBS, except for Agency MBS IOs, are recorded in accumulated other comprehensive income, a separate component of stockholders' equity, until sale or disposition of the investment. Upon sale or disposition, the cumulative gain or loss previously reported in stockholders' equity is recognized in income. Realized gains and losses from sales of MBS are determined based upon the specific identification method.

 
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Agency MBS IOs are hybrid financial instruments that contain embedded derivatives. Agency MBS IOs are carried at fair value on the Company's consolidated balance sheet with changes in fair value recognized in the Company's condensed consolidated statements of operations because the embedded interest derivative in Agency MBS IOs cannot be reliably measured.
GSE CRTs are unsecured obligations of Fannie Mae and Freddie Mac. Coupon payments on the securities are based on LIBOR and principal payments are based on prepayments and defined credit events in a reference pool of mortgage loans that collateralize Agency RMBS. GSE CRTs are accounted for as hybrid financial instruments consisting of a debt host contract and an embedded derivative. GSE CRTs are measured at fair value. Unrealized gains or losses arising from changes in fair value of the debt host contract, excluding other-than-temporary impairment, are recognized in accumulated other comprehensive income, a separate component of stockholders’ equity, until sale or disposition of the investment. Upon sale or disposition of the debt host contract, the cumulative gain or loss previously reported as a separate component of stockholders’ equity is recognized in income. Realized gains and losses from sales of GSE CRTs are determined based upon the specific identification method. Realized and unrealized gains or losses arising from changes in fair value of the embedded derivative are recognized in realized and unrealized credit derivative income (loss), net in the Company’s condensed consolidated statements of operations.
The Company considers its portfolio of Agency RMBS to be of high credit quality under applicable accounting guidance. For non-Agency RMBS, GSE CRTs and CMBS, the Company does not rely on ratings from third party agencies to determine the credit quality of the investment. The Company uses internal models that analyze the loans underlying each security and evaluates factors including, but not limited to, delinquency status, loan-to-value ratios, borrower credit scores, occupancy status and geographic concentration to estimate the expected future cash flows. The Company places reliance on these internal models in determining credit quality.
While non-Agency RMBS, GSE CRTs and CMBS with expected future losses would generally be purchased at a discount to par, the potential for a significant adverse change in expected cash flows remains. The Company therefore evaluates each security for other-than-temporary impairment at least quarterly.
The determination of whether a security is other-than-temporarily impaired involves judgments and assumptions based on subjective and objective factors. Consideration is given to (i) the length of time and the extent to which the fair value has been less than amortized 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.
The Company recognizes in earnings and reflects as a reduction in the cost basis of the security the amount of any other-than-temporary impairment related to credit losses or impairments on securities that the Company intends to sell or for which it is more likely than not that the Company will need to sell before recoveries. The amount of the other-than-temporary impairment on debt securities related to other factors is recorded consistent with changes in the fair value of all other available-for-sale securities as a component of condensed consolidated stockholders’ equity in other comprehensive income or loss with no change to the cost basis of the security.
Residential Loans Held-For-Investment
Residential loans held-for-investment are residential mortgage loans held by consolidated securitization trusts. Residential loans held-for-investment are carried at unpaid principal balance net of any premiums and an allowance for loan losses. The Company expects that it will be required to continue to consolidate the securitization trusts that hold the residential loans.
The Company establishes an allowance for residential loan losses based on the Company's estimate of credit losses. The Company calculates expected losses by estimating the default rate and expected loss severities on the loans. The Company considers the following factors in its evaluation of the allowance for loan losses:
•
Loan-to-value ratios, credit scores, geographic concentration and other observable data;
•
Historical default rates of loans with similar characteristics; and
•
Expected future macroeconomic trends including changes in home prices and the unemployment rate.
Commercial Loans Held-For-Investment
Commercial loans held-for-investment by the Company are carried at cost, net of any allowance for loan losses. An individual loan is considered impaired when it is deemed probable that the Company will not be able to recover its investment and any other anticipated futures payments. The Company generally considers the following factors in evaluating whether a commercial loan is impaired:

 
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•
Loan-to-value ratios;
•
The most recent financial information available for each loan and associated properties, including net operating income, debt service coverage ratios, occupancy rates, rent rolls, as well as any other factors the Company considers relevant, including, but not limited to, specific loan trigger events that would indicate an adverse change in expected cash flows or payment delinquency;
•
Economic trends, both macroeconomic as well as those directly affecting the properties associated with the loans, and the supply and demand trends in the market in which the subject property is located; and
•
The loan sponsor or borrowing entity’s ability to ensure that properties associated with the loan are managed and operated sufficiently.
Where an individual commercial loan is deemed to be impaired, the Company records an allowance to reduce the carrying value of the loan to the current present value of expected future cash flows discounted at the loan’s effective interest rate, with a corresponding charge to provision for loan losses on the Company's condensed consolidated statements of operations.
Interest Income Recognition
Mortgage-Backed Securities
Interest income on MBS is accrued based on the outstanding principal balance of the securities and their contractual terms. Premiums or discounts are amortized or accreted into interest income over the life of the investment using the effective interest method. Interest income on the Company's non-Agency RMBS (and other prepayable mortgage-backed securities where the Company may not recover substantially all of its initial investment) is based on estimated cash flows. 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. Over the life of the investments, these estimated cash flows are updated and a revised yield is computed based on the current amortized cost of the investment. In estimating these cash flows, there are a number of assumptions that are subject to uncertainties and contingencies, including the rate and timing of principal payments (prepayments, repurchases, defaults and liquidations), the pass through or coupon rate and interest rate fluctuations. These uncertainties and contingencies are difficult to predict and are subject to future events that may impact management’s estimates and the Company's interest income.
For Agency RMBS that cannot be prepaid in such a way that the Company would not recover substantially all of its initial investment, interest income recognition is based on contractual cash flows. The Company does not estimate prepayments in applying the effective interest method.
Credit Risk Transfer Securities
Interest income on credit risk transfer securities is accrued based on the coupon rate of the debt host contract which reflects the credit risk of GSE unsecured senior debt with a similar maturity. Premiums or discounts associated with the purchase of credit risk transfer securities are amortized or accreted into interest income over the life of the debt host contract using the effective interest method. The difference between the coupon rate on the hybrid instrument and the coupon rate on the GSE CRT debt host contract is considered premium income associated with the embedded derivative and is recorded in realized and unrealized credit derivative income (loss), net in the Company’s condensed consolidated statements of operations.
Residential Loans
The Company recognizes interest income from residential loans on an accrual basis and amortizes the related premiums into interest income using the effective interest method over the weighted average life of these loans. In estimating the weighted average life of these loans, there are a number of assumptions that are subject to estimation, including the rate and timing of principal payments, defaults, loss severity given default and other factors. Coupon interest is recognized as revenue when earned and deemed collectible or until a loan becomes more than 90 days past due, at which point the loan is placed on nonaccrual status. Interest previously accrued for loans that have been placed on non-accrual status is reversed against interest income in the period the loan is placed in nonaccrual status. Residential loans delinquent more than 90 days or in foreclosure are characterized as delinquent. Cash principal and interest that is advanced from servicers after a loan becomes greater than 90 days past due is recorded as a liability due to the servicer. When a delinquent loan previously placed on nonaccrual status has cured, meaning all delinquent principal and interest have been remitted by the borrower, the loan is placed back on accrual status. Alternatively, nonaccrual loans may be placed back on accrual status if restructured and after the loan is considered re-performing. A restructured loan is considered re-performing when the loan has been current for at least 12 months.

 
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Commercial Loans
The Company recognizes interest income from commercial loans when earned and deemed collectible, or until a loan becomes past due based on the terms of the loan agreement. Any related origination fees, net of origination cost are amortized into interest income using the effective interest method over the life of the loan. Interest received after a loan becomes past due or impaired is used to reduce the outstanding loan principal balance. When a delinquent loan previously placed on nonaccrual status has cured, meaning all delinquent principal and interest have been remitted by the borrower, the loan is placed back on accrual status. Alternately, loans that have been individually impaired may be placed back on accrual status if restructured and after the loan is considered re-performing. A restructured loan is considered re-performing when the loan has been current for at least 12 months.
Repurchase Agreements
Effective January 1, 2015, the Company adopted newly issued accounting guidance for repurchase financings. Under the new standard, the Company no longer applies the "linked" accounting model to instances where the Company purchases mortgage-backed and credit risk transfer securities and enters into repurchase agreements to finance the purchase with the same counterparty. Purchases of mortgage-backed and credit risk transfer securities and repurchase financings are considered separately, and the repurchase agreement component of the transaction is accounted for as a secured borrowing. The Company records the mortgage-backed and credit risk transfer securities and the related repurchase agreement financing on a gross basis in its condensed consolidated balance sheets, and the corresponding interest income and interest expense on a gross basis in its condensed consolidated statements of operations.
None of the Company's repurchase financing transactions prior to January 1, 2015 qualified as linked transactions and therefore were not accounted for as derivatives. Accordingly, the Company did not record a cumulative effect adjustment to retained earnings as of January 1, 2015 as a result of adopting the new guidance.
Asset-Backed Securities Issued by Securitization Trusts
Asset-backed securities issued by securitization trusts are recorded at principal balances net of unamortized premiums or discounts. The Company recognizes interest expense on an accrual basis and amortizes the related premiums or discounts into interest expense using the effective interest method over the weighted average contractual maturity of these asset-backed securities.
Comprehensive Income
The Company's comprehensive income consists of net income, as presented in the condensed consolidated statements of operations, adjusted for changes in fair value of MBS classified as available for sale securities; changes in the fair value of the debt host contract associated with GSE CRTs; amortization of repurchase agreement interest expense resulting from the de-designation of derivatives previously accounted for as cash flow hedges and foreign currency translation adjustments. Unrealized gains and losses on the Company's MBS and the debt host contract associated with GSE CRTs are reclassified into net income upon their sale or termination.
Accounting for Derivative Financial Instruments
U.S. GAAP provides disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (i) how and why an entity uses derivative instruments; (ii) how derivative instruments and related hedged items are accounted for; and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. U.S. GAAP requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.
The Company records all derivatives on its condensed consolidated balance sheets at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts, such as credit default

 
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swaps, that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting under U.S. GAAP.
The Company is a party to hybrid financial instruments that contain embedded derivative instruments. At inception, the Company assesses whether the economic characteristics of the embedded derivative instruments are clearly and closely related to the economic characteristics of the remaining component of the financial instrument (i.e., the debt host contract), whether the financial instrument is remeasured to fair value through earnings and whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument. When it is determined that (1) the embedded instrument possesses economic characteristics that are not clearly and closely related to the economic characteristics of the debt host contract, (2) the financial instrument is not remeasured to fair value through earnings and (3) a separate instrument with the same terms would qualify as a derivative instrument, the embedded instrument qualifies as an embedded derivative that is separated from the debt host contract. The embedded derivative is recorded at fair value, and changes in fair value are recorded in realized and unrealized credit derivative income (loss), net in the Company's condensed consolidated statements of operations.
Effective December 31, 2013, the Company voluntarily discontinued hedge accounting for its interest rate swap agreements by de-designating the interest rate swaps as cash flow hedges. No interest rate swaps were terminated in conjunction with this action, and the Company’s risk management and hedging practices were not impacted. However, the Company’s accounting for these transactions changed beginning January 1, 2014. All of the Company’s interest rate swaps had previously been accounted for as cash flow hedges under the applicable guidance. As a result of discontinuing hedge accounting, changes in the fair value of the interest rate swap agreements are recorded in gain (loss) on derivative instruments, net in the Company’s condensed consolidated statements of operations, rather than in accumulated other comprehensive income (loss) (“AOCI”). Also, net interest paid or received under the interest rate swaps, which up through December 31, 2013 was recognized in interest expense, is now recognized in gain (loss) on derivative instruments, net on the Company's condensed consolidated statements of operations. The interest rate swaps continue to be reported as derivative assets or derivative liabilities on the Company’s condensed consolidated balance sheets at their fair value.
As long as the forecasted transactions that were being hedged (i.e., rollovers of the Company’s repurchase agreement borrowings) are still expected to occur, the balance in AOCI from the interest rate swap activity up through December 31, 2013 will remain in AOCI and be recognized in the Company’s condensed consolidated statements of operations as interest expense over the remaining term of the interest rate swaps. Refer to Note 8 - "Derivatives and Hedging Activities" for further information.
The Company evaluates the terms and conditions of its holdings of swaptions, futures contracts, currency forward contracts and to-be-announced ("TBA") securities to determine if an instrument has the characteristics of an investment or should be considered a derivative under U.S. GAAP. Accordingly swaptions, futures contracts, currency forward contracts and TBAs having the characteristics of derivatives are accounted for at fair value with such changes recognized in gain (loss) on derivative instruments, net in the condensed consolidated statements of operations. The fair value of these swaptions, futures contracts, currency forward contracts and TBAs is included in derivative assets or derivative liabilities on the condensed consolidated balance sheets.
Reclassifications
Certain prior period reported amounts have been reclassified to be consistent with the current presentation. Such reclassifications had no impact on net income or equity attributable to common stockholders.
Recent Accounting Pronouncements Not Yet Adopted
In February 2015, the FASB issued modifications to existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. The guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2015, and requires either a retrospective or a modified retrospective approach to adoption. Early adoption is permitted. The new guidance is not expected to have a material impact on the Company's condensed consolidated financial statements.
In April 2015, the FASB issued guidance to amend the presentation of debt issuance cost related to a recognized debt liability. Under the new guidance, the debt issuance costs will be presented in the balance sheet as a direct deduction from the carrying amount of the recognized debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected under the new guidance. The standard is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. The guidance should be applied on a retrospective basis. The balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Upon adoption, an entity is required to comply with the applicable disclosures for a change in an accounting principle. These disclosures include the nature of and reason for the change in accounting principle,

 
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the transition method, a description of the prior-period information that has been retrospectively adjusted, and the effect of the change on the financial statement line items (i.e., debt issuance cost asset and the debt liability). The new guidance is not expected to have a material impact on the Company's condensed consolidated financial statements.
Note 3 – Variable Interest Entities
The Company's maximum risk of loss in VIEs in which the Company is not the primary beneficiary at September 30, 2015 is presented in the table below.
$ in thousands
Carrying Amount
 
Company's Maximum Risk of Loss
Non-Agency RMBS
2,624,608

 
2,624,608

CMBS
3,304,214

 
3,304,214

Total
5,928,822

 
5,928,822

Refer to Note 4 - "Mortgage-Backed and Credit Risk Transfer Securities" for additional details regarding these investments.
As discussed in Note 2 - "Summary of Significant Accounting Policies," the Company has determined that it is the primary beneficiary of certain securitization trusts. The following table presents a summary of the assets and liabilities of the Company's consolidated securitization trusts as of September 30, 2015 and December 31, 2014. Intercompany balances have been eliminated for purposes of this presentation.
$ in thousands
September 30, 2015
 
December 31, 2014
Residential loans, held-for-investment
3,307,249

 
3,365,003

Accrued interest receivable
20,211

 
10,562

Deferred costs
4,482

 
5,032

Total assets
3,331,942

 
3,380,597

Accrued interest and accrued expenses payable
16,636

 
8,692

Asset-backed securities issued by securitization trusts
2,859,423

 
2,929,820

Total liabilities
2,876,059

 
2,938,512

The Company’s risk with respect to each investment in a securitization trust is limited to its direct ownership in the securitization trust. The residential loans held by the consolidated securitization trusts are held solely to satisfy the liabilities of the securitization trusts, and the investors in the securitization trusts have no recourse to the general credit of the Company for the asset-backed securities issued by the securitization trusts. The assets of a consolidated securitization trust can only be used to satisfy the obligations of that trust. The Company is not contractually required to provide, and has not provided, any additional financial support to the securitization trusts for the period ended September 30, 2015.
During the nine months ended September 30, 2015, the Company invested in and consolidated one new securitization trust. The following table presents the balances of the assets and liabilities of the newly consolidated securitization trust before consolidation into the Company. The current period activity for the securitization trust is reflected in the Company’s condensed consolidated financial statements.
$ in thousands
2015
Residential loans, held-for-investment
372,305

Accrued interest receivable
1,236

Total assets
373,541

Accrued interest and accrued expenses payable
1,236

Asset-backed securities issued by securitization trusts
372,305

Total liabilities
373,541

The Company did not deconsolidate any securitization trusts during the nine months ended September 30, 2015.

 
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Residential Loans Held by Consolidated Securitization Trusts
Residential loans held by consolidated securitization trusts are carried at unpaid principal balance net of any premiums and discount and allowance for loan losses. The residential loans are secured by a lien on the underlying residential property.
The following table details the carrying value for residential loans held-for-investment at September 30, 2015 and December 31, 2014.
$ in thousands
September 30, 2015
 
December 31, 2014
Principal balance
3,279,984

 
3,332,192

Unamortized premium (discount), net
27,794

 
33,553

Recorded investment
3,307,778

 
3,365,745

Allowance for loan losses
(529
)
 
(742
)
Carrying value
3,307,249

 
3,365,003

The following table summarizes residential loans held-for-investment at September 30, 2015 by year of origination.
$ in thousands
2014
 
2013
 
2012
 
2011
 
2010
 
2009
 
2008
 
2007
 
Total
Portfolio Characteristics:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of Loans
692

 
2,596

 
720

 
86

 
25

 
6

 
14

 
14

 
4,153

Current Principal Balance
513,819

 
1,998,969

 
625,255

 
91,620

 
23,841

 
2,737

 
12,327

 
11,416

 
3,279,984

Net Weighted Average Coupon Rate
3.46
%
 
3.45
%
 
3.24
%
 
3.38
%
 
3.74
%
 
3.69
%
 
5.47
%
 
4.67
%
 
3.42
%
Weighted Average Maturity (years)
28.72

 
27.81

 
27.28

 
25.74

 
25.22

 
23.76

 
22.92

 
21.84

 
27.73

Current Performance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
Current
513,819

 
1,997,171

 
625,255

 
91,620

 
23,841

 
2,737

 
11,697

 
11,416

 
3,277,556

30 Days Delinquent
—

 
560

 
—

 
—

 
—

 
—

 
630

 
—

 
1,190

60 Days Delinquent
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

90+ Days Delinquent (1)
—

 
1,238

 
—

 
—

 
—

 
—

 
—

 
—

 
1,238

Bankruptcy/Foreclosure
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Total
513,819

 
1,998,969

 
625,255

 
91,620

 
23,841

 
2,737

 
12,327

 
11,416

 
3,279,984

(1)
The Company has stopped recording interest income on these loans as of September 30, 2015.
The following table summarizes the geographic concentrations of residential loans held-for-investment at September 30, 2015 based on principal balance outstanding.
State
Percent
California
53.1
%
New York
7.6
%
Massachusetts
5.9
%
Illinois
3.6
%
Other states (none greater than 3%)
29.8
%
Total
100.0
%


 
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The following table presents future contractual minimum annual principal payments of residential loans held-for-investment at September 30, 2015.
$ in thousands
 
Scheduled Principal
September 30, 2015
Within one year
58,964

One to three years
125,167

Three to five years
135,008

Greater than or equal to five years
2,960,845

Total
3,279,984

Allowance for Loan Losses on Residential Loans Held by Consolidated Securitization Trusts
As discussed in Note 2 - "Summary of Significant Accounting Policies," the Company establishes and maintains an allowance for loan losses on residential loans held by consolidated securitization trusts based on the Company's estimate of credit losses.
The following table summarizes the activity in the allowance for loan losses for the nine months ended September 30, 2015 and 2014.
$ in thousands
September 30, 2015
 
September 30, 2014
Balance at beginning of period
(742
)
 
(884
)
Charge-offs, net
—

 
—

Reduction in (provision for) loan losses
213

 
52

Balance at end of period
(529
)
 
(832
)
Asset-Backed Securities Issued by Securitization Trusts
Asset-backed securities issued by securitization trusts are recorded at principal balance net of unamortized premiums or discounts. Asset-backed securities issued by securitization trusts are issued in various tranches and have a weighted average contractual maturity of 28.37 years and 28.94 years at September 30, 2015 and December 31, 2014, respectively. The investors in the asset-backed securities are not affiliated with the Company and have no recourse to the general credit of the Company.

 
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The asset-backed securities are collateralized by residential loans held in the securitization trusts as summarized in the following table at September 30, 2015 and December 31, 2014.
 
September 30, 2015
 
December 31, 2014
 
ABS
 
Residential loans
 
ABS
 
Residential loans
$ in thousands
Outstanding
 
Held as Collateral
 
Outstanding
 
Held as Collateral
Principal balance
2,836,398

 
3,279,984

 
2,902,378

 
3,332,192

Interest-only securities
12,930

 
—

 
15,040

 
—

Unamortized premium
19,763

 
34,810

 
23,735

 
41,928

Unamortized discount
(9,668
)
 
(7,016
)
 
(11,333
)
 
(8,375
)
Allowance for loan losses
—

 
(529
)
 
—

 
(742
)
Carrying value
2,859,423

 
3,307,249

 
2,929,820

 
3,365,003

Range of weighted average interest rates
2.8% - 3.9%

 
 
 
2.8% - 4.0%

 
 
Number of securitization trusts consolidated
11

 
 
 
10

 
 
The following table presents the estimated principal repayment schedule of asset-backed securities issued by securitization trusts at September 30, 2015 based on estimated cash flows of the underlying residential mortgage loans, as adjusted for projected prepayments and losses on such loans. The estimated principal repayments may differ from actual amounts to the extent prepayments and/or loan losses vary.
$ in thousands
 
Estimated principal repayment
September 30, 2015
Within one year
378,803

One to three years
621,255

Three to five years
464,837

Greater than or equal to five years
1,371,503

Total
2,836,398


 
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Table of Contents


Note 4 – Mortgage-Backed and Credit Risk Transfer Securities
The following tables summarize the Company’s MBS and GSE CRT portfolio by asset type as of September 30, 2015 and December 31, 2014.
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$ in thousands
Principal
Balance
 
Unamortized
Premium
(Discount)
 
Amortized
Cost
 
Unrealized
Gain/
(Loss), net
 
Fair
Value
 
Net
Weighted
Average
Coupon (1)
 
Period-
end
Weighted
Average
Yield (2)
 
Quarterly
Weighted
Average
Yield (3)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
1,602,338

 
77,013

 
1,679,351

 
23,031

 
1,702,382

 
3.73
%
 
2.44
%
 
2.26
%
30 year fixed-rate
3,905,465

 
259,092

 
4,164,557

 
50,389

 
4,214,946

 
4.26
%
 
2.70
%
 
2.68
%
ARM*
438,335

 
5,088

 
443,423

 
9,408

 
452,831

 
2.73
%
 
2.63
%
 
2.22
%
Hybrid ARM
3,335,619

 
65,957

 
3,401,576

 
46,037

 
3,447,613

 
2.73
%
 
2.55
%
 
2.18
%
Total Agency pass-through
9,281,757

 
407,150

 
9,688,907

 
128,865

 
9,817,772

 
3.55
%
 
2.60
%
 
2.41
%
Agency-CMO(4)
1,928,406

 
(1,521,514
)
 
406,892

 
9,770

 
416,662

 
2.26
%
 
3.60
%
 
2.31
%
Non-Agency RMBS(5)(6)
3,066,848

 
(526,501
)
 
2,540,347

 
84,261

 
2,624,608

 
3.41
%
 
3.64
%
 
4.94
%
GSE CRT(7)
645,000

 
23,376

 
668,376

 
(16,671
)
 
651,705

 
1.01
%
 
0.51
%
 
0.53
%
CMBS(8)
3,745,038

 
(551,404
)
 
3,193,634

 
110,580

 
3,304,214

 
4.12
%
 
4.44
%
 
4.38
%
Total
18,667,049

 
(2,168,893
)
 
16,498,156

 
316,805

 
16,814,961

 
3.42
%
 
3.05
%
 
3.11
%
* Adjustable-rate mortgage ("ARM")
 
(1)
Net weighted average coupon as of September 30, 2015 is presented net of servicing and other fees.
(2)
Period-end weighted average yield is based on amortized cost as of September 30, 2015 and incorporates future prepayment and loss assumptions but excludes changes in anticipated interest rates.
(3)
Quarterly weighted average portfolio yield for the period was calculated by dividing interest income, including amortization of premiums and discounts, by the Company's average of the amortized cost of the investments. All yields are annualized.
(4)
Agency collateralized mortgage obligation ("Agency-CMO") includes Agency MBS IOs which represent 31.6% of the balance based on fair value.
(5)
Non-Agency RMBS held by the Company is 51.3% variable rate, 41.5% fixed rate, and 7.2% floating rate based on fair value.
(6)
Of the total discount in non-Agency RMBS, $328.4 million is non-accretable.
(7)
GSE CRT weighted average coupon and weighted average yield excludes embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net.
(8)
CMBS includes interest-only securities and commercial real estate mezzanine loan pass-through certificates, which represent 0.8% and 1.3% of the balance based on fair value, respectively.


 
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December 31, 2014 (As Restated)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$ in thousands
Principal
Balance
 
Unamortized
Premium
(Discount)
 
Amortized
Cost
 
Unrealized
Gain/
(Loss), net
 
Fair
Value
 
Net
Weighted
Average
Coupon (1)
 
Period-
end
Weighted
Average
Yield (2)
 
Quarterly
Weighted
Average
Yield (3)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
1,236,297

 
60,764

 
1,297,061

 
30,040

 
1,327,101

 
4.05
%
 
2.60
%
 
2.66
%
30 year fixed-rate
4,432,301

 
297,311

 
4,729,612

 
60,681

 
4,790,293

 
4.29
%
 
2.97
%
 
3.05
%
ARM
531,281

 
9,068

 
540,349

 
6,433

 
546,782

 
2.83
%
 
2.27
%
 
2.29
%
Hybrid ARM
2,901,078

 
50,757

 
2,951,835

 
25,083

 
2,976,918

 
2.78
%
 
2.34
%
 
2.24
%
Total Agency pass-through
9,100,957

 
417,900

 
9,518,857

 
122,237

 
9,641,094

 
3.69
%
 
2.68
%
 
2.71
%
Agency-CMO(4)
1,957,296

 
(1,502,785
)
 
454,511

 
(3,616
)
 
450,895

 
2.34
%
 
4.57
%
 
3.62
%
Non-Agency RMBS(5)(6)
3,555,249

 
(583,890
)
 
2,971,359

 
90,288

 
3,061,647

 
3.51
%
 
4.12
%
 
4.86
%
GSE CRT(7)
615,000

 
25,814

 
640,814

 
(15,390
)
 
625,424

 
1.03
%
 
0.49
%
 
0.48
%
CMBS(8)
3,277,208

 
54,893

 
3,332,101

 
137,734

 
3,469,835

 
4.74
%
 
4.39
%
 
4.38
%
Total
18,505,710

 
(1,588,068
)
 
16,917,642

 
331,253

 
17,248,895

 
3.61
%
 
3.24
%
 
3.36
%
 
(1)
Net weighted average coupon as of December 31, 2014 is presented net of servicing and other fees.
(2)
Period-end weighted average yield based on amortized cost as of December 31, 2014 incorporates future prepayment and loss assumptions but excludes changes in anticipated interest rates.
(3)
Quarterly weighted average portfolio yield for the period was calculated by dividing interest income, including amortization of premiums and discounts, by the Company's average of the amortized cost of the investments. All yields are annualized.
(4)
Agency-CMO includes Agency MBS IOs, which represent 29.1% of the balance based on fair value.
(5)
Non-Agency RMBS held by the Company is 52.8% variable rate, 40.1% fixed rate, and 7.1% floating rate based on fair value.
(6)
Of the total discount in non-Agency RMBS, $405.5 million is non-accretable.
(7)
GSE CRT weighted average coupon and weighted average yield excludes embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net.
(8)
CMBS includes commercial real estate mezzanine loan pass-through certificates which represent 1.3% of the balance based on fair value.
The following table summarizes the Company's non-Agency RMBS portfolio by asset type as of September 30, 2015 and December 31, 2014.
$ in thousands
September 30, 2015
 
% of Non-Agency
 
December 31, 2014
 
% of Non-Agency
Prime
821,249

 
31.3
%
 
969,849

 
31.7
%
Re-REMIC
790,577

 
30.1
%
 
1,000,635

 
32.7
%
Alt-A
598,198

 
22.8
%
 
694,467

 
22.7
%
Subprime/reperforming
414,584

 
15.8
%
 
396,696

 
12.9
%
Total Non-Agency
2,624,608

 
100.0
%
 
3,061,647

 
100.0
%

 
18
 

Table of Contents


The following table summarizes the credit enhancement provided to the Company's re-securitization of real estate mortgage investment conduit ("Re-REMIC") holdings as of September 30, 2015 and December 31, 2014.
  
Percentage of Re-REMIC Holdings at Fair Value
Re-REMIC Subordination(1)
September 30, 2015
 
December 31, 2014
0% - 10%
9.4
%
 
7.0
%
10% - 20%
5.0
%
 
4.4
%
20% - 30%
12.4
%
 
11.9
%
30% - 40%
25.4
%
 
26.1
%
40% - 50%
32.5
%
 
31.8
%
50% - 60%
11.7
%
 
15.2
%
60% - 70%
3.6
%
 
3.6
%
Total
100.0
%
 
100.0
%
 
(1)
Subordination refers to the credit enhancement provided to the Re-REMIC tranche held by the Company by any junior Re-REMIC tranche or tranches in a resecuritization. This figure reflects the percentage of the balance of the underlying securities represented by any junior tranche or tranches at the time of resecuritization. Generally, principal losses on the underlying securities in excess of the subordination amount would result in principal losses on the Re-REMIC tranche held by the Company. 19.5% of the Company's Re-REMIC holdings are not senior tranches.
The components of the carrying value of the Company’s MBS and GSE CRT portfolio at September 30, 2015 and December 31, 2014 are presented below. 
$ in thousands
September 30, 2015
 
December 31, 2014 
 (As Restated)
Principal balance
18,667,049

 
18,505,710

Unamortized premium
522,515

 
550,071

Unamortized discount
(2,691,408
)
 
(2,138,139
)
Gross unrealized gains
404,948

 
439,513

Gross unrealized losses
(88,143
)
 
(108,260
)
Fair value
16,814,961

 
17,248,895

The following table summarizes the Company’s MBS and GSE CRT portfolio according to estimated weighted average life classifications as of September 30, 2015 and December 31, 2014. 
$ in thousands
September 30, 2015
 
December 31, 2014
Less than one year
478,122

 
440,471

Greater than one year and less than five years
7,806,669

 
7,997,709

Greater than or equal to five years
8,530,170

 
8,810,715

Total
16,814,961

 
17,248,895



 
19
 

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The following tables present the estimated fair value and gross unrealized losses of the Company's MBS and GSE CRTs by length of time that such securities have been in a continuous unrealized loss position at September 30, 2015 and December 31, 2014.
September 30, 2015
  
Less than 12 Months
 
12 Months or More
 
Total
$ in thousands
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
565,796

 
(2,633
)
 
30

 
81,804

 
(804
)
 
6

 
647,600

 
(3,437
)
 
36

30 year fixed-rate
571,870

 
(7,717
)
 
20

 
1,154,766

 
(26,693
)
 
45

 
1,726,636

 
(34,410
)
 
65

ARM
2,277

 
(1
)
 
1

 
—

 
—

 
—

 
2,277

 
(1
)
 
1

Hybrid ARM
484,179

 
(1,761
)
 
21

 
—

 
—

 
—

 
484,179

 
(1,761
)
 
21

Total Agency pass-through
1,624,122

 
(12,112
)
 
72

 
1,236,570

 
(27,497
)
 
51

 
2,860,692

 
(39,609
)
 
123

Agency-CMO
124,401

 
(2,399
)
 
10

 
13,831

 
(6,714
)
 
9

 
138,232

 
(9,113
)
 
19

Non-Agency RMBS
299,461

 
(2,074
)
 
20

 
423,348

 
(12,583
)
 
31

 
722,809

 
(14,657
)
 
51

GSE CRT (1)
230,241

 
(7,236
)
 
13

 
121,475

 
(13,124
)
 
4

 
351,716

 
(20,360
)
 
17

CMBS
428,580

 
(4,133
)
 
38

 
32,191

 
(271
)
 
1

 
460,771

 
(4,404
)
 
39

Total
2,706,805

 
(27,954
)
 
153

 
1,827,415

 
(60,189
)
 
96

 
4,534,220

 
(88,143
)
 
249

(1) Balance includes unrealized losses on both the debt host contract and the embedded derivative.
December 31, 2014 (As Restated)
  
Less than 12 Months
 
12 Months or More
 
Total
$ in thousands
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
10,897

 
(42
)
 
1

 
105,644

 
(1,395
)
 
6

 
116,541

 
(1,437
)
 
7

30 year fixed-rate
137,680

 
(2,662
)
 
5

 
1,756,894

 
(40,181
)
 
62

 
1,894,574

 
(42,843
)
 
67

ARM
24,074

 
(9
)
 
1

 
3,719

 
(23
)
 
1

 
27,793

 
(32
)
 
2

Hybrid ARM
630,775

 
(1,544
)
 
28

 
20,361

 
(197
)
 
2

 
651,136

 
(1,741
)
 
30

Total Agency pass-through
803,426

 
(4,257
)
 
35

 
1,886,618

 
(41,796
)
 
71

 
2,690,044

 
(46,053
)
 
106

Agency-CMO
36,723

 
(6,192
)
 
18

 
265,863

 
(9,481
)
 
10

 
302,586

 
(15,673
)
 
28

Non-Agency RMBS
573,122

 
(5,799
)
 
34

 
354,532

 
(11,990
)
 
21

 
927,654

 
(17,789
)
 
55

GSE CRT (1)
306,603

 
(25,394
)
 
13

 
—

 
—

 
—

 
306,603

 
(25,394
)
 
13

CMBS
134,364

 
(277
)
 
11

 
227,452

 
(3,074
)
 
19

 
361,816

 
(3,351
)
 
30

Total
1,854,238

 
(41,919
)
 
111

 
2,734,465

 
(66,341
)
 
121

 
4,588,703

 
(108,260
)
 
232

(1) Balance includes unrealized losses on both the debt host contract and the embedded derivative.
Gross unrealized losses on the Company’s Agency RMBS were $39.6 million at September 30, 2015. Due to the inherent credit quality of Agency RMBS, the Company determined that at September 30, 2015, any unrealized losses on its Agency RMBS portfolio are temporary.
Gross unrealized losses on the Company’s Agency-CMO, non-Agency RMBS, GSE CRT and CMBS were $48.5 million at September 30, 2015. The Company does not consider these unrealized losses to be credit related, but rather due to non-credit

 
20
 

Table of Contents


related factors such as interest rate spreads, prepayment speeds, and market fluctuations. These investment securities are included in the Company’s assessment for other-than-temporary impairment on a quarterly basis.
The following table presents the impact of the Company’s MBS and GSE CRT debt host contract on its accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2015 and 2014.  The table excludes Agency MBS IOs because unrealized gains and losses on Agency MBS IOs are included in earnings on the condensed consolidated statements of operations.
$ in thousands
Three Months 
 ended 
 September 30, 2015
 
Three Months 
 ended 
 September 30, 2014 
 (As Restated)
 
Nine Months 
 ended 
 September 30, 2015
 
Nine Months 
 ended 
 September 30, 2014 
 (As Restated)
Accumulated other comprehensive income (loss) from investment securities:
 
 
 
 
 
 
 
Unrealized gain (loss) on MBS and GSE CRT at beginning of period
279,803

 
278,713

 
351,774

 
(160,083
)
Unrealized gain (loss) on MBS and GSE CRT
41,978

 
(81,267
)
 
(25,390
)
 
325,045

Reclassification of unrealized (gain) loss on sale of MBS and GSE CRT to gain (loss) on investments, net
1,380

 
49,169

 
(3,223
)
 
81,653

Balance at the end of period
323,161

 
246,615

 
323,161

 
246,615

During the three months ended September 30, 2015 and 2014, the Company reclassified $1.4 million of net unrealized losses and $49.2 million of net unrealized losses, respectively, from other comprehensive income into gain (loss) on investments, net as a result of the Company selling certain investments.
During the nine months ended September 30, 2015 and 2014, the Company reclassified $3.2 million of net unrealized gains and $81.7 million of net unrealized losses, respectively, from other comprehensive income into gain (loss) on investments as a result of the Company selling certain investments.
The following table summarizes the Company's gross realized gains and losses during the three and nine months ended September 30, 2015 and 2014.
$ in thousands
Three Months 
 ended 
 September 30, 2015
 
Three Months 
 ended 
 September 30, 2014 
 (As Restated)
 
Nine Months 
 ended 
 September 30, 2015
 
Nine Months 
 ended 
 September 30, 2014 
 (As Restated)
Gross realized gain on sale of investments
—

 
3,038

 
4,487

 
13,888

Gross realized loss on sale of investments
(1,404
)
 
(50,990
)
 
(1,288
)
 
(94,324
)
Net unrealized gain (loss) on Agency MBS IOs
(1,554
)
 
(412
)
 
6,891

 
(5,897
)
Total gains (loss) on investments, net
(2,958
)
 
(48,364
)
 
10,090

 
(86,333
)
The Company assesses its investment securities for other-than-temporary impairment on a quarterly basis. When the fair value of an investment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated as either “temporary” or “other-than-temporary.” The Company evaluates each security that has had a fair value less than amortized cost for nine or more consecutive months for other-than-temporary impairment. This analysis includes a determination of estimated future cash flows through an evaluation of the characteristics of the underlying loans and the structural features of the investment. Loan characteristics reviewed include, but are not limited to, delinquency status, loan-to-value ratios, borrower credit scores, occupancy status and geographic concentration. To the extent a security is deemed impaired, the amount by which the amortized cost exceeds the security's market value would be considered other-than-temporary impairment.
The Company did not have other-than-temporary impairments for the three and nine months ended September 30, 2015 and 2014.

 
21
 

Table of Contents


The following table presents components of interest income on the Company’s MBS and GSE CRT portfolio for the three and nine months ended September 30, 2015 and 2014. GSE CRT interest income excludes coupon interest associated with embedded derivatives recorded in realized and unrealized credit derivative income (loss), net.
For the three months ended September 30, 2015
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
93,366

 
(32,153
)
 
61,213

Non-Agency
26,761

 
5,407

 
32,168

GSE CRT
1,663

 
(782
)
 
881

CMBS
38,350

 
(3,342
)
 
35,008

Other
(10
)
 
—

 
(10
)
Total
160,130

 
(30,870
)
 
129,260

For the three months ended September 30, 2014 (As Restated)
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
98,106

 
(29,371
)
 
68,735

Non-Agency
32,313

 
2,971

 
35,284

GSE CRT
1,489

 
(792
)
 
697

CMBS
40,164

 
(5,434
)
 
34,730

Other
(27
)
 
—

 
(27
)
Total
172,045

 
(32,626
)
 
139,419

For the nine months ended September 30, 2015
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
282,132

 
(93,840
)
 
188,292

Non-Agency
85,854

 
8,224

 
94,078

GSE CRT
4,849

 
(2,312
)
 
2,537

CMBS
113,862

 
(8,193
)
 
105,669

Other
47

 
—

 
47

Total
486,744

 
(96,121
)
 
390,623

For the nine months ended September 30, 2014 (As Restated)
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
308,683

 
(80,099
)
 
228,584

Non-Agency
102,785

 
7,639

 
110,424

GSE CRT
3,888

 
(2,242
)
 
1,646

CMBS
120,290

 
(24,996
)
 
95,294

Other
71

 
—

 
71

Total
535,717

 
(99,698
)
 
436,019


 
22
 

Table of Contents


Note 5 – Commercial Loans Held-for-Investment
The following table summarizes commercial loans held-for-investment as of September 30, 2015 and December 31, 2014 that were purchased or originated by the Company.
September 30, 2015
$ in thousands
Number of
loans
 
Principal
Balance
 
Unamortized (fees)/
costs, net
 
Carrying
value
 
Unfunded
commitment
First mortgage loan
1

 
19,789

 
4

 
19,793

 
892

Mezzanine loans
7

 
167,515

 
(270
)
 
167,245

 
2,128

Total
8

 
187,304

 
(266
)
 
187,038

 
3,020

December 31, 2014
$ in thousands
Number of
loans
 
Principal
Balance
 
Unamortized (fees)/
costs, net
 
Carrying
value
 
Unfunded
commitment
First mortgage loan
1

 
19,978

 
41

 
20,019

 
1,623

Subordinate interests:
 
 
 
 
 
 
 
 
 
Mezzanine loans
4

 
71,643

 
(94
)
 
71,549

 
3,357

Other(1)
2

 
54,188

 
—

 
54,188

 
—

Total
7

 
145,809

 
(53
)
 
145,756

 
4,980

(1) Other subordinate interests include a B-note and a preferred equity investment.
These loans were not impaired, and no allowance for loan loss has been recorded as of September 30, 2015 and December 31, 2014.
Note 6 – Other Investments
The following table summarizes the Company's other investments as of September 30, 2015 and December 31, 2014.
$ in thousands
September 30, 2015
 
December 31, 2014
FHLBI stock
75,375

 
62,500

Investments in unconsolidated ventures
37,922

 
43,998

Total
113,297

 
106,498

IAS Services LLC, the Company's wholly-owned subsidiary, is required to purchase and hold FHLBI stock as a condition of membership in the Federal Home Loan Bank of Indianapolis ("FHLBI"). The stock is recorded at cost.
The Company has invested in unconsolidated ventures that are managed by an affiliate of the Company's Manager. The unconsolidated ventures invest in the Company's target assets. Refer to Note 15 - "Commitments and Contingencies" for additional details regarding the Company's commitments to these unconsolidated ventures.

 
23
 

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Note 7 – Borrowings
The Company has entered into repurchase agreements and secured loans and issued exchangeable senior notes to finance the majority of its portfolio of investments. The following table summarizes certain characteristics of the Company’s borrowings at September 30, 2015 and December 31, 2014.
$ in thousands
September 30, 2015
 
December 31, 2014
 
 
 
 
Weighted
 
 
 
 
 
Weighted
 
 
Weighted
 
Average
 
 
 
Weighted
 
Average
 
 
Average
 
Remaining
 
 
 
Average
 
Remaining
Amount
 
Interest
 
Maturity
 
Amount
 
Interest
 
Maturity
Outstanding
 
Rate
 
(days)
 
Outstanding
 
Rate
 
(days)
Repurchase Agreements:
 
 
 
 
 
 
 
 
 
 
 
Agency RMBS
8,637,589

 
0.43
%
 
25

 
9,018,818

 
0.35
%
 
18

Non-Agency RMBS
2,362,985

 
1.56
%
 
34

 
2,676,626

 
1.51
%
 
36

GSE CRT
497,213

 
1.74
%
 
25

 
468,782

 
1.55
%
 
27

CMBS
1,414,344

 
1.37
%
 
27

 
1,458,451

 
1.32
%
 
26

Secured Loans
1,675,000

 
0.42
%
 
2,979

 
1,250,000

 
0.37
%
 
3,472

Exchangeable Senior Notes
400,000

 
5.00
%
 
897

 
400,000

 
5.00
%
 
1,170

Total
14,987,131

 
0.86
%
 
380

 
15,272,677

 
0.81
%
 
335

The Company finances its residential loans held-for-investment through asset-backed securities issued by securitization trusts. Refer to Note 3 - "Variable Interest Entities" for a discussion of asset-backed securities issued by securitization trusts.
Repurchase Agreements
Repurchase agreements bear interest at a contractually agreed upon rate and have maturities ranging from one month to twelve months. Repurchase agreements are accounted for as secured borrowings since the Company maintains effective control of the financed assets. Under the repurchase agreements, the respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets would require the Company to provide additional collateral or fund margin calls. The Company intends to maintain a level of liquidity that will enable the Company to meet margin calls. In addition, the repurchase agreements are subject to certain financial covenants. The Company was in compliance with these covenants at September 30, 2015.


 
24
 

Table of Contents


The following tables summarize certain characteristics of the Company’s repurchase agreements at September 30, 2015 and December 31, 2014.
September 30, 2015
 
 
 
 
 
 
$ in thousands
Repurchase Agreement Counterparties
Amount Outstanding
 
Percent of Total Amount Outstanding
 
Company MBS and GSE CRTs Held as Collateral
 
HSBC Securities (USA) Inc
1,309,753

 
10.1
%
 
1,348,367

 
Royal Bank of Canada
1,180,780

 
9.1
%
 
1,415,584

 
ING Financial Market LLC
950,618

 
7.4
%
 
1,005,589

 
Citigroup Global Markets Inc.
865,237

 
6.7
%
 
1,066,005

(1) 
South Street Securities LLC
842,839

 
6.5
%
 
884,109

 
Goldman, Sachs & Co.
702,265

 
5.4
%
 
847,918

 
J.P. Morgan Securities LLC
635,905

 
4.9
%
 
737,560

 
Industrial and Commercial Bank of China Financial Services LLC
629,954

 
4.9
%
 
664,662

 
Mitsubishi UFJ Securities (USA), Inc.
628,936

 
4.9
%
 
662,515

 
Pierpont Securities LLC
610,956

 
4.7
%
 
636,871

 
Wells Fargo Securities, LLC
566,916

 
4.4
%
 
684,380

 
Scotia Capital
522,070

 
4.0
%
 
543,435

 
Morgan Stanley & Co. Incorporated
495,090

 
3.8
%
 
551,500

(2) 
CRT Capital Group LLC
491,160

 
3.8
%
 
517,341

 
BNP Paribas Securities Corp.
487,219

 
3.8
%
 
550,913

 
Banc of America Securities LLC
467,057

 
3.6
%
 
545,628

(3) 
KGS-Alpha Capital Markets, L.P.
394,015

 
3.1
%
 
415,438

 
All other counterparties (5)
1,131,361

 
8.9
%
 
1,348,841

(4) 
Total
12,912,131

 
100.0
%
 
14,426,656

 
(1) Includes $204.6 million of MBS held as collateral which are eliminated in consolidation.
(2) Includes $41.0 million of MBS held as collateral which are eliminated in consolidation.
(3) Includes $81.6 million of MBS held as collateral which are eliminated in consolidation.
(4) Includes $85.1 million of MBS held as collateral which are eliminated in consolidation.
(5) Represents amounts outstanding with eleven counterparties.
 

 
25
 

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December 31, 2014
 
 
 
 
 
 
$ in thousands
Repurchase Agreement Counterparties
Amount Outstanding
 
Percent of Total Amount Outstanding
 
Company MBS and GSE CRTs Held as Collateral
 
Credit Suisse Securities (USA) LLC
1,517,530

 
11.1
%
 
1,925,973

(1 
) 
HSBC Securities (USA) Inc
1,190,769

 
8.7
%
 
1,225,194

 
Royal Bank of Canada
1,057,798

 
7.8
%
 
1,278,612

 
Citigroup Global Markets Inc.
979,247

 
7.2
%
 
1,157,265

(2 
) 
South Street Securities LLC
961,938

 
7.1
%
 
1,020,054

 
Banc of America Securities LLC
791,196

 
5.9
%
 
875,984

(3 
) 
ING Financial Market LLC
767,733

 
5.6
%
 
820,166

 
Mitsubishi UFJ Securities (USA), Inc.
710,058

 
5.2
%
 
744,836

 
J.P. Morgan Securities LLC
698,856

 
5.1
%
 
814,896

 
Industrial and Commercial Bank of China Financial Services LLC
682,193

 
5.0
%
 
716,989

 
Wells Fargo Securities, LLC
627,071

 
4.6
%
 
754,706

 
Pierpont Securities LLC
601,222

 
4.4
%
 
627,534

 
Morgan Stanley & Co. Incorporated
589,950

 
4.3
%
 
632,002

 
BNP Paribas Securities Corp.
559,658

 
4.1
%
 
622,749

 
Scotia Capital
521,778

 
3.8
%
 
542,044

 
KGS-Alpha Capital Markets, L.P.
407,920

 
3.0
%
 
430,241

 
All other counterparties (4)
957,760

 
7.1
%
 
1,071,019

 
Total
13,622,677

 
100.0
%
 
15,260,264

 
(1) Includes $276.1 million of MBS held as collateral which are eliminated in consolidation.
(2) Includes $20.3 million of MBS held as collateral which are eliminated in consolidation.
(3) Includes $106.8 million of MBS held as collateral which are eliminated in consolidation.
(4) Represents amounts outstanding with ten counterparties.

Company MBS and GSE CRTs held by counterparties as security for repurchase agreements was $14.4 billion and $15.3 billion at September 30, 2015 and December 31, 2014, respectively. This represents a collateral ratio (Company MBS and GSE CRTs Held as Collateral/Amount Outstanding) of 112% and 112% for September 30, 2015 and December 31, 2014, respectively.
No cash collateral was held by the counterparties at September 30, 2015 and December 31, 2014.
Secured Loans
The Company's wholly-owned subsidiary, IAS Services LLC is a member of the FHLBI. As a member of the FHLBI, IAS Services LLC may borrow funds from the FHLBI in the form of secured advances.
As of September 30, 2015, IAS Services LLC, had $1.675 billion in outstanding secured advances from the FHLBI and is approved for total available uncommitted credit for borrowing of an amount up to $2.5 billion. These secured advances have fixed or floating rates. Floating rates are based on the three-month FHLB swap rate plus a spread. For the nine months ended September 30, 2015, IAS Services LLC had average borrowings of $1.6 billion with a weighted average borrowing rate of 0.39% and a weighted average maturity of 8.16 years.
The ability to borrow from the FHLBI is subject to the Company's continued creditworthiness, pledging of sufficient eligible collateral to secure advances, and compliance with certain agreements with FHLBI. Each advance requires approval by the FHLBI and is secured by collateral in accordance with FHLBI’s credit and collateral guidelines. The FHLBI retains the right to mark the underlying collateral for FHLBI advances to fair value. A reduction in the value of pledged assets would require IAS Services LLC to provide additional collateral.

 
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Table of Contents


As of September 30, 2015, the FHLBI advances were collateralized by CMBS and Agency RMBS with a fair value of $1.5 billion and $519.6 million, respectively. Cash collateral posted by the Company to FHLBI was $5.0 million at September 30, 2015.
As discussed in Note 6 - "Other Investments," IAS Services LLC is required to purchase and hold a certain amount of FHLBI stock, which is based, in part, upon the outstanding principal balance of secured advances from the FHLBI.
Note 8 – Derivatives and Hedging Activities
Credit Derivatives
As discussed in Note 2 - "Summary of Significant Accounting Policies", the Company's GSE CRTs are accounted for as hybrid financial instruments consisting of a debt host contract and an embedded derivative. At September 30, 2015 and December 31, 2014, terms of the GSE CRT embedded derivatives are:
$ in thousand
September 30, 2015
 
December 31, 2014
Fair value amount
(14,220
)
 
(21,495
)
Notional amount
645,000

 
615,000

Maximum potential amount of future undiscounted payments
645,000

 
615,000

In 2010, the Company entered into a credit default swap contract ("CDS"). The Company sold protection against losses on a specific pool of non-Agency RMBS in excess of a specified threshold. In exchange, the Company is paid a stated fixed rate fee of 3% of the notional amount of the CDS. As of September 30, 2015, the Company has not made any payments related to the CDS contract.
At September 30, 2015 and December 31, 2014, terms of the CDS are:
$ in thousand
September 30, 2015
 
December 31, 2014
Fair value amount
1,044

 
396

Notional amount
25,987

 
36,684

Maximum potential amount of future undiscounted payments
25,987

 
36,684

Recourse provisions with third parties
—

 
—

Collateral held by counterparty
4,073

 
5,642

Interest Rate Swaps
The Company's repurchase agreements are usually settled on a short-term basis ranging from one to twelve months. At each settlement date, the Company typically refinances each repurchase agreement at the market interest rate at that time. In addition, the Company's secured loans have floating interest rates. As such, 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 exposures 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 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.
Effective December 31, 2013, the Company voluntarily discontinued cash flow hedge accounting for its interest rate swaps to gain greater flexibility in managing interest rate exposures. Amounts recorded in AOCI through December 31, 2013 related to cash flow hedges are reclassified to interest expense on repurchase agreements on the condensed consolidated statements of operations as interest is accrued and paid on the related repurchase agreements over the remaining life of the interest rate swap agreements. The Company reclassified $15.7 million (September 30, 2014: $21.2 million) and $51.2 million (September 30, 2014: $64.1 million) as an increase to interest expense for the three and nine months ended September 30, 2015, respectively. During the next 12 months, the Company estimates that $26.9 million will be reclassified as an increase to interest expense, repurchase agreements.
As a result of discontinuing hedge accounting, beginning January 1, 2014, changes in the fair value of the Company’s interest rate swaps are recorded in gain (loss) on derivative instruments, net on the condensed consolidated statements of operations. Monthly net cash settlements under swaps are recorded in gain (loss) on derivative instruments, net on the condensed consolidated statements of operations.

 
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Table of Contents


As of September 30, 2015, the Company had the following interest rate swaps outstanding:
$ in thousands
Counterparty
 
 
 
 
Notional
 
Maturity Date
 
Fixed Interest Rate
in Contract
Credit Suisse International
 
 
 
 
500,000

 
4/15/2016
 
2.27
%
The Bank of New York Mellon
 
 
 
 
500,000

 
4/15/2016
 
2.24
%
JPMorgan Chase Bank, N.A.
 
 
 
 
500,000

 
5/16/2016
 
2.31
%
Goldman Sachs Bank USA
 
 
 
 
500,000

 
5/24/2016
 
2.34
%
Goldman Sachs Bank USA
 
 
 
 
250,000

 
6/15/2016
 
2.67
%
Wells Fargo Bank, N.A.
 
 
 
 
250,000

 
6/15/2016
 
2.67
%
JPMorgan Chase Bank, N.A.
 
 
 
 
500,000

 
6/24/2016
 
2.51
%
Citibank, N.A.
 
 
 
 
500,000

 
10/15/2016
 
1.93
%
Deutsche Bank AG
 
 
 
 
150,000

 
2/5/2018
 
2.90
%
ING Capital Markets LLC
 
 
 
 
350,000

 
2/24/2018
 
0.95
%
ING Capital Markets LLC
 
 
 
 
300,000

 
5/5/2018
 
0.79
%
UBS AG
 
 
 
 
500,000

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

 
6/5/2018
 
0.87
%
The Royal Bank of Scotland Plc
 
 
 
 
500,000

 
9/5/2018
 
1.04
%
Citibank, N.A. CME Clearing House
 
(1
)
 
 
300,000

 
2/5/2021
 
2.50
%
The Royal Bank of Scotland Plc CME Clearing House
 
(1
)
 
 
300,000

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

 
200,000

 
3/15/2021
 
3.14
%
JPMorgan Chase Bank, N.A. CME Clearing House
 
(2
)

 
500,000

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

 
5/25/2021
 
2.83
%
HSBC Bank USA, National Association CME Clearing House
 
(3
)
 
 
500,000

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

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

 
6/9/2022
 
2.21
%
HSBC Bank USA, National Association
 



 
250,000

 
6/5/2023
 
1.91
%
The Royal Bank of Scotland Plc
 
 

 
500,000

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

 
8/24/2023
 
2.88
%
UBS AG
 
 
 
 
250,000

 
11/15/2023
 
2.23
%
HSBC Bank USA, National Association
 
 
 
 
500,000

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

 
4/2/2025
 
2.04
%
Total
 
 
 
 
11,450,000

 
 
 
2.12
%
(1)
Forward start date of February 2016
(2)
Forward start date of May 2016
(3)
Forward start date of June 2016
At September 30, 2015, the Company’s counterparties held $174.7 million in cash margin deposits and approximately $215.8 million in Agency RMBS as collateral against its interest rate swaps, CDS and currency forward contracts. Cash margin posted by the Company is classified as due from counterparties, and cash margin posted by counterparties that are restricted in use, if any, is classified as restricted cash. As of September 30, 2015 and December 31, 2014, the Company did not have any restricted cash. The Agency RMBS collateral posted by the Company is included in total mortgage-backed and credit risk transfer securities on the Company’s condensed consolidated balance sheets. Cash collateral that is not restricted for use by the Company is included in cash and cash equivalents and the liability to return the collateral is included in collateral held payable on the condensed consolidated balance sheets. Non-cash collateral posted by counterparties to the Company would be recognized if any counterparty defaults or if the Company sold the pledged collateral. As of September 30, 2015 and December 31, 2014, the Company did not recognize any non-cash collateral held as collateral.

 
28
 

Table of Contents


Interest Rate Swaptions
The Company has purchased interest rate swaptions to help mitigate the potential impact of increases or decreases in interest rates on the performance of a portion of the Company’s investment portfolio (referred to as “convexity risk”). The interest rate swaptions provide the Company the option to enter into interest rate swap agreements for a predetermined notional amount, stated term and pay and receive interest rates in the future. The premium paid for interest rate swaptions is reported as an asset in the Company’s condensed consolidated balance sheets. The premium is valued at an amount equal to the fair value of the swaption that would have the effect of closing the position adjusted for nonperformance risk, if any. The difference between the premium and the fair value of the swaption is reported in gain (loss) on derivative instruments, net in the Company’s condensed consolidated statements of operations. If an interest rate swaption expires unexercised, the loss on the interest rate swaption would be equal to the premium paid. If the Company sells or exercises an interest rate swaption, the realized gain or loss on the interest rate swaption would be equal to the difference between the cash or the fair value of the underlying interest rate swap received and the premium paid. The Company had $2.6 million (September 30, 2014: $0) and $10.3 million (September 30, 2014: $23.3 million) of realized loss for the interest rate swaptions that expired unexercised during the three and nine months ended September 30, 2015 and 2014, respectively. For the three and nine months ended September 30, 2015 and 2014, the Company had $2.6 million (September 30, 2014: $2.2 million unrealized loss) and $8.6 million (September 30, 2014: $13.6 million) of unrealized gain, respectively, which represents the change in fair value of the Company's interest rate swaptions that are recognized directly in earnings.
As of September 30, 2015, the Company had the following outstanding interest rate swaptions:
$ in thousands
 
Option
 
Underlying Swap
 
 
 
 
 
 
 
 
Average
 
 
 
Average
 
Average
 
Average
Interest Rate
 
 
 
 
 
Fair
 
Months to
 
Notional
 
Fixed Pay
 
Receive
 
Term
Swaptions
 
Expiration
 
Cost
 
Value
 
Expiration
 
Amount
 
Rate
 
rate
 
(Years)
Receiver
 
< 6 Months
 
1,485

 
73

 
4
 
300,000

 
3M LIBOR
 
1.11
%
 
10.0
Total Receiver
 
 
 
1,485

 
73

 
4
 
300,000

 
3M LIBOR
 
1.11
%
 
10.0
TBAs, Futures and Currency Forward Contracts
The Company purchases or sells certain TBAs and U.S. Treasury futures contracts to help mitigate the potential impact of changes in interest rates on the performance of the Company's portfolio. Realized and unrealized gains and losses associated with the purchase or sales of the TBAs and U.S. Treasury futures contracts are recognized in gain (loss) on derivative instruments, net in the Company's condensed consolidated statements of operations.
The Company uses currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on the Company's investments denominated in foreign currencies. Realized and unrealized gains and losses associated with the purchases or sales of currency forward contracts are recognized in gain (loss) on derivative instruments, net in the Company's condensed consolidated statements of operations.


 
29
 

Table of Contents


The following table presents information with respect to the Company's derivative instruments:
$ in thousands
 
Notional Amount as
of January 1, 2015
 
Additions
 
Settlement,
Termination,
Expiration
or Exercise
 
Notional Amount as
of September 30, 2015
 
Amount of Realized
Gain (Loss), net on Derivative
Instruments (excluding net interest paid or received) for the nine months ended September 30, 2015
Interest Rate Swaptions
 
1,050,000

 
300,000

 
(1,050,000
)
 
300,000

 
(10,328
)
Interest Rate Swaps
 
10,550,000

 
2,100,000

 
(1,200,000
)
 
11,450,000

 
(31,881
)
Sale of TBAs
 
198,000

 
248,000

 
(446,000
)
 
—

 
(2,292
)
Futures Contracts
 
127,400

 
120,900

 
(248,300
)
 
—

 
(943
)
Currency Forward Contracts
 
35,688

 
98,840

 
(127,613
)
 
6,915

 
1,050

Total
 
11,961,088

 
2,867,740

 
(3,071,913
)
 
11,756,915

 
(44,394
)
Tabular Disclosure of the Effect of Derivative Instruments on the Balance Sheet
The table below presents the fair value of the Company’s derivative financial instruments, as well as their classification on the condensed consolidated balance sheets as of September 30, 2015 and December 31, 2014.
$ in thousands
Derivative Assets
 
Derivative Liabilities
 
 
As of September 30, 2015
 
As of December 31, 2014
 
 
 
As of September 30, 2015
 
As of December 31, 2014
Balance
Sheet
 
Fair Value
 
Fair Value
 
Balance
Sheet
 
Fair Value
 
Fair Value
Interest Rate Swap Asset
 
—

 
22,772

 
Interest Rate Swap Liability
 
343,847

 
253,468

CDS Contract
 
1,044

 
396

 
TBAs
 
—

 
558

Interest Rate Swaptions
 
73

 
322

 
Currency Forward Contracts
 
50

 
—

Futures Contracts
 
—

 
89

 
 
 
 
 
 
Currency Forward Contracts
 
191

 
599

 
 
 
 
 
 
Embedded derivatives associated with GSE CRTs are recorded within mortgage-backed and credit risk transfer securities, at fair value, on the consolidated balance sheets. The fair value of the embedded derivatives associated with the GSE CRTs is a net liability of $14.2 million as of September 30, 2015 (December 31, 2014: $21.5 million net liability).
Tabular Disclosure of the Effect of Derivative Instruments on the Income Statement
The tables below present the effect of the Company’s derivative financial instruments on the condensed consolidated statements of operations for the three and nine months ended September 30, 2015 and 2014.

$ in thousands
 
 
 
 
Derivative
not designated as
hedging instrument
 
Location of unrealized gain (loss)
recognized in income
on derivative
 
Three months ended September 30, 2015
 
Three Months 
 ended 
 September 30, 2014 
 (As Restated)
CDS Contract
 
Realized and unrealized credit derivative income (loss), net
 
(96
)
 
(78
)
GSE CRT Embedded Derivatives
 
Realized and unrealized credit derivative income (loss), net
 
(3,848
)
 
(33,644
)
Total
 
 
 
(3,944
)
 
(33,722
)


 
30
 

Table of Contents


$ in thousands
 
 
 
 
Derivative
not designated as
hedging instrument
 
Location of unrealized gain (loss)
recognized in income
on derivative
 
Nine months ended September 30, 2015
 
Nine Months 
 ended 
 September 30, 2014 
 (As Restated)
CDS Contract
 
Realized and unrealized credit derivative income (loss), net
 
648

 
(185
)
GSE CRT Embedded Derivatives
 
Realized and unrealized credit derivative income (loss), net
 
7,275

 
8,307

Total
 
 
 
7,923

 
8,122


The following table summarizes the effect of interest rate swaps, swaption contracts, TBAs, futures contracts and currency forwards reported in gain (loss) on derivative instruments, net on the condensed consolidated statements of operations for the three and nine months ended September 30, 2015 and 2014:
$ in thousands
Three months ended September 30, 2015
Derivative
not designated as
hedging instrument
Realized gain (loss) on settlement, termination, expiration or exercise, net
 
 Contractual interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
—

 
(46,785
)
 
(173,817
)
 
(220,602
)
Interest Rate Swaptions
(2,590
)
 
—

 
2,589

 
(1
)
TBAs
—

 
—

 
—

 
—

Futures Contracts
—

 
—

 
—

 
—

Currency Forward Contracts
(489
)
 
—

 
490

 
1

Total
(3,079
)
 
(46,785
)
 
(170,738
)
 
(220,602
)
$ in thousands
Nine months ended September 30, 2015
Derivative
not designated as
hedging instrument
Realized gain (loss) on settlement, termination, expiration or exercise, net
 
 Contractual interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
(31,881
)
 
(138,404
)
 
(113,151
)
 
(283,436
)
Interest Rate Swaptions
(10,328
)
 
—

 
8,594

 
(1,734
)
TBAs
(2,292
)
 
—

 
558

 
(1,734
)
Futures Contracts
(943
)
 
—

 
(90
)
 
(1,033
)
Currency Forward Contracts
1,050

 
—

 
(457
)
 
593

Total
(44,394
)
 
(138,404
)
 
(104,546
)
 
(287,344
)
$ in thousands
Three months ended September 30, 2014
Derivative
not designated as
hedging instrument
Realized gain (loss) on settlement, termination, expiration or exercise, net
 
 Contractual interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
1,348

 
(50,446
)
 
47,709

 
(1,389
)
Interest Rate Swaptions
—

 
—

 
(2,185
)
 
(2,185
)
TBAs
(2,943
)
 
—

 
368

 
(2,575
)
Futures Contracts
249

 
—

 
786

 
1,035

Currency Forward Contracts
330

 
—

 
1,080

 
1,410

Total
(1,016
)
 
(50,446
)
 
47,758

 
(3,704
)

 
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$ in thousands
Nine months ended September 30, 2014
Derivative
not designated as
hedging instrument
Realized gain (loss) on settlement, termination, expiration or exercise, net
 
 Contractual interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
1,348

 
(154,092
)
 
(146,116
)
 
(298,860
)
Interest Rate Swaptions
(23,275
)
 
—

 
13,596

 
(9,679
)
TBAs
(4,343
)
 
—

 
(867
)
 
(5,210
)
Futures Contracts
(8,937
)
 
—

 
(1,556
)
 
(10,493
)
Currency Forward Contracts
330

 
—

 
1,080

 
1,410

Total
(34,877
)
 
(154,092
)
 
(133,863
)
 
(322,832
)
Credit-risk-related Contingent Features
The Company has agreements with each of its bilateral derivative counterparties. Some of those agreements contain a provision whereby if the Company defaults on any of its indebtedness, including default whereby repayment of the indebtedness has not been accelerated by the lender, the Company could be declared in default on its derivative obligations.
At September 30, 2015, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for non-performance risk related to these agreements, was $183.4 million. The Company has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $215.8 million of Agency RMBS and $174.7 million of cash as of September 30, 2015. If the Company had breached any of these provisions at September 30, 2015, it could have been required to settle its obligations under the agreements at their termination value.
In addition, as of September 30, 2015, the Company has an agreement with a central clearing counterparty. The fair value of such derivatives in a net liability position, which includes accrued interest but excludes any adjustment for non-performance risk related to this agreement, was $160.5 million.
The Company was in compliance with all of the financial provisions of these counterparty agreements as of September 30, 2015.
Note 9 – Offsetting Assets and Liabilities
Certain of the Company's repurchase agreements and derivative transactions are governed by underlying agreements that generally provide for a right of setoff under master netting arrangements (or similar agreements) in the event of default or in the event of bankruptcy of either party to the transactions. Assets and liabilities subject to such arrangements are presented on a gross basis in the condensed consolidated balance sheets.
The following tables present information about the assets and liabilities that are subject to master netting agreements (or similar agreements) and can potentially be offset on the Company’s condensed consolidated balance sheets at September 30, 2015 and December 31, 2014.

Offsetting of Derivative Assets
As of September 30, 2015
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
 
 
$ in thousands
Description
Gross
Amounts of
Recognized
Assets
 
Gross
Amounts
Offset in the Condensed Consolidated
Balance
Sheets
 
Net Amounts
of Assets
presented in
the Condensed
Consolidated
Balance Sheets
 
Financial
Instruments (1)
 
Collateral
Received (4)
 
Net Amount
Derivatives
1,308

 
—

 
1,308

 
(1,308
)
 
—

 
—

Total
1,308

 
—

 
1,308

 
(1,308
)
 
—

 
—



 
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Offsetting of Derivative Liabilities, Repurchase Agreements and Secured Loans
As of September 30, 2015
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheets
 
 
$ in thousands
Description
Gross
Amounts of
Recognized
Liabilities
 
Gross
Amounts
Offset in the Condensed Consolidated
Balance
Sheets
 
Net Amounts
of Liabilities
presented in
the Condensed
Consolidated
Balance Sheets
 
Financial
Instruments (2)(3)(5)
 

Collateral
Posted (2)(4)(5)
 
Net Amount
Derivatives
343,897

 
—

 
343,897

 
(180,965
)
 
(160,482
)
 
2,450

Repurchase Agreements
12,912,131

 
—

 
12,912,131

 
(12,912,131
)
 
—

 
—

Secured Loans
1,675,000

 
—

 
1,675,000

 
(1,675,000
)
 
—

 
—

Total
14,931,028

 
—

 
14,931,028

 
(14,768,096
)
 
(160,482
)
 
2,450

Offsetting of Derivative Assets
As of December 31, 2014
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
$ in thousands
Description
Gross
Amounts of
Recognized
Assets
 
Gross
Amounts
Offset in the Condensed Consolidated
Balance
Sheets
 
Net Amounts
of Assets
presented in
the Condensed
Consolidated
Balance Sheets
 
Financial
Instruments (1)
 
Collateral
Received (4)
 
Net Amount
Derivatives
24,178

 
—

 
24,178

 
(5,277
)
 
(18,901
)
 
—

Total
24,178

 
—

 
24,178

 
(5,277
)
 
(18,901
)
 
—


Offsetting of Derivative Liabilities and Repurchase Agreements
As of December 31, 2014
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
$ in thousands
Description
Gross
Amounts of
Recognized
Liabilities
 
Gross
Amounts
Offset in the Condensed Consolidated
Balance
Sheets
 
Net Amounts
of Liabilities
presented in
the Condensed
Consolidated
Balance Sheets
 
Financial
Instruments (2)(3)
 

Collateral
Posted (2)(4)
 
Net Amount
Derivatives
254,026

 
—

 
254,026

 
(235,908
)
 
(18,118
)
 
—

Repurchase Agreements
13,622,677

 
—

 
13,622,677

 
(13,622,677
)
 
—

 
—

Secured Loans
1,250,000

 
—

 
1,250,000

 
(1,250,000
)
 
—

 
—

Total
15,126,703

 
—

 
15,126,703

 
(15,108,585
)
 
(18,118
)
 
—


(1)
Amounts represent derivatives in an asset position which could potentially be offset against derivatives in a liability position at September 30, 2015 and December 31, 2014, subject to a netting arrangement.
(2)
Amounts represent collateral pledged that is available to be offset against liability balances associated with repurchase agreements, secured loans and derivatives.
(3)
The fair value of securities pledged against the Company's borrowing under repurchase agreements was $14.4 billion and $15.3 billion at September 30, 2015 and December 31, 2014, respectively, including securities held as collateral that are eliminated in consolidation of $412.3 million and $403.2 million, respectively at September 30, 2015 and December 31, 2014.
(4)
Cash collateral received on the Company's derivatives was $0 and $14.9 million at September 30, 2015 and December 31, 2014, respectively. Non-cash collateral received on the Company's derivatives was $0 and $10.8 million

 
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at September 30, 2015 and December 31, 2014. Cash collateral posted by the Company on its derivatives was $174.7 million and $57.6 million at September 30, 2015 and December 31, 2014, respectively.
(5)
The fair value of securities pledged against IAS Services LLC's borrowing under secured loans was $2.0 billion and $1.5 billion at September 30, 2015 and December 31, 2014, respectively. Cash collateral posted by the Company to FHLBI was $5.0 million at September 30, 2015. No cash collateral was posted by the Company at December 31, 2014.
Note 10 – Fair Value of Financial Instruments
A three-level valuation hierarchy exists for disclosure of fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels are defined as follows:
•
Level 1 Inputs – Quoted prices for identical instruments in active markets.
•
Level 2 Inputs – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
•
Level 3 Inputs – Instruments with primarily unobservable value drivers.

 
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The following tables present the Company's assets and liabilities measured at fair value on a recurring basis.
 
September 30, 2015
 
 
 
Fair Value Measurements Using:
 
 
 
 
 
 
 
 
 
Total at
$ in thousands
Level 1
 
Level 2
 
Level 3
 
Fair Value
Assets:
 
 
 
 
 
 
 
Mortgage-backed and credit risk transfer securities(1) (2)
—

 
16,829,181

 
(14,220
)
 
16,814,961

Derivative assets
—

 
1,308

 
—

 
1,308

Total assets
—

 
16,830,489

 
(14,220
)
 
16,816,269

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
—

 
343,897

 
—

 
343,897

Total liabilities
—

 
343,897

 
—

 
343,897

 
December 31, 2014 (As Restated)
 
 
 
Fair Value Measurements Using:
 
 
 
 
 
 
 
 
 
Total at
$ in thousands
Level 1
 
Level 2
 
Level 3
 
Fair Value
Assets:
 
 
 
 
 
 
 
Mortgage-backed and credit risk transfer securities(1) (2)
—

 
17,270,390

 
(21,495
)
 
17,248,895

Derivative assets
89

 
23,693

 
396

 
24,178

Total assets
89

 
17,294,083

 
(21,099
)
 
17,273,073

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
—

 
254,026

 
—

 
254,026

Total liabilities
—

 
254,026

 
—

 
254,026

(1)
For more detail about the fair value of the Company's MBS and GSE CRTs, refer to Note 4 - "Mortgage-Backed and Credit Risk Transfer Securities."
(2)
As discussed in Note 2 "Summary of Significant Accounting Policies", the Company's GSE CRTs are accounted for as hybrid financial instruments with an embedded derivative. The hybrid instruments consist of debt host contracts classified as Level 2 and embedded derivatives classified as Level 3. As of September 30, 2015, the net embedded derivative liability position of $14.2 million includes $3.7 million of embedded derivatives in an asset position and $17.9 million of embedded derivatives in a liability position. As of December 31, 2014, the net embedded derivative liability position of $21.5 million includes $3.1 million of embedded derivatives in an asset position and $24.6 million of embedded derivatives in a liability position.
The following table shows a reconciliation of the beginning and ending fair value measurements of the Company's GSE CRT embedded derivatives, which the Company has valued utilizing Level 3 inputs:
$ in thousands
September 30, 2015
 
December 31, 2014
Beginning balance
(21,495
)
 
—

Sales and settlements
2,184

 
—

Total net gains / (losses) included in net income:
 
 
 
Realized gains/(losses), net
(2,184
)
 
—

Unrealized gains/(losses), net
7,275

 
(21,495
)
Ending balance
(14,220
)
 
(21,495
)


 
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The following table summarizes significant unobservable inputs used in the fair value measurement of the Company's GSE CRT embedded derivative:
 
Fair Value at
 
Valuation
 
Unobservable
 
 
 
Weighted
$ in thousands
September 30, 2015
 
Technique
 
Input
 
Range
 
Average
GSE CRT Embedded Derivatives
(14,220
)
 
Market Comparables
 
Prepayment Rate
 
4.95% - 9.85%
 
6.17
%
 
 
 
Vendor Pricing
 
Default Rate
 
0.11% - 0.36%
 
0.17
%
 
Fair Value at
 
Valuation
 
Unobservable
 
 
 
Weighted
$ in thousands
December 31, 2014
 
Technique
 
Input
 
Range
 
Average
GSE CRT Embedded Derivatives
(21,495
)
 
Market Comparables
 
Prepayment Rate
 
4.46% - 8.98%
 
5.29
%
 
 
 
Vendor Pricing
 
Default Rate
 
0.12% - 0.37%
 
0.18
%

These significant unobservable inputs change according to market conditions and security performance. Prepayment rate and default rate are used to estimate the maturity of GSE CRTs in order to identify GSE corporate debt with a similar maturity. Therefore, changes in prepayment rate and default rate do not have an explicit directional impact on the fair value measurement.
The following table shows a reconciliation of the beginning and ending Level 3 fair value measurements of the Company's credit default swap ("CDS") contract:
$ in thousands
September 30, 2015
 
December 31, 2014
Beginning balance
396

 
654

Unrealized gains/(losses), net
648

 
(258
)
Transfer out of level 3 (1)
(1,044
)
 
—

Ending balance
—

 
396

(1)
During the three months ended September 30, 2015, the CDS contract was transferred from Level 3 to Level 2. As of September 30, 2015, the Company accepted an offer to terminate the CDS in October 2015 in exchange for a payment to the Company of $1.0 million. As of September 30, 2015, the fair value of the CDS was the offer amount.
The following table summarizes significant unobservable inputs used in the fair value measurement of the Company's CDS contract as of December 31, 2014:

 
Fair Value at
 
Valuation
 
Unobservable
 
 
 
Weighted
$ in thousands
December 31, 2014
 
Technique
 
Input
 
Range
 
Average
CDS Contract
396

 
Discounted cash flow
 
Swap Rate
 
 
 
2.39
%
 
 
 
 
 
Discount Rate
 
 
 
0.76
%
 
 
 
 
 
Credit Spread
 
 
 
0.24
%
 
 
 
 
 
Constant Prepayment Rate
 
1.0% - 20.0%
 
5.46
%
 
 
 
 
 
Constant Default Rate
 
0.6% - 100.0%
 
4.15
%
 
 
 
 
 
Loss Severity
 
1.1% - 62.3%
 
39.35
%
These significant unobservable inputs change according to market conditions and security performance expectations. Significant increases (decreases) in swap rate, discount rate, credit spread, constant prepayment rate, constant default rate or loss severity in isolation would result in a lower (higher) fair value measurement. Generally, a change in the assumption used for the constant default rate would likely be accompanied by a directionally similar change in the assumptions used for swap rate, credit spread and loss severity and a directionally opposite change in the assumption used for discount rate and constant prepayment rate.

 
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The following table presents the carrying value and estimated fair value of the Company's financial instruments that are not carried at fair value on the condensed consolidated balance sheets, at September 30, 2015 and December 31, 2014:
 
September 30, 2015
 
December 31, 2014
$ in thousands
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
Financial Assets
 
 
 
 
 
 
 
Residential loans, held-for-investment
3,307,249

 
3,303,889

 
3,365,003

 
3,399,964

Commercial loans, held-for-investment
187,038

 
188,723

 
145,756

 
147,497

Other investments
113,297

 
113,297

 
106,498

 
106,498

Total
3,607,584

 
3,605,909

 
3,617,257

 
3,653,959

Financial Liabilities
 
 
 
 
 
 
 
Repurchase agreements
12,912,131

 
12,919,190

 
13,622,677

 
13,630,571

Secured loans
1,675,000

 
1,675,000

 
1,250,000

 
1,250,000

Asset-backed securities issued by securitization trusts
2,859,423

 
2,843,143

 
2,929,820

 
2,930,422

Exchangeable senior notes
400,000

 
378,000

 
400,000

 
379,500

Total
17,846,554

 
17,815,333

 
18,202,497

 
18,190,493

The following describes the Company’s methods for estimating the fair value for financial instruments.
•
The fair value of residential loans held-for-investment is a Level 3 fair value measurement which is 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.
•
The fair value of commercial loans held-for-investment is a Level 3 fair value measurement. New commercial loans are carried at their unpaid principal balance until the end of the calendar year in which they were originated or purchased unless market factors indicate cost may not be a reliable indicator of fair value. Subsequent to the year of origination, commercial loan investments are valued on at least an annual basis by an independent third party valuation agent using a discounted cash flow technique.
•
The fair value of FHLBI stock, included in "Other investments," is a Level 3 fair value measurement. FHLBI stock may only be sold back to the FHLBI at its discretion at cost. As a result, the cost of the FHLBI stock approximates its fair value.
•
The fair value of investments in unconsolidated ventures, included in "Other investments," is a Level 3 fair value measurement. The fair value measurement is based on the net asset value per share of the Company's investments.
•
The fair value of repurchase agreements is a Level 3 fair value measurement based on an expected present value technique. This method discounts future estimated cash flows using rates the Company determined best reflect current market interest rates that would be offered for repurchase agreements with similar characteristics and credit quality.
•
The fair value of asset-backed securities issued by securitization trusts is a Level 3 fair value measurement based on valuations obtained from a third party pricing service. There is not an active trading market for many of the underlying asset-backed securities. Accordingly, these securities are valued by the third party pricing service by discounting future estimated cash flows using rates that best reflect current market interest rates that would be offered for securities with similar characteristics and credit quality.
•
The fair value of secured loans is a Level 3 fair value measurement. The secured loans have floating rates based on an index plus a spread. Accordingly, the interest rates on these secured loans are at market, and thus the carrying amount approximates fair value.
•
The fair value of the exchangeable senior notes issued is a Level 2 fair value measurement based on valuation obtained from a third-party pricing service.

 
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Note 11 – Related Party Transactions
The Company is externally managed and advised by Invesco Advisers, Inc., a wholly-owned subsidiary of Invesco Ltd. Under the terms of the management agreement, the Manager and its affiliates provide the Company with its management team, including its officers, along with appropriate support personnel. Each of the Company’s officers is an employee of the Manager or one of its affiliates. The Company does not have any employees. The Manager is not obligated to dedicate any of its employees exclusively to the Company, nor are the Manager or its employees obligated to dedicate any specific portion of its or their time to the Company’s business. The Manager is at all times subject to the supervision and oversight of the Company’s Board of Directors and has only such functions and authority as the Company delegates to it.
The Company has invested $76.3 million and $149.3 million as of September 30, 2015 and December 31, 2014, respectively, in money market or mutual funds managed by affiliates of the Company’s Manager. The investments are reported as cash and cash equivalents on the Company’s condensed consolidated balance sheets.
Management Fee
The Company pays its Manager a management fee equal to 1.50% of the Company’s stockholders’ equity per annum. The fee is calculated and payable quarterly in arrears. For purposes of calculating the management fee, stockholders’ equity is equal to the sum of the net proceeds from all issuances of equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus retained earnings at the end of the most recently completed calendar quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less any amount paid to repurchase common stock since inception. Stockholder's equity shall exclude (i) any unrealized gains, losses or other items that do not affect realized net income (regardless of whether such items are included in other comprehensive income or loss, or in net income); (ii) cumulative net realized losses that are not attributable to permanently impaired investments and that relate to the investments for which market movement is accounted for in other comprehensive income; provided, however, that such adjustment shall not exceed cumulative unrealized net gains in other comprehensive income; (iii) one-time events pursuant to changes in U.S. GAAP; and (iv) certain non-cash items after discussions between the Manager and the Company’s independent directors and approval by a majority of the Company’s independent directors.
The Manager has agreed to reduce (but not below zero) the management fee payable by the Company under the management agreement with respect to any equity investment managed by the Manager. The fee reduction occurs at the equity investment level.
For the three and nine months ended September 30, 2015, the Company incurred management fees of $10.1 million (September 30, 2014: $9.2 million) and $28.8 million (September 30, 2014: $27.9 million), of which $9.9 million (September 30, 2014: $9.2 million) was accrued but has not been paid.
Expense Reimbursement
The Company is required to reimburse its Manager for Company operating expenses incurred on its behalf by the Manager, including directors and officers insurance, accounting services, auditing and tax services, filing fees, and miscellaneous general and administrative costs. The Company’s reimbursement obligation is not subject to any dollar limitation.
The following table summarizes the costs originally paid by the Manager, incurred on behalf of the Company for the three and nine months ended September 30, 2015 and 2014.
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
$ in thousands
2015
 
2014
 
2015
 
2014
Incurred costs, prepaid or expensed
2,668

 
1,274

 
5,017

 
4,373

Incurred costs, charged against equity as a cost of raising capital
22

 
—

 
22

 
—

Total incurred costs, originally paid by the Manager
2,690

 
1,274

 
5,039

 
4,373

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

 
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Note 12 – Stockholders’ Equity
Securities Convertible into Shares of Common Stock
The non-controlling interest holder of the Operating Partnership units, a wholly-owned Invesco subsidiary, has the right to cause the Operating Partnership to redeem their operating partnership ("OP Units") for cash equal to the market value of an equivalent number of shares of common stock, or at the Company’s option, the Company may purchase their OP Units by issuing one share of common stock for each OP Unit redeemed. The Company has also adopted an equity incentive plan which allows the Company to grant securities convertible into the Company’s common stock to its non-executive directors and employees of the Company's Manager and its affiliates.
Common Stock
The Company has a dividend reinvestment and stock purchase plan (the “DRSPP”) that allows participating stockholders to purchase shares of common stock directly from the Company. DRSPP participants may also automatically reinvest all or a portion of their dividends in exchange for additional shares of common stock.
During the nine months ended September 30, 2015, the Company issued 10,317 shares of common stock at an average price of $15.29 under the DRSPP. The Company received total proceeds of approximately $158,000.
Preferred Stock
Holders of the Company’s Series A Preferred Stock are entitled to receive dividends at an annual rate of 7.75% of the liquidation preference of $25.00 per share or $1.9375 per share per annum. The dividends are cumulative and payable quarterly in arrears.
Holders of the Company’s Series B Preferred Stock are entitled to receive dividends at an annual rate of 7.75% of the liquidation preference of $25.00 per share or $1.9375 per share per annum until December 27, 2024. After December 27, 2024, holders are entitled to receive dividends at a floating rate equal to three-month LIBOR plus a spread of 5.18% of the $25.00 liquidation preference per annum. Dividends are cumulative and payable quarterly in arrears.
The Company may elect to redeem shares of preferred stock at its option after July 26, 2017 (with respect to the Series A Preferred Stock) and after December 27, 2024 (with respect to the Series B Preferred Stock) for $25.00 per share, plus any accumulated and unpaid dividends through the date of the redemption. These shares are not redeemable, convertible into or exchangeable for any other property or any other securities of the Company prior to those times, except under circumstances intended to preserve the Company's qualification as a REIT or upon the occurrence of a change in control.
Share Repurchase Program
During the three and nine months ended September 30, 2015, the Company repurchased 3,695,368 shares of its common stock at an average repurchase price of $13.53 per share for a net cost of $50.0 million, including acquisition expenses. As of September 30, 2015, the Company had authority to purchase 11,146,416 additional shares of its common stock under its share repurchase program. The share repurchase program has no stated expiration date.
Share-Based Compensation
The Company has currently reserved 1,000,000 shares of common stock for issuance to its non-executive directors and officers and employees of the Manger and its affiliates under the terms of its 2009 Equity Incentive Plan (the "Incentive Plan"). Unless terminated earlier, the Incentive Plan will terminate in 2019, but will continue to govern the unexpired awards.
The Company recognized compensation expense of approximately $85,000 (September 30, 2014: $60,000) and approximately $255,000 (September 30, 2014: $172,000) related to the Company's non-executive directors for the three and nine months ended September 30, 2015 and 2014, respectively. During the three months ended September 30, 2015 and 2014, the Company issued 6,152 shares and 3,532 shares of stock, respectively, pursuant to the Incentive Plan to the Company’s non-executive directors. During the nine months ended September 30, 2015 and 2014, the Company issued 16,896 shares and 9,356 shares of stock, respectively, pursuant to the Incentive 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 the grant.
The Company recognized compensation expense of approximately $31,000 (September 30, 2014: $62,000) and $168,000 (September 30, 2014: $223,000) for the three and nine months ended September 30, 2015, respectively, related to awards to employees of the Manager and its affiliates which is reimbursed by the Manager under the management agreement. During March 2015, the Company issued 11,547 shares of common stock (net of tax withholding) to employees of the Manager and its affiliates in exchange for 17,783 restricted stock units that vested under the Incentive Plan. In addition, during the nine months

 
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ended September 30, 2015, the Company awarded 17,652 restricted stock units to employees of the Manager and its affiliates and employees forfeited 4,600 restricted stock units.
Dividends
On September 15, 2015, the Company declared the following dividends:
•
a dividend of $0.40 per share of common stock to be paid on October 27, 2015 to stockholders of record as of the close of business on September 28, 2015;
•
a dividend of $0.4844 per share of Series A Preferred Stock to be paid on October 26, 2015 to stockholders of record as of the close of business on October 1, 2015; and
•
a dividend of $0.4844 per share of Series B Preferred Stock to be paid on December 28, 2015 to stockholders of record as of the close of business on December 5, 2015.
Note 13 – Earnings per Common Share
Earnings per share for the three and nine months ended September 30, 2015 and 2014 is computed as follows: 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
$ and share amounts in thousands
2015
 
2014 
 (As Restated)
 
2015
 
2014 
 (As Restated)
Numerator (Income)
 
 
 
 
 
 
 
Basic Earnings
 
 
 
 
 
 
 
Net income (loss) available to common stockholders
(144,550
)
 
(2,836
)
 
(22,065
)
 
(135,368
)
Effect of dilutive securities:
 
 
 
 
 
 
 
Income allocated to exchangeable senior notes
—

 
—

 
—

 
—

Income (loss) allocated to non-controlling interest
(1,629
)
 
6

 
(80
)
 
(1,456
)
Dilutive net income (loss) available to stockholders
(146,179
)
 
(2,830
)
 
(22,145
)
 
(136,824
)
Denominator (Weighted Average Shares)
 
 
 
 
 
 
 
Basic Earnings:
 
 
 
 
 
 
 
Shares available to common stockholders
122,047

 
123,098

 
122,763

 
123,105

Effect of dilutive securities:
 
 

 
 
 
 
Restricted stock awards
—

 
—

 
—

 
—

OP units
1,425

 
1,425

 
1,425

 
1,425

Exchangeable senior notes
—

 
—

 
—

 
—

Dilutive Shares
123,472

 
124,523

 
124,188

 
124,530

The following potential common shares were excluded from diluted earnings per common share for the three and nine months ended September 30, 2015 as the effect would be anti-dilutive: 16,835,720 for the exchangeable senior notes, respectively, and 40,810 and 41,404 for restricted stock awards, respectively. The following potential common shares were excluded from diluted earnings per common share for the three and nine months ended September 30, 2014 as the effect would be anti-dilutive: 16,835,720 for the exchangeable senior notes, respectively, and 45,540 and 44,046 for restricted stock awards, respectively.

 
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Note 14 – Non-controlling Interest - Operating Partnership
Non-controlling interest represents the aggregate Operating Partnership Units in the Company's Operating Partnership held by a wholly-owned Invesco subsidiary. 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 a Share equivalent. Therefore, such transactions are treated as capital transactions and result in an allocation between stockholders’ equity and non-controlling interest in the accompanying condensed consolidated balance sheets. As of September 30, 2015 and December 31, 2014, non-controlling interest related to the outstanding 1,425,000 OP Units represented a 1.2% interest and 1.1% interest in the Operating Partnership, respectively.
The following table presents the net income (loss) allocated and distributions paid to the Operating Partnership non-controlling interest for the three and nine months ended September 30, 2015 and 2014.
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
$ in thousands
2015
 
2014 
 (As Restated)
 
2015
 
2014 
 (As Restated)
Net income (loss) allocated
(1,629
)
 
6

 
(80
)
 
(1,456
)
Distributions paid
570

 
713

 
1,853

 
2,138

As of September 30, 2015 and December 31, 2014, distributions payable to the non-controlling interest were approximately $570,000 and $641,000, respectively.
Note 15 – Commitments and Contingencies
Commitments and Contingencies
Commitments and contingencies may arise in the ordinary course of business.
Off Balance Sheet Commitments
As discussed in Note 6 - "Other Investments", the Company has invested in unconsolidated ventures that are sponsored by an affiliate of the Company’s Manager. The unconsolidated ventures are structured as partnerships, and the Company invests in the partnerships as a limited partner. The entities are structured such that capital commitments are to be drawn down over the life of the partnership as investment opportunities are identified. As of September 30, 2015 and December 31, 2014, the Company’s undrawn capital and purchase commitments were $25.4 million and $31.0 million, respectively.
As discussed in Note 5 - “Commercial Loans Held-for-Investment”, the Company purchases and originates commercial loans. As of September 30, 2015 and December 31, 2014, the Company has unfunded commitments on commercial loans held-for-investment of $3.0 million and $5.0 million, respectively.
The Company has entered into agreements with financial institutions to guarantee certain obligations of its subsidiaries.  The Company would be required to perform under these guarantees in the event of certain defaults. The Company has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote.

Note 16 – Subsequent Events
The Company has reviewed subsequent events occurring through the date that these condensed consolidated financial statements were issued, and determined that no subsequent events occurred that would require accrual or additional disclosure.


 
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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 (which does not include us), as “Invesco.”
The following discussion should be read in conjunction with our condensed consolidated financial statements and the accompanying notes to our condensed 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/A filed with the Securities and Exchange Commission (the “SEC”).

Forward-Looking Statements
We make forward-looking statements in this Report and other filings we make with the SEC within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and such statements are intended to be covered by the safe harbor provided by the same. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, investment strategies, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may” or similar expressions and future or conditional verbs such as “will,” “may,” “could,” “should,” and “would,” and any other statement that necessarily depends on future events, we intend to identify forward-looking statements. Factors that could cause actual results to differ from those expressed in our forward-looking statements include, but are not limited to:
•
our business and investment strategy;
•
our investment portfolio;
•
our projected operating results;
•
general volatility of financial markets and effects of governmental responses, including actions and initiatives of the U.S. governmental agencies and changes to U.S. government policies, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), mortgage loan modification programs, actions and initiatives of foreign governmental agencies and central banks, and the completion of the Federal Reserve long-term asset purchases (quantitative easing or "QE"), and our ability to respond to and comply with such actions, initiatives and changes;
•
the availability of financing sources, including our ability to obtain additional financing arrangements and the terms of such arrangements;
•
financing and advance rates for our target assets;
•
changes to our expected leverage;
•
our expected investments;
•
our expected book value per share of common stock;
•
interest rate mismatches between our target assets and our borrowings used to fund such investments;
•
the adequacy of our cash flow from operations and borrowings to meet our short-term liquidity needs;
•
our ability to maintain sufficient liquidity to meet any margin calls;
•
changes in the credit rating of the U.S. government;
•
changes in interest rates and interest rate spreads and the market value of our target assets;
•
changes in prepayment rates on our target assets;
•
the impact of any deficiencies in foreclosure practices of third parties and related uncertainty in the timing of collateral disposition;
•
our reliance on third parties in connection with services related to our target assets;
•
effects of hedging instruments on our target assets;
•
rates of default or decreased recovery rates on our target assets;

 
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•
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;
•
the degree to which derivative contracts expose us to contingent liabilities;
•
counterparty defaults;
•
compliance with financial covenants in our financing arrangements;
•
changes in governmental regulations, tax law and rates, and similar matters and our ability to respond to such changes;
•
our ability to maintain our qualification as a real estate investment trust for U.S. federal income tax purposes;
•
our ability to maintain our exception from the definition of “investment company” under the Investment Company Act of 1940, as amended (the “1940 Act”);
•
availability of investment opportunities in mortgage-related, real estate-related and other securities;
•
availability of U.S. Government Agency guarantees with regard to payments of principal and interest on securities;
•
the market price and trading volume of our capital stock;
•
availability of qualified personnel of our Manager;
•
the relationship with our Manager;
•
estimates relating to taxable income and our ability to continue to make distributions to our stockholders in the future;
•
estimates relating to fair value of our target assets and loan loss reserves;
•
our understanding of our competition;
•
changes to generally accepted accounting principles in the United States of America (“U.S. GAAP”);
•
the impact of the Restatement and the adequacy of our disclosure controls and procedures over financial reporting; and
•
market trends in our industry, interest rates, real estate values, the debt securities markets or the general economy.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. You should not place undue reliance on these forward-looking statements. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. Some of these factors are described under the headings “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. New risks and uncertainties arise over time, and it is not possible for us to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The following discussion should be read in conjunction with our condensed consolidated financial statements and the accompanying notes to our condensed consolidated financial statements, which are included in this Report.
Overview
We are a Maryland corporation primarily focused on investing in, financing and managing residential and commercial mortgage-backed securities ("MBS") and mortgage loans. We are externally managed and advised by Invesco Advisers, Inc., our Manager, a registered investment adviser and an indirect, wholly-owned subsidiary of Invesco Ltd., a leading independent global investment management firm. We elected to be taxed as a real estate investment trust (“REIT”) for U.S. federal income tax purposes under the provisions of the Internal Revenue Code of 1986, as amended (“Code”), commencing with our taxable year ended December 31, 2009. To maintain our REIT qualification, we are generally required to distribute at least 90% of our REIT taxable income to our stockholders annually. We operate our business in a manner that permits our exclusion from the definition of “Investment Company” under the 1940 Act.
Our objective is to provide attractive risk-adjusted returns to our investors, primarily through dividends and secondarily through capital appreciation. To achieve this objective, we primarily invest in the following:
•
Residential mortgage-backed securities (“RMBS”) that are guaranteed by a U.S. government agency such as the Government National Mortgage Association ("Ginnie Mae") or a federally chartered corporation such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”) (collectively "Agency RMBS");

 
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•
RMBS that are not guaranteed by a U.S. government agency ("non-Agency RMBS");
•
Credit risk transfer securities that are unsecured obligations issued by government-sponsored enterprises ("GSE CRT");
•
Commercial mortgage-backed securities (“CMBS”); 
•
Residential and commercial mortgage loans; and
•
Other real estate-related financing arrangements.
We generally finance our investments through short- and long-term borrowings structured as repurchase agreements and secured loans. We finance our residential loans held-for-investment through asset-backed securities ("ABS") issued by consolidated securitization trusts. We have also financed investments through the issuances of debt and equity and may utilize other forms of financing in the future.
Capital Activities
On September 15, 2015, we declared the following dividends:
•
a dividend of $0.40 per share of common stock to be paid on October 27, 2015 to stockholders of record as of the close of business on September 28, 2015;
•
a dividend of $0.4844 per share of Series A Preferred Stock to be paid on October 26, 2015 to stockholders of record as of the close of business on October 1, 2015; and
•
a dividend of $0.4844 per share of Series B Preferred Stock to be paid on December 28, 2015 to stockholders of record as of the close of business on December 5, 2015.
During the three and nine months ended September 30, 2015, we repurchased 3,695,368 shares of our common stock at an average repurchase price of $13.53 per share for a net cost of $50.0 million, including acquisition expenses.
Factors Impacting Our Operating Results
Our operating results can be affected by a number of factors and primarily depend on the level of our net interest income and the market value of our assets. Our net interest income, which includes the amortization of purchase premiums, reclassification of amortization of net deferred losses on de-designated interest rate swaps to repurchase agreements interest expense and accretion of purchase discounts, varies primarily as a result of changes in market interest rates and prepayment speeds, as measured by the constant prepayment rate (“CPR”) on our target assets. Interest rates and prepayment speeds vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. The market value of our assets can be impacted by asset spreads and the supply of, and demand for, target assets in which we invest.
Market Conditions
Macroeconomic factors that affect our business include credit spread premiums, market interest rates, Federal Reserve policy initiatives, residential and commercial real estate prices, credit availability, personal income, corporate earnings, employment conditions, financial conditions and inflation. In the third quarter of 2015 market attention was focused on global events, particularly economic weakness in China and the potential actions of the Federal Reserve. Many investors decreased risk exposure due to the potential for tighter U.S. monetary policy, a stronger dollar, declining commodity prices, and generally weaker global economic growth. As a result, equity and interest rate volatility increased, interest rates declined, credit spread premiums widened, and financial conditions generally tightened.
Consensus forecasts for domestic economic activity in the second half of 2015 are being reduced. Monthly increases in payroll employment averaged just 167,000 for the third quarter after increasing by 213,000 per month in the first half of 2015. Still, the unemployment rate has continued to decline to 5.1% as of September 2015 from 5.3% as of June 2015. Third quarter financial conditions weakened with increased interest rate volatility, wider credit spreads, and lower U.S. equity prices. Still, the low interest rate environment, coupled with the decline in energy prices, should be supportive of U.S. economic growth, as policy rates are below levels that would be historically indicated by recent unemployment and inflation indicators alone. Countering the positive influence on the economy is weak capital investment, tepid wage and consumer debt growth, and the stronger dollar. Households are once again increasing their debt levels, albeit at a modest rate, which increases their ability to consume goods and services. Inflation data has continued to indicate smaller increases than the Federal Reserve's 2% target, with core personal consumption expenditures prices having increased 1.3% year-over-year as of August 2015. Markets continue

 
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to try to discern the timing of the first interest rate increase by the Federal Reserve and still expect that it may come later this year.
The interest rate environment has been broadly supportive for Agency RMBS, and we believe it will continue to be. Range-bound interest rates create a good environment for MBS investors, as the prepayment option embedded in Agency RMBS is less onerous if interest rates are likely to neither fall nor rise dramatically. Further, continued tight residential mortgage loan underwriting standards restrict the ability of homeowners to refinance, which is normally to the detriment of MBS investors. We believe quantitative easing in Europe and Japan will create international demand for Agency RMBS due to the relatively attractive yield and the implicit U.S. government guarantee. Further, Agency RMBS investors saw the muted market impact from Federal Reserve tapering of Agency RMBS purchases in the fourth quarter of 2014 as that program ended with little noticeable impact on Agency RMBS valuations. There has been adequate demand from investors and limited supply of new Agency RMBS to offset the decline in demand from the Federal Reserve. Still, Agency MBS modestly underperformed equal duration U.S. Treasury notes during the third quarter reflecting worsening financial conditions including wider investment grade credit spreads. Exacerbating the under performance of Agency MBS was the strong performance of interest rate swaps which are commonly used to hedge the interest rate duration risk in MBS portfolios. Interest rate swap spreads, generally thought likely to widen in times of weakening financial conditions, actually tightened markedly in the third quarter. Ten year swap yields declined by approximately 46 basis points while similar maturity Treasury yields only declined by 31 basis points, thus the spread or difference narrowed by 15 basis points. By comparison, the 30 year current coupon mortgage yield declined 30 basis points. Repurchase agreement financing one-month rates for Agency RMBS increased in the third quarter from the high 30’s basis points range in July to nearly 50 basis points in early September due in large part to expectations of a September rate increase by the Federal Reserve and possibly also due to weakening financial conditions. After the September Federal Reserve meeting passed with no rate increase, rates declined to the low 40’s basis points range, which was still somewhat elevated due to quarter end pressures.
With respect to mortgage credit assets, CMBS yield spreads over comparable term interest rate swaps widened over the quarter as financial conditions deteriorated and supply of CMBS increased. Spreads in unrated GSE CRTs also widened over the third quarter of 2015, while legacy non-Agency RMBS prices were generally stable. We continue to believe a gradually improving economy, coupled with low interest rates, should foster a favorable environment for residential and commercial real estate. Specifically, this environment should support modest growth in property prices and rents, encourage favorable financing terms and aid in tempering new supply.
The impact of regulatory initiatives on the economy may also affect our business and our financial results. The Dodd-Frank Act, enacted in July 2010, contains numerous provisions affecting the financial and mortgage industries, many of which may affect our cost of doing business, may limit our investment opportunities and may affect the competitive balance within our industry and the markets in which we invest. For example, the Ability-to-Repay (“ATR”) rule requires lenders to make a reasonable, good-faith determination that residential borrowers have a reasonable ability to repay a mortgage loan. In addition to the ATR rule, the Consumer Financial Protection Bureau adopted a Qualified Mortgage (“QM”) framework that provides certain legal protections to residential mortgage loan lenders, which includes restrictions on loan features, points and fees and borrower debt-to-income ratios. While we are not directly subject to compliance with the implementation of rules regarding the origination of residential mortgage loans, the impact of these regulations and others could affect our ability to securitize or invest in newly originated loans in the future.
In addition, the regulatory landscape for our repurchase agreement counterparties continues to evolve following the adoption of new capital rules which generally affects the manner in which banks lend. Regulators are also focused on liquidity requirements which will likely impact how banks fund themselves. While we are not directly subject to compliance with the implementation of rules regarding financial institutions, the effect of these regulations and others could affect our ability to finance our assets in the future.
On September 2, 2014, the Federal Housing Finance Agency ("FHFA"), proposed to revise its regulations governing Federal Home Loan Bank membership to, among other things, exclude captive insurance companies. However, the proposed rules would permit existing captive insurers, such as our captive insurance company subsidiary IAS Services LLC, to remain members for a period of five years following the effective date of the final rules. In addition, the Federal Home Loan Bank of Indianapolis ("FHLBI") would be permitted to allow outstanding advances to IAS Services LLC that were made prior to the effective date of the final rules to honor contractual terms to maturity. Therefore, under the proposed rules, we do not expect there would be any impact to our existing FHLBI borrowings. The rules are subject to change prior to their final adoption. However, if the FHFA’s rules are adopted substantially as proposed, we do not expect that the rules would have a material effect on our sources or costs of funding or our results of operations. The date set for the end of the comment period was January 23, 2015. The vast majority of the comments were against adoption of the proposed rule. The FHFA has not yet made a formal statement as to their intentions with respect to the proposed rule.

 
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Investment Activities
In the third quarter of 2015, our investment portfolio remained positioned to take advantage of opportunities in both mortgage-backed and credit risk transfer securities and newly originated loans against a backdrop of improving housing and commercial real estate markets. We have over the last year and over the last quarter maintained a relatively balanced allocation of our equity among residential credit, commercial credit and Agency RMBS.
The table below shows the allocation of our equity as of September 30, 2015, December 31, 2014 and September 30, 2014:
 
As of
$ in thousands
September 30, 2015
 
December 31, 2014
 
September 30, 2014
Agency RMBS
35
%
 
32
%
 
33
%
Residential Credit (1)
31
%
 
34
%
 
33
%
Commercial Credit (2)
34
%
 
34
%
 
34
%
Total
100
%
 
100
%
 
100
%
(1)
Non-Agency RMBS, GSE CRT and Residential Loans are considered residential credit.
(2)
CMBS, Commercial Loans and Investments in unconsolidated ventures of $37.9 million (which are included in Other Investments), are considered commercial credit.
The table below shows the breakdown of our investment portfolio as of September 30, 2015, December 31, 2014 and September 30, 2014:
 
As of
$ in thousands
September 30, 2015
 
December 31, 2014
 
September 30, 2014
Agency RMBS:
 
 
 
 
 
30 year fixed-rate, at fair value
4,214,946

 
4,790,293

 
4,901,116

15 year fixed-rate, at fair value
1,702,382

 
1,327,101

 
1,389,953

Hybrid ARM, at fair value
3,447,613

 
2,976,918

 
2,650,321

ARM, at fair value
452,831

 
546,782

 
532,880

Agency CMO, at fair value
416,662

 
450,895

 
453,748

Non-Agency RMBS, at fair value
2,624,608

 
3,061,647

 
3,302,080

GSE CRT, at fair value
651,705

 
625,424

 
610,326

CMBS, at fair value
3,304,214

 
3,469,835

 
3,456,610

Residential loans, at amortized cost
3,307,249

 
3,365,003

 
3,103,434

Commercial loans, at amortized cost
187,038

 
145,756

 
144,707

Total Investment portfolio
20,309,248

 
20,759,654

 
20,545,175

During 2015, we have reinvested cash flows from our Agency RMBS portfolio into 15 year fixed-rate Agency RMBS and Hybrid ARM Agency RMBS.  We have continued to hold certain 30 year fixed-rate Agency RMBS that have relatively short durations because they are collateralized by higher coupons.  We expect these securities to prepay more favorably than their applicable cohorts based on their seasoning and collateral attributes. The average coupon of our 30 year fixed-rate Agency RMBS declined to 4.26% at September 30, 2015, compared to 4.30% at September 30, 2014. Additionally, we hold 15 year fixed-rate Agency RMBS, Hybrid ARM Agency RMBS and ARM Agency RMBS that we believe have lower durations and better cash flow certainty relative to current coupon 30 year fixed-rate Agency RMBS. Further, we own Agency collateralized mortgage obligations ("CMOs"), some of which are interest-only securities, to hedge the risk of higher interest rates.
Our portfolio of investments that have credit exposure include non-Agency RMBS, GSE CRTs, CMBS and residential and commercial real estate loans. We use our proprietary models to perform a detailed review of each investment which often includes loan level analysis of expected performance. We do not place any reliance on ratings by various agencies as we believe our models more accurately evaluate the performance based on our assumptions about market conditions. As shown in the table above, exposure to credit assets has remained relatively stable as we believe the improving economy will provide better risk-adjusted returns for this asset class while having lower interest rate exposure relative to Agency RMBS.
With respect to our non-Agency RMBS portfolio, we primarily invest in RMBS collateralized by prime and Alt-A loans. In addition, we have invested in re-securitizations of real estate mortgage investment conduit ("Re-REMIC") RMBS and

 
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reperforming mortgage loans that we believe provide attractive risk adjusted returns. We also invest in GSE CRTs, which have the added benefit of paying a floating rate coupon and reduces our need to hedge interest rate risk. Based on our view of the improving housing market and relative value opportunities, we increased holdings in GSE CRTs over the past twelve months as paydowns from principal repayments and limited dispositions have reduced our non-Agency RMBS holdings.
Our CMBS portfolio generally consists of assets originated before 2007, assets originated after 2010 (“CMBS 2.0”) and multi-family CMBS issued by Freddie Mac under their “K” program. Over the past twelve months we have primarily invested in CMBS 2.0. The allocation of our CMBS holdings in our MBS and GSE CRT portfolio is approximately 19.7% as of September 30, 2015.
During 2015, we invested in and consolidated one additional residential loan securitization trust collateralized by prime jumbo loans that were generally originated in 2011 or later. We believe these loans have high credit quality based on their risk characteristics, including but not limited to high FICO scores, low historical delinquencies and low loan-to-value ratios based on current estimated home values. We have invested in and consolidated eleven residential loan securitization trusts that hold $3.3 billion of residential loans as of September 30, 2015. For further details on the residential loan portfolio, refer to Note 3 - "Variable Interest Entities" of our condensed consolidated financial statements.
During 2015, we originated three new commercial real estate loans, and two of our existing commercial real estate loans prepaid ahead of their contractual maturities. As of September 30, 2015, our commercial real estate loan portfolio includes a first mortgage loan and seven mezzanine loans that we purchased or originated. For further details on our commercial loan portfolio, see Note 5 - "Commercial Loans Held-for-Investment" of our condensed consolidated financial statements.
Portfolio Characteristics
The table below represents the vintage of our MBS and GSE CRT credit assets as of September 30, 2015 as a percentage of the fair value: 
 
2003
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
2014
 
2015
 
Total
Prime
0.5
%
 
1.6
%
 
4.0
%
 
3.8
%
 
9.9
%
 
2.1
%
 
—
%
 
—
%
 
0.1
%
 
—
%
 
7.4
%
 
1.9
%
 
—
%
 
31.3
%
Re-REMIC (1)
—
%
 
—
%
 
—
%
 
—
%
 
0.3
%
 
—
%
 
0.9
%
 
4.2
%
 
16.7
%
 
7.5
%
 
0.5
%
 
—
%
 
—
%
 
30.1
%
Alt-A
—
%
 
0.6
%
 
8.1
%
 
6.2
%
 
7.9
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
22.8
%
Subprime/reperforming
—
%
 
—
%
 
—
%
 
0.1
%
 
0.3
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
2.0
%
 
11.9
%
 
1.5
%
 
15.8
%
Total Non-Agency
0.5
%
 
2.2
%
 
12.1
%
 
10.1
%
 
18.4
%
 
2.1
%
 
0.9
%
 
4.2
%
 
16.8
%
 
7.5
%
 
9.9
%
 
13.8
%
 
1.5
%
 
100.0
%
GSE CRT
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
—
%
 
38.6
%
 
52.5
%
 
8.9
%
 
100.0
%
CMBS
—
%
 
—
%
 
4.1
%
 
10.0
%
 
0.4
%
 
—
%
 
—
%
 
7.4
%
 
22.6
%
 
12.2
%
 
13.7
%
 
27.7
%
 
1.9
%
 
100.0
%
(1)
For Re-REMICs, the table reflects the year in which the resecuritizations were issued. The vintage distribution of the securities that collateralize the Company’s Re-REMIC investments is 11.0% for 2005, 32.3% for 2006, and 56.7% for 2007.


 
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The tables below represent the geographic concentration of the underlying collateral for our MBS and GSE CRT credit assets as of September 30, 2015: 
Non-Agency RMBS
State
 
Percentage
 
GSE CRT
State
 
Percentage
 
CMBS
State
 
Percentage
California
 
41.8
%
 
California
 
22.0
%
 
California
 
16.1
%
New York
 
6.8
%
 
Texas
 
5.6
%
 
New York
 
12.6
%
Florida
 
6.8
%
 
Virginia
 
4.5
%
 
Texas
 
9.3
%
Virginia
 
3.8
%
 
New York
 
4.1
%
 
Florida
 
5.7
%
New Jersey
 
3.7
%
 
Illinois
 
4.0
%
 
Pennsylvania
 
4.2
%
Maryland
 
3.7
%
 
Massachusetts
 
3.6
%
 
Illinois
 
4.2
%
Washington
 
2.8
%
 
Florida
 
3.6
%
 
New Jersey
 
3.5
%
Illinois
 
2.8
%
 
Washington
 
3.3
%
 
Ohio
 
3.0
%
Massachusetts
 
2.1
%
 
Colorado
 
3.3
%
 
Virginia
 
2.9
%
Georgia
 
2.1
%
 
New Jersey
 
3.2
%
 
Maryland
 
2.8
%
Other
 
23.6
%
 
Other
 
42.8
%
 
Other
 
35.7
%
Total
 
100.0
%
 
Total
 
100.0
%
 
Total
 
100.0
%
The following table displays certain characteristics of our residential loans held-for-investment at September 30, 2015 by year of origination.
$ in thousands
2014
 
2013
 
2012
 
2011
 
2010
 
2009
 
2008
 
2007
 
Total
Portfolio Characteristics:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of Loans
692

 
2,596

 
720

 
86

 
25

 
6

 
14

 
14

 
4,153

Current Principal Balance
513,819

 
1,998,969

 
625,255

 
91,620

 
23,841

 
2,737

 
12,327

 
11,416

 
3,279,984

% of Current Principal Balance to Total
15.7
%
 
60.9
%
 
19.1
%
 
2.8
%
 
0.7
%
 
0.1
%
 
0.4
%
 
0.3
%
 
100.0
%
Net Weighted Average Coupon Rate
3.46
%
 
3.45
%
 
3.24
%
 
3.38
%
 
3.74
%
 
3.69
%
 
5.47
%
 
4.67
%
 
3.42
%
Weighted Average Maturity (years)
28.72

 
27.81

 
27.28

 
25.74

 
25.22

 
23.76

 
22.92

 
21.84

 
27.73

Current Performance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 


 
 
Current
513,819

 
1,997,171

 
625,255

 
91,620

 
23,841

 
2,737

 
11,697

 
11,416

 
3,277,556

30 Days Delinquent
—

 
560

 
—

 
—

 
—

 
—

 
630

 
—

 
1,190

60 Days Delinquent
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

90+ Days Delinquent
—

 
1,238

 
—

 
—

 
—

 
—

 
—

 
—

 
1,238

Bankruptcy/Foreclosure
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Total
513,819

 
1,998,969

 
625,255

 
91,620

 
23,841

 
2,737

 
12,327

 
11,416

 
3,279,984

The following table presents the geographic concentrations of our residential loans held-for-investment at September 30, 2015 based on principal balance outstanding:
State
Percent
California
53.1
%
New York
7.6
%
Massachusetts
5.9
%
Illinois
3.6
%
Other states (none greater than 3%)
29.8
%
Total
100.0
%


 
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Financing and Other Liabilities
We enter into repurchase agreements to finance the majority of our target assets. These agreements are secured by our Agency RMBS, non-Agency RMBS, GSE CRTs and CMBS. In addition, these agreements are generally settled on a short-term basis, usually from one to twelve months, and bear interest at rates that have historically moved in close relationship to LIBOR. At each settlement date, we typically refinance each repurchase agreement at the market interest rate at that time. As of September 30, 2015, we had entered into repurchase agreements totaling $12.9 billion (December 31, 2014: $13.6 billion). The decrease in our repurchase agreement balance over the past nine months was primarily due to replacing some of our repurchase borrowings with secured loans, as discussed below.
Our wholly-owned subsidiary, IAS Services LLC, is a member of the FHLBI. As a member of the FHLBI, IAS Services LLC has borrowed funds from the FHLBI in the form of secured advances. As of September 30, 2015, IAS Services LLC had $1.675 billion in outstanding secured advances and is approved for total available uncommitted credit for borrowing of an amount up to $2.5 billion. Available uncommitted credit may be adjusted at the sole discretion of the FHLBI. For the three and nine months ended September 30, 2015, IAS Services LLC had average borrowings of $1.6 billion with a weighted average borrowing rate of 0.40% and 0.39%, respectively.
During the nine months ended September 30, 2015, we repurchased 3,695,368 shares of our common stock at an average repurchase price of $13.53 per share for a net cost of $50.0 million, including acquisition expenses.
We have also committed to invest up to $122.4 million in unconsolidated ventures that are sponsored by an affiliate of our Manager. As of September 30, 2015, $97.0 million of our commitment to these unconsolidated ventures has been called. We are committed to fund $25.4 million in additional capital to fund future investments and cover future expenses should they occur.
We record a liability for mortgage-backed and credit risk transfer securities purchased, for which settlement has not taken place, as an investment related payable. As of September 30, 2015 and December 31, 2014, we had investment related payables of $55.0 million, and $17.0 million, respectively. None of these investment related payables were outstanding more than thirty days. The change in balance was primarily due to an increase in unsettled MBS purchases as of September 30, 2015. We record a receivable for mortgage-backed and credit risk transfer securities sold for which settlement has not taken place as an investment related receivable. As of September 30, 2015 and December 31, 2014, the Company had investment related receivables of $24.9 million and $38.7 million, respectively. None of these investment related receivables were outstanding more than thirty days.
Hedging Instruments. We generally hedge as much of our interest rate and foreign exchange risk as we deem prudent in light of market conditions. No assurance can be given that our hedging activities will have the desired beneficial impact on our results of operations or financial condition. Our investment policies do not contain specific requirements as to the percentages or amount of risk that we are required to hedge.
Hedging may fail to protect or could adversely affect us because, among other things:
•
available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;
•
the duration of the 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 or mark-to-market losses would reduce our stockholders’ equity.
As of September 30, 2015, we have entered into interest rate swap agreements designed to mitigate the effects of increases in interest rates under a portion of our borrowings. These swap agreements provide for fixed interest rates indexed off of one-month LIBOR and effectively fix the floating interest rates on $11.5 billion (September 30, 2014: $12.2 billion) of borrowings. The notional amount of interest rate swaps was reduced in line with the reduced interest rate risk in our portfolio after the reallocation away from longer duration 30 year fixed-rate Agency RMBS into shorter duration 15 year fixed-rate Agency RMBS and Hybrid ARM Agency RMBS. As of September 30, 2015, included in this amount are forward starting swaps with a total notional amount of $1.6 billion, with starting dates ranging from February 5, 2016 to June 24, 2016. The change in the amount of interest rate swaps was due to our view of interest rate risk and the expected duration of our investment portfolio and liabilities.
As of September 30, 2015, we have no outstanding fixed pay interest rate swaptions. As of September 30, 2014, we held $1.1 billion in notional amount of fixed pay interest rate swaptions as an asset with a fair value of $3.0 million. The swaptions

 
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that we held at September 30, 2014 expired unexercised, and the Company realized a loss of $10.3 million on these contracts. As of September 30, 2015, we held $300.0 million in notional amount of fixed receive interest rate swaptions as an asset with a fair value of $73,000. We did not have any out outstanding fixed receive interest rate swaptions as of September 30, 2014. We purchase interest rate swaptions to reduce the impact that interest rate volatility has on our portfolio. The change in the notional amount of swaptions held was due to our views on the potential for change in volatility.
As of September 30, 2015, we have no outstanding futures contracts. As of September 30, 2014, we held $250.1 million in notional amount of short U.S. Treasury futures contracts as an asset with a fair value of $1.0 million. During the nine months ended September 30, 2015, we sold U.S. Treasury futures contracts of $248.3 million (September 30, 2014: $989.5 million) in notional amount and realized a net loss of $943,000 (September 30, 2014: $8.9 million). We periodically invest in U.S. Treasury futures contracts to help mitigate the potential impact of changes in interest rates on the performance of our portfolio.
As of September 30, 2015, we have no outstanding to-be-announced securities ("TBAs"). As of September 30, 2014, we held $826.0 million in notional amount of TBAs as a liability with a fair value of $1.5 million and $281.0 million in notional amount of TBAs as an asset with a fair value of $608,000. During the nine months ended September 30, 2015, we settled TBAs of $446.0 million (September 30, 2014: $1.2 billion) in notional amount and realized a net loss of $2.3 million (September 30, 2014: $4.3 million). TBAs are contracts for which we agree to purchase or deliver in the future Agency RMBS with certain principal and interest terms. We periodically purchase or sell certain TBAs to help mitigate the potential impact of changes in interest rates on the performance of our portfolio.
As of September 30, 2015, we held $6.9 million (September 30, 2014: $38.1 million) in notional amount of currency forward contracts as an asset with a fair value of $191,000 (September 30, 2014: $1.1 million), and a liability with a fair value of $50,000 (September 30, 2014: $0). During the nine months ended September 30, 2015, we settled currency forward contracts of $127.6 million (September 30, 2014: $33.8 million) in notional amount and realized a net gain of $1.1 million (September 30, 2014: $330,000). We use currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on our investments denominated in foreign currencies.
Book Value per Share
Our book value per diluted common share was $17.66 and $18.82 as of September 30, 2015 and December 31, 2014, respectively. Book value per diluted common share is calculated as total equity less the liquidation preference of our Series A Preferred Stock ($140.0 million) and Series B Preferred Stock ($155.0 million); divided by total common shares outstanding plus Operating Partnership Units convertible into shares of common stock (1,425,000 shares).
The change in our book value through the third quarter of 2015 was primarily due to realized and unrealized losses on derivative instruments recorded in our condensed consolidated statements of operations and the change in valuation of our investment portfolio that is recorded in accumulated other comprehensive income on our condensed consolidated balance sheets.
Critical Accounting Policies
Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP, which requires the use of estimates and assumptions that involve the exercise of judgment and use of assumptions as to future uncertainties. Accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to an understanding of our financial statements because they involve significant judgments and uncertainties. All of these estimates reflect our best judgment about current, and for some estimates, future economic and market conditions and their effects based on information available as of the date of these financial statements. If conditions change from those expected, it is possible that the judgments and estimates described below could change, which may result in a change in valuation of our investment portfolio, future impairments of our MBS and GSE CRTs, change in our interest income recognition, allowance for loan losses, and a change in our tax liability among other effects.
Mortgage-Backed and Credit Risk Transfer Securities. We record our MBS except Agency MBS IOs as available-for-sale and report them at fair value. Agency MBS IOs and GSE CRTs are hybrid financial instruments reported at fair value. Fair value is determined by obtaining valuations from an independent source. If the fair value of a security is not available from a third-party pricing service, the Company may estimate the fair value of the security using a variety of methods including other pricing services, discounted cash flow analysis, matrix pricing, option adjusted spread models and other fundamental analysis of observable market factors. Various observable inputs are used to fair value our MBS and GSE CRTs that may change with market conditions. It is possible that changes in these inputs could change the valuation estimate and lead to impairment of our MBS and GSE CRT portfolio. Further information is provided in Note 2 - "Summary of Significant Accounting Policies" of our Annual Report on Form 10-K/A for the year ended December 31, 2014 and Note 4 - “Mortgage-Backed and Credit Risk Transfer Securities" of our condensed consolidated financial statements.

 
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Other-than-temporary Impairment. We regularly review our available-for-sale portfolio for other-than-temporary impairment. This determination involves both qualitative and quantitative data. It is possible that estimates may be incorrect, economic conditions may change or we may be forced to sell the investment before recovery of our amortized cost. Further information is provided in Note 2 - "Summary of Significant Accounting Policies" of our Annual Report on Form 10-K/A for the year ended December 31, 2014 and Note 4 - “Mortgage-Backed and Credit Risk Transfer Securities" of our condensed consolidated financial statements.
Residential and Commercial Loans. Residential loans held-for-investment are carried at unpaid principal balance net of any allowance for loan losses. Commercial loans held-for-investment are carried at cost net of any allowance for loan losses. An allowance for loan losses is established based on credit losses inherent in the portfolio. These estimates require consideration of various observable inputs including, but not limited to, historical loss experience, delinquency status, borrower credit scores, geographic concentrations and loan-to-value ratios, and are adjusted for current economic conditions as we deem necessary. In addition, since we have not incurred any direct losses on our portfolio, we use national historical credit performance information from a third party to assist in our analysis. Changes in our estimates can significantly impact the allowance for loan losses and provision expense. It is also possible that we will experience credit losses that are different from our current estimates or that the timing of those losses may differ from our estimates. Further information on the allowance for loan losses is provided in Note 2 - “Summary of Significant Accounting Policies” of our Annual Report on Form 10-K/A for the year ended December 31, 2014.
Interest Income Recognition. Interest income on MBS is accrued based on the outstanding principal balance of the securities and their contractual terms. Premiums or discounts are amortized or accreted into interest income over the life of the investment using the effective interest method. Interest income on our non-Agency RMBS (and other prepayable mortgage-backed securities where we may not recover substantially all of our initial investment) is based on estimated cash flows. We estimate, at the time of purchase, the future expected cash flows and determines the effective interest rate based on these estimated cash flows and our purchase price. Over the life of the investments, these estimated cash flows are updated and a revised yield is computed based on the current amortized cost of the investment. In estimating these cash flows, there are a number of assumptions that are subject to uncertainties and contingencies, including the rate and timing of principal payments (prepayments, repurchases, defaults and liquidations), the pass through or coupon rate and interest rate fluctuations. These uncertainties and contingencies are difficult to predict and are subject to future events that may impact management’s estimates and interest income. Interest income recognition on our Agency RMBS that cannot be prepaid in such a way that we would not recover substantially all of our initial investment is based on contractual cash flows. We do not estimate prepayments in applying the effective interest method. Interest income from our residential loans is recognized on an accrual basis with the related premiums being amortized into interest income using the effective interest method over the weighted average life of these loans. As needed, these estimated cash flows are updated and a revised yield is computed based on the current amortized cost of the investment. Interest income from our commercial loans is recognized when earned and deemed collectible or until a loan becomes past due based on the terms of the loan agreement.
Accounting for Derivative Financial Instruments. We use derivatives to manage interest rate and currency exchange risk. The Company records all derivatives on its condensed consolidated balance sheets at fair value. Effective December 31, 2013, the Company voluntarily discontinued hedge accounting for its interest rate swap agreements by de-designating the interest rate swaps as cash flow hedges. As a result of discontinuing hedge accounting, changes in the fair value of the interest rate swaps are recorded in gain (loss) on derivative instruments, net in the Company's condensed consolidated statements of operations, rather than in accumulated other comprehensive income (loss). Further information is provided in Note 8 - “Derivatives and Hedging Activities" of our condensed consolidated financial statements.
Income Taxes. We have elected to be taxed as a REIT. Accordingly, we generally will not be subject to U.S. federal and applicable state and local corporate income tax to the extent that we make qualifying distributions and provided we satisfy on a continuing basis, through actual investment and operating results, the REIT requirements including certain asset, income, distribution and stock ownership tests. The REIT qualifications rules are complex and failure to apply them correctly could subject us to U.S. federal, state and local income taxes.
Expected Impact of New Authoritative Guidance on Future Financial Information
In February 2015, the FASB issued modifications to existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. The guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2015, and requires either a retrospective or a modified retrospective approach to adoption. Early adoption is permitted. The new guidance is not expected to have a material impact on our condensed consolidated financial statements.
In April 2015, the FASB issued guidance to amend the presentation of debt issuance cost related to a recognized debt liability. Under the new guidance, the debt issuance costs will be presented in the balance sheet as a direct deduction from the carrying amount of the recognized debt liability, consistent with debt discounts. The recognition and measurement guidance for

 
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debt issuance costs are not affected under the new guidance. The standard is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. The guidance should be applied on a retrospective basis. The balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Upon adoption, an entity is required to comply with the applicable disclosures for a change in an accounting principle. These disclosures include the nature of and reason for the change in accounting principle, the transition method, a description of the prior-period information that has been retrospectively adjusted, and the effect of the change on the financial statement line items (i.e., debt issuance cost asset and the debt liability). The new guidance is not expected to have a material impact on our condensed consolidated financial statements.


 
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Results of Operations
The table below presents certain information from our condensed consolidated statements of operations for the three and nine month periods ended September 30, 2015 and 2014. 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
$ in thousands, except share data
2015
 
2014 
 (As Restated)
 
2015
 
2014 
 (As Restated)
Interest Income
 
 
 
 
 
 
 
Mortgage-backed and credit risk transfer securities
129,260

 
139,419

 
390,623

 
436,019

Residential loans (1)
28,380

 
22,713

 
88,001

 
60,888

Commercial loans
3,743

 
2,649

 
11,349

 
6,329

Total interest income
161,383

 
164,781

 
489,973

 
503,236

Interest Expense
 
 
 
 
 
 
 
Repurchase agreements
41,303

 
45,756

 
125,544

 
142,649

Secured loans
1,622

 
1,223

 
4,639

 
1,399

Exchangeable senior notes
5,620

 
5,620

 
16,840

 
16,840

Asset-backed securities (1)
20,686

 
17,660

 
64,913

 
47,421

Total interest expense
69,231

 
70,259

 
211,936

 
208,309

Net interest income
92,152

 
94,522

 
278,037

 
294,927

(Reduction in) provision for loan losses
(81
)
 
(209
)
 
(213
)
 
(52
)
Net interest income after (reduction in) provision for loan losses
92,233

 
94,731

 
278,250

 
294,979

Other Income (loss)
 
 
 
 
 
 
 
Gain (loss) on investments, net
(2,958
)
 
(48,364
)
 
10,090

 
(86,333
)
Equity in earnings of unconsolidated ventures
1,894

 
1,145

 
9,131

 
5,480

Gain (loss) on derivative instruments, net
(220,602
)
 
(3,704
)
 
(287,344
)
 
(322,832
)
Realized and unrealized credit derivative income (loss), net
2,928

 
(28,613
)
 
24,904

 
20,929

Other investment income (loss), net
739

 
(1,358
)
 
1,518

 
(1,358
)
Total other income (loss)
(217,999
)
 
(80,894
)
 
(241,701
)
 
(384,114
)
Expenses
 
 
 
 
 
 
 
Management fee – related party
10,058

 
9,214

 
28,816

 
27,876

General and administrative
2,507

 
2,519

 
6,186

 
6,906

Consolidated securitization trusts (1)
2,132

 
1,560

 
6,544

 
4,108

Total expenses
14,697

 
13,293

 
41,546

 
38,890

Net income (loss)
(140,463
)
 
544

 
(4,997
)
 
(128,025
)
Net income (loss) attributable to non-controlling interest
(1,629
)
 
6

 
(80
)
 
(1,456
)
Net income (loss) attributable to Invesco Mortgage Capital Inc.
(138,834
)
 
538

 
(4,917
)
 
(126,569
)
Dividends to preferred stockholders
5,716

 
2,713

 
17,148

 
8,138

Undeclared cumulative dividends to preferred stockholders
—

 
661

 
—

 
661

Net income (loss) attributable to common stockholders
(144,550
)
 
(2,836
)
 
(22,065
)
 
(135,368
)
Earnings (loss) per share:
 
 
 
 
 
 
 
Net income (loss) attributable to common stockholders
 
 
 
 
 
 
 
Basic
(1.18
)
 
(0.02
)
 
(0.18
)
 
(1.10
)
Diluted
(1.18
)
 
(0.02
)
 
(0.18
)
 
(1.10
)
Dividends declared per common share
0.40

 
0.50

 
1.30

 
1.50

Weighted average number of shares of common stock:
 
 
 
 
 
 
 
Basic
122,046,614

 
123,098,355

 
122,763,243

 
123,104,728

Diluted
123,471,614

 
124,523,355

 
124,188,243

 
124,529,728


(1)
The condensed consolidated statements of operations include income and expenses of consolidated variable interest entities. Refer to Note 3 - “Variable Interest Entities” of our condensed consolidated financial statements for further discussion.

 
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Net Income (Loss) Summary
For the three months ended September 30, 2015, our net loss attributable to common stockholders was $144.6 million (September 30, 2014: $2.8 million) or $1.18 (September 30, 2014: $0.02) basic and diluted net loss per average share available to common stockholders. The higher net loss attributable to common stockholders for the three months ended September 30, 2015 versus 2014 is primarily attributable to realized and unrealized losses on derivative instruments of $220.6 million in the 2015 period versus $3.7 million in the 2014 period. Higher net losses are partially offset by lower net losses on investments totaling $3.0 million for the three months ended September 30, 2015 versus $48.4 million for the three months ended September 30, 2014.
For the nine months ended September 30, 2015 our net loss attributable to common stockholders was $22.1 million (September 30, 2014: $135.4 million) or $0.18 (September 30, 2014: $1.10) basic and diluted net loss per average share available to common stockholders. The lower net loss attributable to common stockholders for the nine months ended September 30, 2015 versus 2014 is primarily attributable to a net gain on investments of $10.1 million in the 2015 period versus a net loss on investments of $86.3 million in the 2014 period; and lower realized and unrealized losses on derivative instruments of $287.3 million in the 2015 period versus $322.8 million in the 2014 period.
As a result of discontinuing hedge accounting, beginning January 1, 2014, changes in the fair value of the interest rate swap agreements are recorded in gain (loss) on derivative instruments, net in our condensed consolidated statements of operations, rather than in AOCI. For the three months ended September 30, 2015, we recognized an unrealized loss for the change in fair value of our interest rates swaps of $173.8 million (September 30, 2014: $47.7 million unrealized gain). For the nine months ended September 30, 2015, we recognized an unrealized loss for the change in fair value of our interest rates swaps of $113.2 million (September 30, 2014: $146.1 million unrealized loss). In addition, during the three months ended September 30, 2015, we recognized reclassification of amortization of net deferred losses on de-designated interest rate swaps to repurchase agreements interest expense, previously recognized in other comprehensive income of $15.7 million (September 30, 2014: $21.2 million) and $51.2 million (September 30, 2014: $64.1 million) for the nine months ended September 30, 2015. Reclassification of amortization of net deferred losses on de-designated interest rate swaps is recorded as interest expense in our condensed consolidated statements of operations.
Non-GAAP Financial Measures
We are presenting the following non-GAAP financial measures: core earnings (and by calculation, core earnings per common share), effective interest income (and by calculation, effective yield), effective interest expense (and by calculation, effective cost of funds), effective net interest income (and by calculation, effective interest rate margin), effective debt-to-equity ratio and repurchase agreement debt-to-equity ratio. Our management uses these non-GAAP financial measures in our internal analysis of results and believes these measures are useful to investors for the reasons explained below. The most directly comparable U.S. GAAP measures are net income attributable to common stockholders (and by calculation, basic earnings (loss) per common share), total interest income (and by calculation, yield), total interest expense (and by calculation, cost of funds), net interest income (and by calculation, net interest rate margin) and debt-to-equity ratio. 
These non-GAAP financial measures should not be considered as substitutes for any measures derived in accordance with U.S. GAAP and may not be comparable to other similarly titled measures of other companies. An analysis of any non-GAAP financial measure should be made in conjunction with results presented in accordance with U.S. GAAP. Additional reconciling items may be added in the future to these non-GAAP measures if deemed appropriate.
Core Earnings
We calculate core earnings as U.S. GAAP net income (loss) attributable to common stockholders adjusted for (gain) loss on investments, net; realized (gain) loss on derivative instruments, net (excluding contractual net interest on interest rate swaps); unrealized (gain) loss on derivative instruments, net; realized and unrealized change in fair value of GSE CRT embedded derivatives, net; (gain) loss on foreign currency transactions, net; amortization of net deferred swap losses on de-designation; and an adjustment attributable to non-controlling interest. We record changes in the valuation of our mortgage-backed securities and the valuation assigned to the debt host contract associated with our GSE CRTs in other comprehensive income on our consolidated balance sheets. We believe the presentation of core earnings provides a consistent measure of operating performance by excluding the impact of gains and losses described above from operating results.
We believe that providing transparency into core earnings enables our investors to consistently measure, evaluate and compare our operating performance to that of our peers over multiple reporting periods. However, we caution that core earnings should not be considered as an alternative to net income (determined in accordance with U.S. GAAP), or as an indication of our cash flow from operating activities (determined in accordance with U.S. GAAP), a measure of our liquidity, or as an indication of amounts available to fund our cash needs, including our ability to make cash distributions.

 
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The table below provides a reconciliation of U.S. GAAP net income (loss) attributable to common stockholders to core earnings for the following periods:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
$ in thousands, except per share data
2015
 
2014 
 (As Restated)
 
2015
 
2014 
 (As Restated)
Net income (loss) attributable to common stockholders
(144,550
)
 
(2,836
)
 
(22,065
)
 
(135,368
)
Adjustments:
 
 
 
 
 
 
 
(Gain) loss on investments, net
2,958

 
48,364

 
(10,090
)
 
86,333

Realized (gain) loss on derivative instruments, net (excluding contractual net interest on interest rate swaps of $46,785, $50,446, $138,404 and $154,092, respectively)
3,079

 
1,016

 
44,394

 
34,877

Unrealized (gain) loss on derivative instruments, net
170,738

 
(47,758
)
 
104,546

 
133,863

Realized and unrealized change in fair value of GSE CRT embedded derivatives, net
3,564

 
33,644

 
(5,091
)
 
(8,307
)
(Gain) loss on foreign currency transactions, net
—

 
1,479

 
529

 
1,479

Amortization of net deferred swap losses on de-designation
15,724

 
21,227

 
51,182

 
64,055

Subtotal
196,063

 
57,972

 
185,470

 
312,300

Adjustment attributable to non-controlling interest
(2,272
)
 
(664
)
 
(2,152
)
 
(3,564
)
Core earnings
49,241

 
54,472

 
161,253

 
173,368

Basic income (loss) per common share
(1.18
)
 
(0.02
)
 
(0.18
)
 
(1.10
)
Core earnings per share attributable to common stockholders
0.40

 
0.44

 
1.31

 
1.41


Effective Interest Income / Effective Yield/ Effective Interest Expense / Effective Cost of Funds / Effective Net Interest Income / Effective Interest Rate Margin
We calculate effective interest income (and by calculation, effective yield) as U.S. GAAP total interest income adjusted for GSE CRT embedded derivative coupon interest that is recorded in realized and unrealized credit derivative income (loss), net. We add back GSE CRT embedded derivative coupon interest to our total interest income because we consider GSE CRT embedded derivative coupon interest a current component of our total interest income.
We calculate effective interest expense (and by calculation, effective cost of funds) as U.S. GAAP total interest expense adjusted for net interest paid on our interest rate swaps that is recorded in gain (loss) on derivative instruments and the amortization of net deferred swap losses on de-designation. We view our interest rate swaps as an economic hedge against increases in future market interest rates on our floating rate borrowings. We add back the net payments we make on our interest rate swap agreements to our total U.S. GAAP interest expense because we use interest rate swaps to add stability to interest expense. We subtract amortization of net deferred losses on de-designated interest rate swaps because we do not consider the amortization a current component of our borrowing costs.
We calculate effective net interest income (and by calculation, effective interest rate margin) as U.S. GAAP net interest income adjusted for net interest paid on our interest rate swaps that is recorded in gain (loss) on derivative instruments, the amortization of net deferred losses on de-designation and GSE CRT embedded derivative coupon interest that is recorded in realized and unrealized credit derivative income (loss), net.
We believe the presentation of effective interest income, effective yield, effective interest expense, effective cost of funds, effective net interest income and effective interest rate margin measures, when considered together with U.S. GAAP financial measures, provide information that is useful to investors in understanding our borrowing costs and operating performance.


 
55
 

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The following table reconciles total interest income to effective interest income and yield to effective yield for the following periods:
 
Three Months Ended September 30,
 
2015
 
2014 (As Restated)
$ in thousands
Reconciliation
 
Yield/Effective Yield
 
Reconciliation
 
Yield/Effective Yield
Total interest income
161,383

 
3.20
%
 
164,781

 
3.37
%
Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net
6,373

 
0.13
%
 
4,784

 
0.10
%
Effective interest income
167,756

 
3.33
%
 
169,565

 
3.47
%
 
Nine Months Ended September 30,
 
2015
 
2014 (As Restated)
$ in thousands
Reconciliation
 
Yield/Effective Yield
 
Reconciliation
 
Yield/Effective Yield
Total interest income
489,973

 
3.20
%
 
503,236

 
3.41
%
Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net
18,443

 
0.12
%
 
11,754

 
0.08
%
Effective interest income
508,416

 
3.32
%
 
514,990

 
3.49
%
The following tables reconcile total interest expense to effective interest expense and cost of funds to effective cost of funds for the following periods.
 
Three Months Ended September 30,
 
2015
 
2014
$ in thousands
Reconciliation
 
Cost of Funds / Effective Cost of Funds
 
Reconciliation
 
Cost of Funds / Effective Cost of Funds
Total interest expense
69,231

 
1.53
 %
 
70,259

 
1.62
 %
Less: Amortization of net deferred swap losses on de-designation
(15,724
)
 
(0.35
)%
 
(21,227
)
 
(0.49
)%
Add: Net interest paid - interest rate swaps
46,785

 
1.04
 %
 
50,446

 
1.16
 %
Effective interest expense
100,292

 
2.22
 %
 
99,478

 
2.29
 %
 
Nine Months Ended September 30,
 
2015
 
2014
$ in thousands
Reconciliation
 
Cost of Funds / Effective Cost of Funds
 
Reconciliation
 
Cost of Funds / Effective Cost of Funds
Total interest expense
211,936

 
1.56
 %
 
208,309

 
1.60
 %
Less: Amortization of net deferred swap losses on de-designation
(51,182
)
 
(0.38
)%
 
(64,055
)
 
(0.49
)%
Add: Net interest paid - interest rate swaps
138,404

 
1.02
 %
 
154,092

 
1.18
 %
Effective interest expense
299,158

 
2.20
 %
 
298,346

 
2.29
 %


 
56
 

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The following tables reconcile net interest income to effective net interest income and net interest rate margin to effective interest rate margin for the following periods.
 
Three Months Ended September 30,
 
2015
 
2014 (As Restated)
$ in thousands
Reconciliation
 
Net Interest Rate Margin / Effective Interest Rate Margin
 
Reconciliation
 
Net Interest Rate Margin / Effective Interest Rate Margin
Net interest income
92,152

 
1.67
 %
 
94,522

 
1.75
 %
Add: Amortization of net deferred swap losses on de-designation
15,724

 
0.35
 %
 
21,227

 
0.49
 %
Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net
6,373

 
0.13
 %
 
4,784

 
0.10
 %
Less: Net interest paid - interest rate swaps
(46,785
)
 
(1.04
)%
 
(50,446
)
 
(1.16
)%
Effective net interest income
67,464

 
1.11
 %
 
70,087

 
1.18
 %
 
Nine Months Ended September 30,
 
2015
 
2014 (As Restated)
$ in thousands
Reconciliation
 
Net Interest Rate Margin / Effective Interest Rate Margin
 
Reconciliation
 
Net Interest Rate Margin / Effective Interest Rate Margin
Net interest income
278,037

 
1.64
 %
 
294,927

 
1.81
 %
Add: Amortization of net deferred swap losses on de-designation
51,182

 
0.38
 %
 
64,055

 
0.49
 %
Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net
18,443

 
0.12
 %
 
11,754

 
0.08
 %
Less: Net interest paid - interest rate swaps
(138,404
)
 
(1.02
)%
 
(154,092
)
 
(1.18
)%
Effective net interest income
209,258

 
1.12
 %
 
216,644

 
1.20
 %

 
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Effective Debt-to-Equity Ratio and Repurchase Agreement Debt-to-Equity Ratio
The tables below show the allocation of our equity to our target assets, our debt-to-equity ratio, our effective debt-to-equity ratio, and our repurchase agreement debt-to-equity ratio as of September 30, 2015 and December 31, 2014. We present an effective debt-to-equity ratio that excludes asset-backed securities issued by consolidated securitization trusts from debt because holders of these asset-backed securities have no recourse to us. We also present a repurchase agreement debt-to-equity ratio because the mortgage REIT industry primarily uses repurchase agreements, which typically mature within one year, to finance investments. We believe that presenting our effective debt-to-equity ratio and repurchase agreement debt-to-equity ratio, non-GAAP financial measures of leverage, when considered together with U.S. GAAP financial measures, provides information that is useful to investors in understanding our refinancing risks and gives investors a comparable statistic to those other mortgage REITs who almost exclusively borrow using short-term repurchase agreements that are subject to refinancing risk.
September 30, 2015
$ in thousands
Agency RMBS
Non-Agency RMBS (6)
GSE CRT(6)
CMBS (7)
Comm-
ercial Loans (7)
Consol-
idated
VIEs (4)(6)
Other (7)
Elimin-
ations (5)
Total
Investments
10,234,434

3,064,454

651,705

3,304,214

187,038

3,307,249

37,922

(439,846
)
20,347,170

Cash and cash
equivalents (1)
33,879

17,275

4,559

20,945

—

—

—

—

76,658

Derivative assets, at fair value (2)
72

1,044

—

—

147

—

45

—

1,308

Other assets
251,765

7,339

525

68,292

1,101

24,692

6,047

(3,551
)
356,210

Total assets
10,520,150

3,090,112

656,789

3,393,451

188,286

3,331,941

44,014

(443,397
)
20,781,346

 
 
 
 
 
 
 
 
 
 
Repurchase agreements
8,637,589

2,362,985

497,213

1,414,344

—

—

—

—

12,912,131

Secured loans (3)
439,264

—

—

1,235,736

—

—

—

—

1,675,000

Asset-backed securities issued by securitization trusts (ABS)
—

—

—

—

—

3,299,269

—

(439,846
)
2,859,423

Exchangeable senior notes
—

—

—

—

—

—

400,000

—

400,000

Derivative liabilities, at fair value
343,847

—

—

—

50

—

—

—

343,897

Other liabilities
100,966

19,191

4,288

19,557

—

20,191

889

(3,554
)
161,528

Total liabilities
9,521,666

2,382,176

501,501

2,669,637

50

3,319,460

400,889

(443,400
)
18,351,979

 
 
 
 
 
 
 
 
 
 
Allocated equity
998,484

707,936

155,288

723,814

188,236

12,481

(356,875
)
3

2,429,367

Less equity associated with secured loans:
 
 
 
 
 
 
 
 
 
Collateral pledged
(519,597
)
—

—

(1,461,730
)
—

—

—

—

(1,981,327
)
Secured loans
439,264

—

—

1,235,736

—

—

—

—

1,675,000

Net equity (excluding secured loans)
918,151

707,936

155,288

497,820

NA

NA

NA

3

2,279,195

Debt-to-equity ratio (8)
9.1

3.3

3.2

3.7

—

 NA

 NA

 NA

7.3

Effective debt-to-equity ratio (9)
 NA

 NA

 NA

 NA

 NA

 NA

 NA

 NA

6.2

Repurchase agreement debt-to-equity ratio (10)
9.4

3.3

3.2

2.8

 NA

 NA

 NA

 NA

5.7

(1)
Cash and cash equivalents is allocated based on a percentage of equity for Agency RMBS, Non-Agency RMBS, GSE CRT and CMBS.
(2)
Derivative assets are allocated based on the hedging strategy for each asset class.
(3)
Secured loans are allocated based on amount of collateral pledged.
(4)
Represents VIE assets and liabilities before intercompany eliminations. VIEs are securitized entities with no substantive equity at risk.
(5)
Represents our ownership of asset-backed securities and accrued interest eliminated upon consolidation.
(6)
Non-Agency RMBS, GSE CRT and Consolidated VIEs are considered residential credit.
(7)
CMBS, Commercial Loans and Investments in unconsolidated ventures of $37.9 million (which are included in Other), are considered commercial credit.
(8)
Debt-to-equity ratio is calculated as the ratio of total debt (sum of repurchase agreements, secured loans, asset-backed securities issued by securitization trusts and exchangeable senior notes) to total equity.
(9)
Effective debt-to-equity ratio is calculated as the ratio of total debt excluding ABS (sum of repurchase agreements, secured loans and exchangeable senior notes) to total equity.
(10)
Repurchase agreement debt-to-equity ratio is calculated as the ratio of repurchase agreements to net equity (excluding secured loans).

 
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December 31, 2014
$ in thousands
Agency RMBS
Non-Agency RMBS (6)
GSE CRT(6)
CMBS (7)
Comm-
ercial Loans (7)
Consol-
idated
VIEs (4)(6)
Other (7)
Elimin-
ations (5)
Total
Investments
10,091,989

3,494,181

625,424

3,469,835

145,756

3,365,003

43,998

(432,534
)
20,803,652

Cash and cash
equivalents (1)
64,603

41,578

10,154

47,809

—

—

—

—

164,144

Derivative assets, at fair value (2)
23,183

396

—

—

599

—

—

—

24,178

Other assets
111,817

13,742

15,639

75,209

1,030

15,591

7,888

(1,873
)
239,043

Total assets
10,291,592

3,549,897

651,217

3,592,853

147,385

3,380,594

51,886

(434,407
)
21,231,017

 
 
 
 
 
 
 
 
 
 
Repurchase agreements
9,018,818

2,676,626

468,782

1,458,451

—

—

—

—

13,622,677

Secured loans (3)
—

—

—

1,250,000

—

—

—

—

1,250,000

Asset-backed securities issued by securitization trusts (ABS)
—

—

—

—

—

3,362,354

—

(432,534
)
2,929,820

Exchangeable senior notes
—

—

—

—

—

—

400,000

—

400,000

Derivative liabilities, at fair value
254,026

—

—

—

—

—

—

—

254,026

Other liabilities
56,894

21,351

5,233

37,589

—

10,563

5,887

(1,873
)
135,644

Total liabilities
9,329,738

2,697,977

474,015

2,746,040

—

3,372,917

405,887

(434,407
)
18,592,167

 
 
 
 
 
 
 
 
 
 
Allocated equity
961,854

851,920

177,202

846,813

147,385

7,677

(354,001
)
—

2,638,850

Less equity associated with secured loans:
 
 
 
 
 
 
 
 
 
Collateral pledged
—

—

—

(1,550,270
)
—

—

—

—

(1,550,270
)
Secured loans
—

—

—

1,250,000

—

—

—

—

1,250,000

Net equity (excluding secured loans)
961,854

851,920

177,202

546,543

NA

NA

NA

—

2,537,519

Debt-to-equity ratio (8)
9.4

3.1

2.6

3.2

—

NA

NA

NA

6.9

Effective debt-to-equity ratio (9)
 NA

 NA

 NA

 NA

 NA

 NA

 NA

 NA

5.8

Repurchase agreement debt-to-equity ratio (9)
9.4

3.1

2.6

2.7

NA

NA

NA

NA

5.4

(1)
Cash and cash equivalents is allocated based on a percentage of equity for Agency RMBS, Non-Agency RMBS, GSE CRT and CMBS.
(2)
Derivative assets are allocated based on the hedging strategy for each asset class.
(3)
Secured loans are allocated based on amount of collateral pledged.
(4)
Represents VIE assets and liabilities before intercompany eliminations. VIEs are securitized entities with no substantive equity at risk.
(5)
Represents our ownership of asset-backed securities and accrued interest eliminated upon consolidation.
(6)
Non-Agency RMBS, GSE CRT and Consolidated VIEs are considered residential credit.
(7)
CMBS, Commercial Loans and Investments in unconsolidated ventures of $44.0 million (which are included in Other), are considered commercial credit.
(8)
Debt-to-equity ratio is calculated as the ratio of total debt (sum of repurchase agreements, secured loans, asset-backed securities issued by securitization trusts and exchangeable senior notes) to total equity.
(9)
Effective debt-to-equity ratio is calculated as the ratio of total debt excluding ABS (sum of repurchase agreements, secured loans and exchangeable senior notes) to total equity.
(10)
Repurchase agreement debt-to-equity ratio is calculated as the ratio of repurchase agreements to net equity (excluding secured loans).


 
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Interest Income and Average Earning Asset Yield
The table below presents certain information for our portfolio for the three and nine months ended September 30, 2015 and 2014. 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
$ in thousands
2015
 
2014 
 (As Restated)
 
2015
 
2014 
 (As Restated)
Average Balances*:
 
 
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
 
 
15 year fixed-rate, at amortized cost
1,673,615

 
1,397,663

 
1,723,135

 
1,494,733

30 year fixed-rate, at amortized cost
4,228,400

 
5,134,370

 
4,402,012

 
6,040,458

ARM, at amortized cost
450,691

 
536,670

 
452,654

 
451,129

Hybrid ARM, at amortized cost
3,403,052

 
2,602,008

 
3,182,022

 
2,304,997

MBS-CMO, at amortized cost
414,310

 
463,742

 
432,916

 
481,800

Non-Agency RMBS, at amortized cost
2,603,949

 
3,177,041

 
2,756,220

 
3,313,231

GSE CRT, at amortized cost
668,639

 
544,057

 
660,457

 
426,611

CMBS, at amortized cost
3,200,091

 
3,084,169

 
3,222,013

 
2,814,581

Residential loans, at amortized cost
3,355,373

 
2,536,820

 
3,399,570

 
2,256,634

Commercial loans, at amortized cost
176,857

 
122,803

 
168,390

 
96,819

Average Investment portfolio
20,174,977

 
19,599,343

 
20,399,389

 
19,680,993

Average Portfolio Yields (1):
 
 
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
 
 
15 year fixed-rate
2.26
%
 
2.59
%
 
2.17
%
 
2.66
%
30 year fixed-rate
2.68
%
 
2.95
%
 
2.79
%
 
3.05
%
ARM
2.22
%
 
2.30
%
 
2.31
%
 
2.31
%
Hybrid ARM
2.18
%
 
2.35
%
 
2.10
%
 
2.30
%
MBS - CMO
2.31
%
 
3.03
%
 
3.08
%
 
3.54
%
Non-Agency RMBS
4.94
%
 
4.44
%
 
4.55
%
 
4.44
%
GSE CRT (2)
0.53
%
 
0.51
%
 
0.51
%
 
0.51
%
CMBS
4.38
%
 
4.50
%
 
4.37
%
 
4.51
%
Residential loans
3.39
%
 
3.61
%
 
3.46
%
 
3.60
%
Commercial loans
8.39
%
 
8.44
%
 
8.16
%
 
8.62
%
Average Investment portfolio
3.20
%
 
3.37
%
 
3.20
%
 
3.41
%
*
 Average amounts for each period are based on weighted month-end balances.
(1)
Average portfolio yield for the period was calculated by dividing interest income, including amortization of premiums and discounts, by our average of the amortized cost of the investments. All yields are annualized.
(2)
GSE CRT average portfolio yield excludes embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net.
Our primary source of income is interest earned on our investment portfolio. We had average earning assets of approximately $20.2 billion (September 30, 2014: $19.6 billion) and earned interest income of $161.4 million (September 30, 2014: $164.8 million) for the three months ended September 30, 2015. The yield on our average investment portfolio was 3.20% (September 30, 2014: 3.37%).
We had average earning assets of approximately $20.4 billion (September 30, 2014: $19.7 billion) and earned interest income of $490.0 million (September 30, 2014: $503.2 million) for the nine months ended September 30, 2015. The yield on our average investment portfolio was 3.20% (September 30, 2014: 3.41%).
Average assets increased during the three and nine months ended September 30, 2015 compared to 2014 primarily due to the consolidation of additional residential loan securitizations. We consolidated eleven residential loan securitizations as of September 30, 2015 compared to nine consolidated residential loan securitizations as of September 30, 2014. The yield on our average investment portfolio declined for the three and nine months ended September 30, 2015 primarily due to a change in portfolio composition and lower available reinvestment yields. During 2015, we have reinvested cash flows from our Agency RMBS portfolio into 15 year fixed-rate Agency RMBS and Hybrid ARM Agency RMBS as we believe these securities have

 
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lower durations and better cash flow certainty relative to current coupon 30 year fixed-rate Agency RMBS.  We also consolidated new residential loan securitizations in the fourth quarter of 2014 and the first quarter of 2015 that hold Hybrid ARM loans which have lower interest rates than the 30-year fixed rate loans held by our earlier consolidated securitizations. We continue to evaluate our investment portfolio and make adjustments based on our views of the market opportunities. As of September 30, 2015, approximately 35% of our equity is allocated to Agency RMBS; 34% is allocated to investments in commercial credit and 31% is allocated to residential credit.
We compute our effective interest income (non-GAAP measure) and effective yield (non-GAAP measure) by adding GSE CRT embedded derivative coupon interest to our interest income. Effective interest income (non-GAAP measure) was $167.8 million (September 30, 2014: $169.6 million) for the three months ended September 30, 2015. Effective interest income (non-GAAP measure) was $508.4 million (September 30, 2014: $515.0 million) for the nine months ended September 30, 2015.
For the three months ended September 30, 2015, our effective yield (non-GAAP measure) was 3.33% (September 30, 2014: 3.47%), and for the nine months ended September 30, 2015, our effective yield (non-GAAP measure) was 3.32% (September 30, 2014: 3.49%). Our effective yield declined in the three and nine months ended September 30, 2015 versus the 2014 period primarily due to decline in the yield on our average investment portfolio.
Our interest income is subject to interest rate risk. Refer to Item 3. “Quantitative and Qualitative Disclosures about Market Risk” for more information relating to interest rate risk and its impact on our operating results.
The constant prepayment rate ("CPR") of our portfolio impacts the amount of premium and discount on the purchase of securities that is recognized into income. The table below shows the three month CPR for our RMBS and GSE CRT compared to bonds with similar characteristics (“Cohorts”).
 
September 30, 2015
 
June 30, 2015
 
Company
 
Cohorts
 
Company
 
Cohorts
15 year Agency RMBS
13.1

 
14.7

 
10.7

 
15.1

30 year Agency RMBS
14.8

 
16.7

 
13.9

 
17.1

Agency Hybrid ARM RMBS
15.2

 
NA

 
17.3

 
NA

Non-Agency RMBS
15.3

 
NA

 
14.0

 
NA

GSE CRT
12.6

 
NA

 
13.9

 
NA

Weighted average CPR
14.7

 
NA

 
14.4

 
NA


 
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Interest Expense and the Cost of Funds
The table below presents certain information related to our financing for the three and nine months ended September 30, 2015 and 2014:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
$ in thousands
2015
 
2014
 
2015
 
2014
Average Borrowings*:
 
 
 
 
 
 
 
Agency RMBS (1)
9,172,106

 
9,078,815

 
9,123,526

 
9,603,237

Non-Agency RMBS
2,405,227

 
2,780,808

 
2,524,969

 
2,857,548

GSE CRT
501,554

 
425,374

 
483,890

 
315,826

CMBS (1)
2,686,395

 
2,437,566

 
2,671,552

 
2,171,806

Exchangeable senior notes
400,000

 
400,000

 
400,000

 
400,000

Asset-backed securities issued by securitization trusts
2,904,831

 
2,228,234

 
2,950,981

 
1,989,656

Total borrowed funds
18,070,113

 
17,350,797

 
18,154,918

 
17,338,073

Maximum borrowings during the period (2)
18,183,099

 
17,967,829

 
18,416,608

 
17,967,829

Average Cost of Funds (3):
 
 
 
 
 
 
 
Agency RMBS (1)
0.40
%
 
0.33
%
 
0.37
%
 
0.34
%
Non-Agency RMBS
1.60
%
 
1.53
%
 
1.56
%
 
1.53
%
GSE CRT
1.75
%
 
1.51
%
 
1.69
%
 
1.49
%
CMBS (1)
0.93
%
 
0.98
%
 
0.91
%
 
1.19
%
Exchangeable senior notes
5.62
%
 
5.62
%
 
5.61
%
 
5.61
%
Asset-backed securities issued by securitization trusts
2.85
%
 
3.17
%
 
2.93
%
 
3.18
%
Unhedged cost of funds (4)
1.18
%
 
1.13
%
 
1.18
%
 
1.11
%
Hedged / Effective cost of funds (non-GAAP measure)
2.22
%
 
2.29
%
 
2.20
%
 
2.29
%
*
 Average amounts for each period are based on weighted month-end balances.
(1)
Agency RMBS and CMBS average borrowing and cost of funds include borrowings under repurchase agreements and secured loans.
(2)
Amount represents the maximum borrowings at month-end during each of the respective periods.
(3)
Average cost of funds is calculated by dividing annualized interest expense by our average borrowings.
(4)
Excludes reclassification of amortization of net deferred losses on de-designated interest rate swaps to repurchase agreements interest expense.
Our largest expense is the interest expense on borrowed funds. We had average borrowed funds of $18.1 billion (September 30, 2014: $17.4 billion) and total interest expense of $69.2 million (September 30, 2014: $70.3 million) for the three months ended September 30, 2015. We had average borrowed funds of $18.2 billion (September 30, 2014: $17.3 billion) and total interest expense of $211.9 million (September 30, 2014: $208.3 million) for the nine months ended September 30, 2015. The increase in average borrowed funds for the three and nine months ended September 30, 2015 compared to 2014 was primarily the result of higher asset-backed security balances associated with new investments in consolidated residential loan securitizations. The Company consolidated eleven residential loan securitizations as of September 30, 2015 (nine consolidated residential loan securitizations as of September 30, 2014).
We compute our effective interest expense (non-GAAP measure) and effective cost of funds (non-GAAP measure) by including the net interest paid related to our interest rate swaps and excluding the amortization of net deferred losses on de-designated interest rate swaps to repurchase agreements interest expense from our interest expense. Effective interest expense (non-GAAP measure) was $100.3 million (September 30, 2014: $99.5 million) for the three months ended September 30, 2015. Effective interest expense (non-GAAP measure) was $299.2 million (September 30, 2014: $298.3 million) for the nine months ended September 30, 2015.
For the three months ended September 30, 2015, our cost of funds was 1.53% (September 30, 2014: 1.62%), and for the nine months ended September 30, 2015, our cost of funds was 1.56% (September 30, 2014: 1.60%). For the three months ended September 30, 2015, our effective cost of funds (non-GAAP measure) was 2.22% (September 30, 2014: 2.29%), and for the nine months ended September 30, 2015, our effective cost of funds (non-GAAP measure) was 2.20% (September 30, 2014: 2.29%). Our effective cost of funds declined in the three and nine months ended September 30, 2015 versus the 2014 period primarily due to lower net interest paid on interest rate swaps.

 
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Net Interest Income
Our net interest income, which equals interest income less interest expense, totaled $92.2 million (September 30, 2014: $94.5 million) for the three months ended September 30, 2015 and $278.0 million (September 30, 2014: $294.9 million) for the nine months ended September 30, 2015. Our net interest rate margin, which equals the yield on our average assets for the period less the average cost of funds for the period, was 1.67% (September 30, 2014: 1.75%) for the three months ended September 30, 2015 and 1.64% (September 30, 2014: 1.81%) for the nine months ended September 30, 2015. The decrease in net interest income and net interest margin was primarily the result of a lower average portfolio yield and higher average borrowed funds for the three and nine months ended September 30, 2015 compared to 2014.
We compute our effective net interest income (non-GAAP measure) and effective interest rate margin (non-GAAP measure) by adding amortization of net deferred losses on de-designated interest rate swaps and GSE CRT embedded derivative coupon interest, and subtracting net interest paid on our interest rate swaps to our net interest income. Our effective net interest income (non-GAAP measure) totaled $67.5 million (September 30, 2014: $70.1 million) for the three months ended September 30, 2015 and $209.3 million (September 30, 2014: $216.6 million) for the nine months ended September 30, 2015. Our effective interest rate margin (non-GAAP measure) was 1.11% (September 30, 2014: 1.18%) for the three months ended September 30, 2015 and 1.12% (September 30, 2014: 1.20%) for the nine months ended September 30, 2015.
Refer to the table in the “Interest Income and Average Earning Asset Yield” section above for changes in average portfolio balance and yields.
Provision for Loan Losses
We evaluate our residential and commercial loans, held-for-investment to determine if it is probable that all amounts due under the terms of the loan agreements will be collected. Based upon this analysis, we recorded a decrease in the provision for loan losses of $81,000 (September 30, 2014: $209,000) for the three months ended September 30, 2015, and $213,000 (September 30, 2014: $52,000) for the nine months ended September 30, 2015. Our provision for loan losses is solely for residential loans held-for-investment by consolidated securitization trusts. The Company has evaluated the collectibility of its commercial loans held-for-investment and determined that no provision for loan losses is required as of September 30, 2015.
Gain (Loss) on Investments, net
Gain (loss) on investments, net includes (i) gains and losses on sales of our investment portfolio; and (ii) the change in fair value of Agency MBS IOs.
As part of our investment process, our mortgage-backed and credit risk transfer securities are continuously reviewed to determine if they continue to meet our risk and return targets. This process involves looking at changing market assumptions and the impact those assumptions will have on the individual securities. Securities that do not meet our risk and return targets are sold. During the three months ended September 30, 2015, we sold mortgage-backed and credit risk transfer securities and recognized a net loss of $1.4 million (September 30, 2014: $48.0 million) and a net gain of $3.2 million (September 30, 2014: $80.4 million net loss) for the nine months ended September 30, 2015.
The Company accounts for Agency MBS IOs as hybrid financial instruments in their entirety at fair value with changes in fair value recognized in income in the Company's condensed consolidated statements of operations. Gain (loss) on Agency MBS IOs totaled $1.6 million net loss (September 30, 2014: $412,000 net loss) during the three months ended September 30, 2015 and $6.9 million net gain (September 30, 2014: $5.9 million net loss) for the nine months ended September 30, 2015.
Loss on Other-Than-Temporary Impaired Securities
For the three and nine months ended September 30, 2015 and 2014, we did not recognize any losses on other-than-temporarily impaired securities in the condensed consolidated statements of operations. Refer to Note 4 – “Mortgage-Backed and Credit Risk Transfer Securities” of our condensed consolidated financial statements for the assessment of other-than-temporary impairment on our investment securities.

 
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Equity in Earnings of Unconsolidated Ventures
For the three months ended September 30, 2015, we recorded equity in earnings of unconsolidated ventures of $1.9 million (September 30, 2014: $1.1 million). Equity in earnings of unconsolidated ventures increased for the three months ended September 30, 2015 compared to 2014 primarily due to higher unrealized appreciation of underlying portfolio investments in the 2015 period.
For the nine months ended September 30, 2015, we recorded equity in earnings of unconsolidated ventures of $9.1 million (September 30, 2014: $5.5 million). Equity in earnings of unconsolidated ventures increased for the nine months ended September 30, 2015 compared to 2014 primarily due to higher unrealized appreciation of underlying portfolio investments in the 2015 period.
Gain (Loss) on Derivative Instruments, net
Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements on our floating rate repurchase agreements and secured loans. To accomplish these objectives, we primarily use interest rate derivative instruments, including interest rate swaps, interest rate swaptions, U.S. Treasury futures contracts and TBAs as part of our interest rate risk management strategy. Interest rate swaps involve the receipt of variable-rate amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. An interest rate swaption provides us the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay and receive interest rates in the future. The premium paid for interest rate swaptions is reported as an asset in our condensed consolidated balance sheets. The premium is valued at an amount equal to the fair value of the swaption that would have the effect of closing the position adjusted for nonperformance risk, if any. TBAs are reported on the balance sheet as an asset or liability at its fair value.
We also use currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on our investments denominated in foreign currencies.

 
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The tables below summarize our realized and unrealized gain (loss) on derivative instruments, net for the following periods:
$ in thousands
Three Months Ended September 30, 2015
Derivative
not designated as
hedging instrument
Realized gain (loss) on settlement, termination, expiration or exercise, net
 
 Contractual interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
—

 
(46,785
)
 
(173,817
)
 
(220,602
)
Interest Rate Swaptions
(2,590
)
 
—

 
2,589

 
(1
)
TBAs
—

 
—

 
—

 
—

Futures Contracts
—

 
—

 
—

 
—

Currency Forward Contracts
(489
)
 
—

 
490

 
1

Total
(3,079
)
 
(46,785
)
 
(170,738
)
 
(220,602
)
$ in thousands
Nine Months Ended September 30, 2015
Derivative
not designated as
hedging instrument
Realized gain (loss) on settlement, termination, expiration or exercise, net
 
 Contractual interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
(31,881
)
 
(138,404
)
 
(113,151
)
 
(283,436
)
Interest Rate Swaptions
(10,328
)
 
—

 
8,594

 
(1,734
)
TBAs
(2,292
)
 
—

 
558

 
(1,734
)
Futures Contracts
(943
)
 
—

 
(90
)
 
(1,033
)
Currency Forward Contracts
1,050

 
—

 
(457
)
 
593

Total
(44,394
)
 
(138,404
)
 
(104,546
)
 
(287,344
)
$ in thousands
Three Months Ended September 30, 2014
Derivative Instrument
Realized gain (loss) on settlement, termination, expiration or exercise, net
 
 Contractual interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
1,348

 
(50,446
)
 
47,709

 
(1,389
)
Interest Rate Swaptions
—

 
—

 
(2,185
)
 
(2,185
)
TBAs
(2,943
)
 
—

 
368

 
(2,575
)
Futures Contracts
249

 
—

 
786

 
1,035

Currency Forward Contracts
330

 
—

 
1,080

 
1,410

Total
(1,016
)
 
(50,446
)
 
47,758

 
(3,704
)
$ in thousands
Nine Months Ended September 30, 2014
Derivative Instrument
Realized gain (loss) on settlement, termination, expiration or exercise, net
 
 Contractual interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
1,348

 
(154,092
)
 
(146,116
)
 
(298,860
)
Interest Rate Swaptions
(23,275
)
 
—

 
13,596

 
(9,679
)
TBAs
(4,343
)
 
—

 
(867
)
 
(5,210
)
Futures Contracts
(8,937
)
 
—

 
(1,556
)
 
(10,493
)
Currency Forward Contracts
330

 
—

 
1,080

 
1,410

Total
(34,877
)
 
(154,092
)
 
(133,863
)
 
(322,832
)

 
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Realized and Unrealized Credit Derivative Income (Loss), net
Realized and unrealized credit derivative income (loss), net includes (i) premium income and the change in fair value on the Company's sole credit default swap ("CDS"); and (ii) GSE CRT embedded derivative coupon interest, the change in fair value of GSE CRT embedded derivatives and realized gain (loss) on settlement of GSE CRT embedded derivatives.
The table below summarizes realized and unrealized credit derivative income (loss), net for the three and nine months ended September 30, 2015 and 2014.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
$ in thousands
2015
 
2014 
 (As Restated)
 
2015
 
2014 
 (As Restated)
CDS premium income
215

 
325

 
722

 
1,053

Change in fair value of CDS
(96
)
 
(78
)
 
648

 
(185
)
GSE CRT embedded derivative coupon interest
6,373

 
4,784

 
18,443

 
11,754

Gain (loss) on settlement of GSE CRT embedded derivatives
284

 
—

 
(2,184
)
 
—

Change in fair value of GSE CRT embedded derivatives
(3,848
)
 
(33,644
)
 
7,275

 
8,307

Total
2,928

 
(28,613
)
 
24,904

 
20,929

Other Investment Income (Loss), net
Other investment income (loss), net primarily consists of quarterly dividends from FHLBI stock and foreign exchange rate gains and losses related to a commercial loan investment that prepaid in the second quarter of 2015 before its contractual maturity.

Expenses
For the three months ended September 30, 2015, we incurred management fees of $10.1 million (September 30, 2014: $9.2 million) and $28.8 million (September 30, 2014: $27.9 million) for the nine months ended September 30, 2015, which are payable to our Manager under our management agreement. Management fees increased during the third quarter of 2015 primarily due to a change in how our fees are calculated. Refer to Note 11 – “Related Party Transactions” of our condensed consolidated financial statements for a discussion of our relationship with our Manager and description of how our fees are calculated.
For the three months ended September 30, 2015, our general and administrative expenses not covered under our management agreement amounted to $2.5 million (September 30, 2014: $2.5 million) and $6.2 million (September 30, 2014: $6.9 million) for the nine months ended September 30, 2015. General and administrative expenses not covered under our management agreement primarily consist of directors and officers insurance, legal costs, accounting, auditing and tax services, filing fees, organization expenses associated with our consolidated securitization trusts and miscellaneous general and administrative costs. During the third quarter of 2015, the Company incurred restatement-related expenses for third party consulting, accounting, auditing and legal fees of approximately $750,000. General and administrative expenses in the three months ended September 30, 2014 included $759,000 of consolidated securitization organization expenses and commercial loan transaction costs. General and administrative costs in the nine months ended September 30, 2015 were lower than the 2014 period primarily because the 2014 period included $1.4 million of commercial loan transaction costs and consolidated securitization organization expenses, which were partially offset by restatement-related expenses of approximately $950,000 incurred in 2015.
For the three months ended September 30, 2015, consolidated securitization trust expenses totaled $2.1 million (September 30, 2014: $1.6 million) and $6.5 million (September 30, 2014: $4.1 million) for the nine months ended September 30, 2015. Consolidated securitization trust expenses consist of direct operating expenses incurred by consolidated residential loan securitizations. The increase in securitization trust expenses for the three and nine months ended September 30, 2015 is primarily due to an increase in the number of consolidated residential loan securitizations from nine as of September 30, 2014 to eleven as of September 30, 2015.

 
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Net Income (loss) after Preferred Dividends and Return on Average Equity
For the three months ended September 30, 2015, our net loss after preferred dividends was $146.2 million (September 30, 2014: $2.8 million) and our annualized loss on average equity was 25.51% (September 30, 2014: 0.47% ). The change in net income (loss) after preferred dividends and return on average equity was primarily attributable to realized and unrealized losses on derivative instruments of $220.6 million in the 2015 period versus $3.7 million in the 2014 period. For the three months ended September 30, 2015, we recognized an unrealized loss for the change in fair value of our interest rates swaps of $173.8 million (September 30, 2014: $47.7 million unrealized gain). In addition, during the three months ended September 30, 2015, we recognized reclassification of amortization of net deferred losses on de-designated interest rate swaps to repurchase agreements interest expense previously recognized in other comprehensive income of $15.7 million (September 30, 2014: $21.2 million).
For the nine months ended September 30, 2015, our net losses after preferred dividends was $22.1 million (September 30, 2014: $136.8 million) and our annualized losses on average equity was 1.23% (September 30, 2014: 7.54%). The change in net income (loss) after preferred dividends and return on average equity was primarily attributable to realized and unrealized losses on derivatives instruments of $287.3 million in the 2015 period versus $322.8 million in the 2014 period. For the nine months ended September 30, 2015, we recognized an unrealized losses for the change in fair value of our interest rates swaps of $113.2 million (September 30, 2014: $146.1 million). In addition, during the nine months ended September 30, 2015, we recognized reclassification of amortization of net deferred losses on de-designated interest rate swaps to repurchase agreements interest expense previously recognized in other comprehensive losses of $51.2 million (September 30, 2014: $64.1 million)

Liquidity and Capital Resources
Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to pay dividends, fund investments, repayment of borrowings and other general business needs. Our primary sources of funds for liquidity consist of the net proceeds from our common and preferred equity offerings, net cash provided by operating activities, proceeds from repurchase agreements and other financing arrangements and future issuances of equity and/or debt securities.
We currently believe that we have sufficient liquidity and capital resources available for the acquisition of additional investments, repayments on borrowings, margin requirements and the payment of cash dividends as required for continued qualification as a REIT. We generally maintain liquidity to pay down borrowings under repurchase arrangements to reduce borrowing costs and otherwise efficiently manage our long-term investment capital. Because the level of these borrowings can be adjusted on a daily basis, the level of cash and cash equivalents carried on our condensed consolidated balance sheets is significantly less important than our potential liquidity available under borrowing arrangements. However, there can be no assurance that we will maintain sufficient levels of liquidity to meet any margin calls.
We held cash and cash equivalents of $76.7 million at September 30, 2015 (September 30, 2014: $128.9 million). Our cash and cash equivalents decreased due to normal fluctuations in cash balances related to the timing of principal and interest payments, repayments of debt, and asset purchases and sales. Our operating activities provided net cash of approximately $276.0 million for the nine month period ended September 30, 2015 (September 30, 2014: $278.3 million).
Our investing activities provided net cash of $354.7 million for the nine month period ended September 30, 2015 (September 30, 2014: $704.8 million used). During the nine month period ended September 30, 2015, we utilized cash to purchase $1.8 billion (September 30, 2014: $3.8 billion) of mortgage-backed and credit risk transfer securities and $372.3 million (September 30, 2014: $1.4 billion) of residential loans. Cash used to purchase new investments was offset by proceeds from asset sales of $290.6 million (September 30, 2014: $3.1 billion), principal payments on mortgage-backed and credit risk transfer securities of $1.9 billion (September 30, 2014: $1.4 billion) and principal repayments on residential loans of $424.6 million (September 30, 2014: $120.9 million). In addition, we originated or funded commercial loans of $105.0 million (September 30, 2014: $81.2 million) which was offset by principal repayments on commercial loans of $63.1 million (September 30, 2014: $400,000).
Our financing activities used net cash of $718.2 million for the nine month period ended September 30, 2015 (September 30, 2014: $344.8 million provided). During the nine months ended September 30, 2015, we utilized cash to repay repurchase agreements of $710.5 million (September 30, 2014: $1.9 billion) and asset-backed securities issued by securitization trusts of $400.2 million (September 30, 2014: $109.6 million). Repayments on repurchase agreements were offset by net proceeds from our secured loans of $425.0 million (September 30, 2014: $1.3 billion), and net proceeds from asset-backed securities issued by new consolidated securitization trusts of $336.1 million (September 30, 2014: $1.2 billion).

 
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As of September 30, 2015, our wholly-owned subsidiary, IAS Services LLC, had $1.675 billion in outstanding secured advances from the FHLBI and is approved for total available uncommitted credit for borrowing of an amount up to $2.5 billion. Available uncommitted credit may be adjusted at the sole discretion of the FHLBI. As of September 30, 2015, the FHLBI advances were collateralized by CMBS and Agency RMBS with a fair value of $1.5 billion and $519.6 million, respectively.
As of September 30, 2015, the average margin requirement (weighted by borrowing amount), or the percentage amount by which the collateral value must exceed the loan amount, which we also refer to as the “haircut,” under our repurchase agreements for Agency RMBS was 4.6%, for non-Agency RMBS was 20.4%, for GSE CRT was 23.5% and for CMBS was 18.4%. Across our repurchase agreements for Agency RMBS, the haircuts range from a low of 3% to a high of 20%, for non-Agency RMBS ranges from a low of 10% to a high of 50%, GSE CRT ranges from a low of 25% to a high of 30% and for CMBS range from a low of 10% to a high of 25%. Our effective cost of funds (non-GAAP measure) was 2.22% (September 30, 2014: 2.29%) for the three months ended September 30, 2015. Declines in the value of our securities portfolio can trigger margin calls by our lenders under our repurchase agreements. An event of default or termination event would give some of our counterparties the option to terminate all repurchase transactions existing with us and require any amount due by us to the counterparties to be payable immediately.
Our total debt-to-equity ratio, which includes longer term financing, was 7.3x as of September 30, 2015 (December 31, 2014: 6.9x). In the third quarter our leverage increased approximately 0.4 times due to lower equity after the quarterly decline in book value as we used cash from principal prepayments and maturities to buy back stock rather than reinvest in unencumbered assets. Improving our balance sheet by diversifying our liabilities away from repurchase agreements has been a focus of management over the past two years. Since we began using other longer-term means of financing our investments, such as our exchangeable senior notes and secured loans, we have reduced our reliance on repurchase agreements. Our weighted average remaining maturity on borrowings has increased from 60 days as of December 31, 2013 to 380 days as of September 30, 2015.
In December 2013, our board of directors approved a share repurchase program of up to 20,000,000 of our common shares with no expiration date. Shares of our common stock may be purchased in the open market, including through block purchases, or through privately negotiated transactions, or pursuant to any trading plan that may be adopted in accordance with Rules 10b5-1 and 10b-18 of the Securities Exchange Act of 1934, as amended. The timing, manner, price and amount of any repurchases will be determined at our discretion and the program may be suspended, terminated or modified at any time for any reason.  The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases.
During the nine months ended September 30, 2015, we repurchased 3,695,368 shares of our common stock at an average repurchase price of $13.53 per share for a net cost of $50.0 million, including acquisition expenses. As of September 30, 2015, the Company had authority to purchase 11,146,416 additional shares of its common stock under its share repurchase program.
In 2011, we implemented the DRSPP. We have registered and reserved for issuance 15,000,000 shares of our common stock under the DRSPP. Under the terms of the DRSPP, stockholders who participate in the DRSPP may purchase shares of our common stock directly from us, in cash investments up to $10,000, or greater than $10,000 if we grant a request for waiver. At our sole discretion, we may accept optional cash investments in excess of $10,000 per month, which may qualify for a discount from the market price of 0% to 3%. The DRSPP participants may also automatically reinvest all or a portion of their dividends for additional shares of our stock. During the nine months ended September 30, 2015, we issued 10,317 shares of common stock (September 30, 2014: 11,459 shares) at an average price of $15.29 (September 30, 2014: $16.71) under the DRSPP with total proceeds of approximately $158,000 (September 30, 2014: $191,000), of which no shares of common stock were issued under the waiver feature of the DRSPP.

Effects of Margin Requirements, Leverage and Credit Spreads
Our securities have values that fluctuate according to market conditions and, as discussed above, the market value of our securities will decrease as prevailing interest rates or credit spreads increase. When the value of the securities pledged to secure a repurchase loan or a secured loan decreases to the point where the positive difference between the collateral value and the loan amount is less than the haircut, our lenders may issue a margin call, which means that the lender will require us to pay the margin call in cash or pledge additional collateral to meet that margin call. Under our repurchase facilities and secured loans, our lenders have full discretion to determine the value of the securities we pledge to them. Most of our lenders will value securities based on recent trades in the market. Lenders also issue margin calls as the published current principal balance factors change on the pool of mortgages underlying the securities pledged as collateral when scheduled and unscheduled paydowns are announced monthly.
We experience margin calls and increased collateral requirements in the ordinary course of our business. In seeking to effectively manage the margin requirements established by our lenders, we maintain a position of cash and unpledged

 
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securities. We refer to this position as our liquidity. The level of liquidity we have available to meet margin calls is directly affected by our leverage levels, our haircuts and the price changes on our securities. If interest rates increase as a result of a yield curve shift or for another reason or if credit spreads widen, then the prices of our collateral (and our unpledged assets that constitute our liquidity) will decline, we will experience margin calls, and we will use our liquidity to meet the margin calls. There can be no assurance that we will maintain sufficient levels of liquidity to meet any margin calls or increased collateral requirements. If our haircuts increase, our liquidity will proportionately decrease. In addition, if we increase our borrowings, our liquidity will decrease by the amount of additional haircut on the increased level of indebtedness.
We intend to maintain a level of liquidity in relation to our assets that enables us to meet reasonably anticipated margin calls and increased collateral requirements but that also allows us to be substantially invested in securities. We may misjudge the appropriate amount of our liquidity by maintaining excessive liquidity, which would lower our investment returns, or by maintaining insufficient liquidity, which would force us to liquidate assets into unfavorable market conditions and harm our results of operations and financial condition.
We are subject to financial covenants in connection with our lending, derivatives and other agreements we enter into in the normal course of our business. We intend to continue to operate in a manner which complies with all of our financial covenants. Our lending and derivative agreements provide that we may be declared in default of our obligations if our leverage ratio exceeds certain thresholds and we fail to maintain stockholders’ equity or market value above certain thresholds over specified time periods.
Forward-Looking Statements Regarding Liquidity
Based upon our current portfolio, leverage rate and available borrowing arrangements, we believe that cash flow from operations and available borrowing capacity will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity requirements to fund our investment activities, pay fees under our management agreement, fund our distributions to stockholders and for other general corporate expenses.
Our ability to meet our long-term (greater than one year) liquidity and capital resource requirements will be subject to obtaining additional debt financing. We may increase our capital resources by obtaining long-term credit facilities or through public or private offerings of equity or debt securities, possibly including classes of preferred stock, common stock, and senior or subordinated notes. Such financing will depend on market conditions for capital raises and our ability to invest such offering proceeds. If we are unable to renew, replace or expand our sources of financing on substantially similar terms, it may have an adverse effect on our business and results of operations.

 
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Contractual Obligations
We have entered into an agreement with our Manager pursuant to which our Manager is entitled to receive a management fee and the reimbursement of certain expenses. The management fee is calculated and payable quarterly in arrears in an amount equal to 1.50% of our stockholders’ equity, per annum. Our Manager uses the proceeds from its management fee in part to pay compensation to its officers and personnel who, notwithstanding that certain of those individuals are also our officers, receive no cash compensation directly from us. We are required to reimburse our Manager for operating expenses related to us incurred by our Manager, including certain salary expenses and other expenses relating to legal, accounting, due diligence and other services. Expense reimbursements to our Manager are made in cash on a monthly basis following the end of each month. Our reimbursement obligation is not subject to any dollar limitation. Refer to Note 11 – “Related Party Transactions” of our condensed consolidated financial statements for details of our reimbursements to our Manager.
Contractual Commitments
As of September 30, 2015, we had the following contractual commitments and commercial obligations:
 
Payments Due by Period
$ in thousands
Total
 
Less than 1
year
 
1-3 years
 
3-5 years
 
After 5
years
Obligations of Invesco Mortgage Capital Inc.
 
 
 
 
 
 
 
 
 
Repurchase agreements
12,912,131

 
12,912,131

 
—

 
—

 
—

Secured loans
1,675,000

 
125,000

 
—

 
300,000

 
1,250,000

Unfunded investments in unconsolidated ventures
25,410

 
4,809

 
20,601

 
—

 
—

Exchangeable senior notes
400,000

 
—

 
400,000

 
—

 
—

Participation interest
150

 
150

 
—

 
—

 
—

Commercial loans
3,020

 
892

 
2,128

 
—

 
—

Total contractual obligations (1)
15,015,711

 
13,042,982

 
422,729

 
300,000

 
1,250,000

Obligations of entities consolidated for financial reporting purposes
 
 
 
 
 
 
 
 
 
Consolidated ABS (2)
2,836,398

 
378,803

 
621,255

 
464,837

 
1,371,503

Anticipated interest payments on ABS (3)
624,226

 
85,624

 
138,334

 
104,445

 
295,823

Total obligations of entities consolidated for financial reporting purposes
3,460,624

 
464,427

 
759,589

 
569,282

 
1,667,326

Total consolidated obligations and commitments
18,476,335

 
13,507,409

 
1,182,318

 
869,282

 
2,917,326

 
(1)
Excluded from total contractual obligations are the amounts due to our Manager under the management agreement, as those obligations do not have fixed and determinable payments. Refer to "Contractual Obligations" above for further details.
(2)
All consolidated ABS issued by VIEs are collateralized by residential mortgage loans. The ABS obligations will pay down as the principal balances of these residential mortgage loans pay down. The amounts shown are the estimated principal repayments, adjusted for projected prepayments and losses.
(3)
The anticipated interest payments on consolidated ABS issued by VIEs are calculated based on estimated principal balances, adjusted for projected prepayments and losses.
As of September 30, 2015, we have approximately $16.0 million, $50.7 million and $62.1 million in contractual interest payments related to our repurchase agreements, exchangeable senior notes and secured loans, respectively.
Off-Balance Sheet Arrangements
We have committed to invest up to $122.4 million in unconsolidated ventures sponsored by an affiliate of our Manager. The unconsolidated ventures are structured as partnerships, and we invest in the partnerships as a limited partner. As of September 30, 2015, $97.0 million of our commitment has been called. We are committed to fund $25.4 million in additional capital to fund future investments and cover future expenses should they occur.
We also utilize credit derivatives, such as credit default swaps, to provide credit event protection based on a financial index or specific security in exchange for receiving a fixed-rate fee or premium over the term of the contract. These instruments enable us to synthetically assume the credit risk of a reference security, portfolio of securities or index of securities. The counterparty pays a premium to us and we agree to make a payment to compensate the counterparty for losses upon the occurrence of a specified credit event. Although contract specific, credit events generally include bankruptcy, failure to pay, restructuring, obligation acceleration, obligation default, or repudiation/moratorium. Upon the occurrence of a defined credit

 
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event, amounts due to the counterparty as set forth by the terms of the CDS agreement would be recorded as realized loss in the condensed consolidated statements of operations.
In 2010, we entered into a CDS contract. We sold protection against losses on a specific pool of non-Agency RMBS in excess of a specified threshold. In exchange, we are paid a stated fixed rate fee of 3% of the notional amount of the CDS. We are required to post collateral as security for potential loss payments. We posted collateral to secure potential loss payments of $4.1 million as of September 30, 2015 (December 31, 2014: $5.6 million). The remaining notional amount of the CDS at September 30, 2015 is $26.0 million (December 31, 2014: $36.7 million), and we estimated the fair market value of the CDS to be $1.0 million at September 30, 2015 (December 31, 2014: $396,000). As of September 30, 2015, we have not made any payments related to the CDS contract. As of September 30, 2015, we accepted an offer to terminate the CDS in October 2015 in exchange for a payment to us of $1.0 million.
As of September 30, 2015, we have unfunded commitments on commercial loans of $3.0 million (December 31, 2014: $5.0 million).
Stockholders’ Equity
During the nine months ended September 30, 2015, we issued 10,317 shares (2014: 11,459 shares) of common stock at an average price of $15.29 (2014: $16.71) under the DRSPP with total proceeds to us of approximately $158,000 (2014: $191,000).
During the nine months ended September 30, 2015, we repurchased 3,695,368 shares of our common stock at an average repurchase price of $13.53 per share for a net cost of $50.0 million, including acquisition expenses. During the nine months ended September 30, 2014, we repurchased 1,438,213 shares of our common stock at an average repurchase price of $14.69 per share for a net cost of $21.1 million, including acquisition expenses. As of September 30, 2015, we had authority to purchase 11,146,416 additional shares of our common stock through our share repurchase program.
Share-Based Compensation
The Company has currently reserved 1,000,000 shares of common stock for issuance to its independent directors and officers and employees of our Manger and its affiliates under the terms of its 2009 Equity Incentive Plan (the "Incentive Plan"). Unless terminated earlier, the Incentive Plan will terminate in 2019, but will continue to govern the unexpired awards.
We recognized compensation expense of approximately $255,000 (September 30, 2014: $172,000) related to our non-executive directors for the nine months ended September 30, 2015. During the nine months ended September 30, 2015, we issued 16,896 shares (September 30, 2014: 9,356 shares) of restricted stock pursuant to the Incentive Plan to our non-executive directors. The fair market value of the shares granted was determined by the closing stock market price on the date of the grant.
We recognized compensation expense of approximately $168,000 (September 30, 2014: $223,000) for the nine months ended September 30, 2015 related to awards to employees of our Manager and its affiliates. Our Manager reimburses us for this compensation expense under the terms of our management agreement.
During March 2015, we issued 11,547 shares of common stock (net of tax withholding) to employees of our Manager and its affiliates in exchange for 17,783 restricted stock units that vested under the Incentive Plan. In addition, during the nine months ended September 30, 2015, we awarded 17,652 restricted stock units to employees of our Manager and its affiliates. During the nine months ended September 30, 2015, 4,600 units were forfeited by employees.

 
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Dividends
We intend to continue to make regular quarterly distributions to holders of our common stock and preferred stock. U.S. federal income tax law generally requires that a REIT distribute at least 90% of its REIT taxable income annually, determined without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its taxable income. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on our repurchase agreements and other debt payable. If our cash available for distribution is less than our taxable income, we could be required to sell assets or borrow funds to make cash distributions, or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.
Inflation
Virtually all of our assets and liabilities are sensitive to interest rates. As a result, interest rates and other factors influence our performance far more than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates.
Unrelated Business Taxable Income
We have not engaged in transactions that would result in a portion of our income being treated as unrelated business taxable income.
Other Matters
We believe that we satisfied each of the asset tests in Section 856(c)(4) of the Internal Revenue Code of 1986, as amended (the "Code") for the period ended September 30, 2015. We also believe that our revenue qualifies for the 75% source of income test and for the 95% source of income test rules for the period ended September 30, 2015. Consequently, we believe we met the REIT income and asset test as of September 30, 2015. We also met all REIT requirements regarding the ownership of our common stock and the distribution of dividends of our net income as of September 30, 2015. Therefore, as of September 30, 2015, we believe that we qualified as a REIT under the Code.
At all times, we intend to conduct our business so that neither we nor our Operating Partnership nor the subsidiaries of our Operating Partnership are required to register as an investment company under the 1940 Act. If we were required to register as an investment company, then our use of leverage would be substantially reduced. Because we are a holding company that conducts our business through our Operating Partnership and the Operating Partnership’s wholly-owned or majority-owned subsidiaries, the securities issued by these subsidiaries that are excepted from the definition of “investment company” under Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any other investment securities the Operating Partnership may own, may not have a combined value in excess of 40% of the value of the Operating Partnership’s total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis, which we refer to as the 40% test. This requirement limits the types of businesses in which we are permitted to engage in through our subsidiaries. In addition, we believe neither we nor the Operating Partnership are considered an investment company under Section 3(a)(1)(A) of the 1940 Act because they do not engage primarily or hold themselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through the Operating Partnership’s wholly-owned or majority-owned subsidiaries, we and the Operating Partnership are primarily engaged in the non-investment company businesses of these subsidiaries. IAS Asset I LLC and certain of the Operating Partnership’s other subsidiaries that we may form in the future rely upon the exclusion from the definition of “investment company” under the 1940 Act provided by Section 3(c)(5)(C) of the 1940 Act, which is available for entities “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” This exclusion generally requires that at least 55% of each subsidiary’s portfolio be comprised of qualifying assets and at least 80% be comprised of qualifying assets and real estate-related assets (and no more than 20% comprised of miscellaneous assets). We calculate that as of September 30, 2015, we conducted our business so as not to be regulated as an investment company under the 1940 Act.

 
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ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The primary components of our market risk are related to interest rate, principal prepayment and market value. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and we seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.
Interest Rate Risk
Interest rate risk is highly sensitive to many factors, including governmental, monetary and tax policies, domestic and international economic and political considerations, and other factors beyond our control. We are subject to interest rate risk in connection with our investments and our repurchase agreements. Our repurchase agreements are typically of limited duration and will be periodically refinanced at current market rates. We mitigate this risk through utilization of derivative contracts, primarily interest rate swap agreements, TBAs and futures contracts.
Interest Rate Effect on Net Interest Income
Our operating results depend in large part upon differences between the yields earned on our investments and our cost of borrowing and interest rate hedging activities. Most of our repurchase agreements provide financing based on a floating rate of interest calculated on a fixed spread over LIBOR. The fixed spread will vary depending on the type of underlying asset which collateralizes the financing. Accordingly, the portion of our portfolio which consists of floating interest rate assets are match-funded utilizing our expected sources of short-term financing, while our fixed interest rate assets are not match-funded. During periods of rising interest rates, the borrowing costs associated with our investments tend to increase while the income earned on our fixed interest rate investments may remain substantially unchanged. This increase in borrowing costs results in the narrowing of the net interest spread between the related assets and borrowings and may even result in losses. Further, during this portion of the interest rate and credit cycles, defaults could increase and result in credit losses to us, which could adversely affect our liquidity and operating results. Such delinquencies or defaults could also have an adverse effect on the spread between interest-earning assets and interest-bearing liabilities.
Hedging techniques are partly based on assumed levels of prepayments of our RMBS. If prepayments are slower or faster than assumed, the life of the RMBS will be longer or shorter, which would reduce the effectiveness of any hedging strategies we may use and may cause losses on such transactions. Hedging strategies involving the use of derivative securities are highly complex and may produce volatile returns.
Interest Rate Effects on Fair Value
Another component of interest rate risk is the effect that changes in interest rates will have on the market value of the assets that we acquire. We face the risk that the market value of our assets will increase or decrease at different rates than those of our liabilities, including our hedging instruments.
We primarily assess our interest rate risk by estimating the duration of our assets and the duration of our liabilities. Duration measures the market price volatility of financial instruments as interest rates change. We generally calculate duration using various financial models and empirical data. Different models and methodologies can produce different duration numbers for the same securities.
The impact of changing interest rates on fair value can change significantly when interest rates change materially. Therefore, the volatility in the fair value of our assets could increase significantly in the event interest rates change materially. In addition, other factors impact the fair value of our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, changes in actual interest rates may have a material adverse effect on us.
Prepayment Risk
As we receive prepayments of principal on our investments, premiums paid on these investments are amortized against interest income. In general, an increase in prepayment rates will accelerate the amortization of purchase premiums, thereby reducing the interest income earned on the investments. Conversely, discounts on such investments are accreted into interest income. In general, an increase in prepayment rates will accelerate the accretion of purchase discounts, thereby increasing the interest income earned on the investments.

 
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Extension Risk
We compute the projected weighted average life of our investments based upon assumptions regarding the rate at which the borrowers will prepay the underlying mortgages. In general, when a fixed-rate or hybrid adjustable-rate security is acquired with borrowings, we may, but are not required to, enter into an interest rate swap agreement or other hedging instrument that effectively fixes our borrowing costs for a period close to the anticipated average life of the fixed-rate portion of the related assets. This strategy is designed to protect us from rising interest rates, because the borrowing costs are fixed for the duration of the fixed-rate portion of the related target asset.
However, if prepayment rates decrease in a rising interest rate environment, then the life of the fixed-rate portion of the related assets could extend beyond the term of the swap agreement or other hedging instrument. This could have a negative impact on our results from operations, as borrowing costs would no longer be fixed after the end of the hedging instrument, while the income earned on the hybrid adjustable-rate assets would remain fixed. This situation may also cause the market value of our hybrid adjustable-rate assets to decline, with little or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses.
Market Risk
Market Value Risk
Our available-for-sale securities are reflected at their estimated fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive income pursuant to ASC Topic 320. The estimated fair value of these securities fluctuates primarily due to changes in interest rates and other factors. Generally, in a rising interest rate environment, the estimated fair value of these securities would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of these securities would be expected to increase.
The sensitivity analysis table presented below shows the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments and net interest income, including net interest paid or received under interest rate swaps, at September 30, 2015, assuming a static portfolio. When evaluating the impact of changes in interest rates, prepayment assumptions and principal reinvestment rates are adjusted based on our Manager’s expectations. The analysis presented utilized assumptions, models and estimates of our Manager based on our Manager’s judgment and experience.
Change in Interest Rates
 
Percentage Change in Projected
Net Interest Income
 
Percentage Change in Projected
Portfolio Value
+1.00%
 
11.64
 %
 
(0.92
)%
+0.50%
 
18.81
 %
 
(0.40
)%
-0.50%
 
(25.65
)%
 
0.01
 %
-1.00%
 
(52.23
)%
 
(0.25
)%
Certain assumptions have been made in connection with the calculation of the information set forth in the foregoing interest rate sensitivity table and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. The base interest rate scenario assumes interest rates at September 30, 2015. The analysis utilizes assumptions and estimates based on management’s judgment and experience. Furthermore, while we generally expect to retain such assets and the associated interest rate risk to maturity, future purchases and sales of assets could materially change our interest rate risk profile.
Given the low interest rates at September 30, 2015, we applied a floor of 0% for all anticipated interest rates included in our assumptions. Because of this floor, we anticipate that any hypothetical interest rate shock decrease would have a limited positive impact on our funding costs; however, because prepayment speeds are unaffected by this floor, we expect that any increase in our prepayment speeds (occurring as a result of any interest rate decrease or otherwise) could result in an acceleration of our premium amortization on Agency and interest-only securities purchased at a premium, and accretion of discount on our non-Agency RMBS purchased at a discount. As a result, because this floor limits the positive impact of any interest rate decrease on our funding costs, hypothetical interest rate decreases could cause the fair value of our financial instruments and our net interest income to decline.
The information set forth in the interest rate sensitivity table above and all related disclosures constitutes forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Actual results could differ significantly from those estimated in the foregoing interest rate sensitivity table.

 
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Real Estate Risk
Residential and commercial property values are subject to volatility and may be adversely affected by a number of factors, including, but not limited to: national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions (such as the supply of housing stock); changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; and retroactive changes to building or similar codes. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could also cause us to suffer losses.
Credit Risk
We believe that our investment strategy will generally keep our credit losses and financing costs low. However, we retain the risk of potential credit losses on all of our residential and commercial mortgage investments. We seek to manage this risk through our pre-acquisition due diligence process. In addition, we re-evaluate the credit risk inherent in our investments on a regular basis pursuant to fundamental considerations such as GDP, unemployment, interest rates, retail sales, store closings/openings, corporate earnings, housing inventory, affordability and regional home price trends. We also review key loan credit metrics including, but not limited to, payment status, current loan-to-value ratios, current borrower credit scores and debt yields. These characteristics assist in determining the likelihood and severity of loan loss as well as prepayment and extension expectations. We then perform structural analysis under multiple scenarios to establish likely cash flow profiles and credit enhancement levels relative to collateral performance projections. This analysis allows us to quantify our opinions of credit quality and fundamental value, which are key drivers of portfolio management decisions.
Foreign Exchange Rate Risk
We have an investment in an unconsolidated joint venture whose net assets and results of operations are exposed to foreign currency translation risk when translated into U.S. dollars upon consolidation. We have hedged our foreign currency exposure by purchasing currency forward contracts.
Risk Management
To the extent consistent with maintaining our REIT qualification, we seek to manage risk exposure to protect our investment portfolio against the effects of major interest rate changes. We generally seek to manage this risk by:
•
monitoring and adjusting, if necessary, the reset index and interest rate related to our target assets and our financings;
•
attempting to structure our financing agreements to have a range of different maturities, terms, amortizations and interest rate adjustment periods;
•
using hedging instruments, primarily interest rate swap agreements but also financial futures, options, interest rate cap agreements, floors and forward sales to adjust the interest rate sensitivity of our target assets and our borrowings; and
•
actively managing, on an aggregate basis, the interest rate indices, interest rate adjustment periods, and gross reset margins of our target assets and the interest rate indices and adjustment periods of our financings.

 
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ITEM 4.
CONTROLS AND PROCEDURES.

Our management is responsible for establishing and maintaining disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act) that are designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that the required information is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.
We have evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures as of September 30, 2015. Based upon our evaluation, our principal executive officer and principal financial officer have concluded that, because a material weakness in our internal control over financial reporting existed at December 31, 2014 and had not been remediated by the end of the period covered by this Form 10-Q, our disclosure controls and procedures were not effective as of September 30, 2015. A “material weakness” is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements presented will not be prevented or detected on a timely basis. This material weakness in our internal control over financial reporting and our remediation actions are described below. 
Notwithstanding the existence of the material weakness described below, we have performed additional analyses and other procedures to enable management to conclude that the consolidated financial statements included in this Form 10-Q present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with GAAP.
There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
Changes in Internal Control over Financial Reporting    
Except as noted below, there has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter ended September 30, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Remedial Action
In connection with the preparation of our consolidated financial statements for the fiscal quarter ended June 30, 2015, we determined that we had been improperly accounting for GSE CRTs and Agency MBS IOs as investment securities under ASC 320 - Investments - Debt and Equity Securities instead of accounting for them as hybrid instruments and assessing them for embedded derivative features that may require bifurcation and separate accounting under ASC 815 - Derivatives and Hedging. Our controls over the analysis and review of the appropriate accounting treatment for our mortgage-backed and credit risk transfer securities were not appropriately designed to prevent a material error resulting from the misapplication of GAAP. Our management concluded that this deficiency constitutes a “material weakness” in our internal control over financial reporting. To remediate the material weakness in 2015, we have implemented certain changes in our internal controls. Specifically, we engaged an internationally recognized accounting firm to assist us in reviewing our accounting treatment for mortgage-backed and credit risk transfer securities. In addition, we have formalized our technical accounting review and documentation procedures related to new investments.
We believe the actions described above will be sufficient to remediate the identified material weakness and strengthen our internal control over financial reporting. However, the new and enhanced controls have not operated for a sufficient amount of time to conclude that the material weakness has been remediated. We will continue to monitor the effectiveness of these controls and will make any further changes management determines appropriate. As we continue to evaluate and work to improve our internal control over financial reporting, management may determine to take additional measures to address control deficiencies or determine to modify the remediation plan described above. We cannot assure you, however, when we will remediate such weakness, nor can we be certain of whether additional actions will be required or the costs of any such actions.


 
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PART II – OTHER INFORMATION
 
ITEM 1.
LEGAL PROCEEDINGS.
From time to time, we may be involved in various claims and legal actions arising in the ordinary course of business. As of September 30, 2015, we were not involved in any such legal proceedings.
ITEM 1A.
RISK FACTORS.
There were no material changes during the period covered by this Report to the risk factors previously disclosed in our annual report on Form 10-K/A for the year ended December 31, 2014, as filed with the SEC on August 17, 2015. Additional risks not presently known, or that we currently deem immaterial, also may have a material adverse effect on our business, financial condition and results of operations.
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
The following table shows common share repurchase activity during the quarter ended September 30, 2015:
Month
Total Number of Shares Purchased
 
Average Price Paid Per Share
 
Total Number of Shares
Purchased as Part of
Publicly Announced Plans or Programs(1)
 
Maximum Number of Shares
that May Yet Be Purchased
Under the Plans
or Programs at end of period(1)
July 1 - 31, 2015
—

 
—

 
—

 
14,841,784

August 1 - 31, 2015
1,291,460

 
13.50

 
1,291,460

 
13,550,324

September 1 - 30, 2015
2,403,908

 
13.55

 
2,403,908

 
11,146,416

 
3,695,368

 
13.53

 
3,695,368

 
 

(1)
In December 2013, our board of directors approved a share repurchase program of up to 20,000,000 of our common shares with no expiration date. The shares may be repurchased from time to time through privately negotiated transactions or open market transactions, including pursuant to a trading plan in accordance with Rules 10b5-1 and 10b-18 under Exchange Act or by any combination of such methods. The manner, price, number and timing of share repurchases are subject to a variety of factors, including market conditions and applicable SEC rules.
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4.
MINE SAFETY DISCLOSURES.
Not applicable.
ITEM 5.
OTHER INFORMATION.
None.

ITEM 6.
EXHIBITS.
A list of exhibits to this Form 10-Q is set forth on the Exhibit Index and is incorporated herein by reference.


 
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
INVESCO MORTGAGE CAPITAL INC.
 
 
 
November 3, 2015
By:
/s/ Richard J. King
 
 
Richard J. King
 
 
President and Chief Executive Officer
 
 
 
November 3, 2015
By:
/s/ Richard Lee Phegley, Jr.
 
 
Richard Lee Phegley, Jr.
 
 
Chief Financial Officer


 
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EXHIBIT INDEX
Item 6.        Exhibits
 
Exhibit
No.
  
Description
 
 
3.1

  
Articles of Amendment and Restatement of Invesco Mortgage Capital Inc. (incorporated by reference to Exhibit 3.1 to our Quarterly Report on Form 10-Q, filed with the Securities and Exchange Commission on August 12, 2009).
 
 
3.2

  
Articles Supplementary of 7.75% Series A Cumulative Redeemable Preferred Stock (incorporated by reference to Exhibit 3.3 to the Registrant’s Registration Statement on Form 8-A, filed with the SEC on July 23, 2012).
 
 
3.3

  
Articles Supplementary of 7.75% Fixed-to-Floating Series B Cumulative Redeemable Preferred Stock (incorporated by reference to Exhibit 3.3 to the Registrant’s Registration Statement on Form 8-A, filed with the SEC on September 8, 2014).
 
 
3.4

  
Amended and Restated Bylaws of Invesco Mortgage Capital Inc. (incorporated by reference to Exhibit 3.2 to Amendment No. 8 to our Registration Statement on Form S-11 (No. 333-151665), filed with the Securities and Exchange Commission on June 18, 2009).
 
 
 
31.1

  
Certification of Richard J. King pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2

  
Certification of Richard Lee Phegley, Jr. pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32.1

  
Certification of Richard J. King pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
32.2

  
Certification of Richard Lee Phegley, Jr. pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101

  
The following series of unaudited XBRL-formatted documents are collectively included herewith as Exhibit 101. The financial information is extracted from Invesco Mortgage Capital Inc.’s unaudited condensed consolidated interim financial statements and notes that are included in this Form 10-Q Report.
 
101.INS XBRL Instance Document
 
101.SCH XBRL Taxonomy Extension Schema Document
 
101.CAL XBRL Taxonomy Calculation Linkbase Document
 
101.LAB XBRL Taxonomy Label Linkbase Document
 
101.PRE XBRL Taxonomy Presentation Linkbase Document
 
101.DEF XBRL Taxonomy Definition Linkbase Document


 
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