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Invesco Mortgage Capital Inc. - Quarter Report: 2018 March (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 March 31, 2018
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
ivrmainimageinblacka05.jpg

(Exact Name of Registrant as Specified in Its Charter)
_______________________________________________
Maryland
 
26-2749336
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
1555 Peachtree Street, N.E., Suite 1800
Atlanta, Georgia
 
30309
(Address of Principal Executive Offices)
 
(Zip Code)
(404) 892-0896
(Registrant’s Telephone Number, Including Area Code) 
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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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
 
 
 
 
 
Emerging growth company
 
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 May 1, 2018, there were 111,636,723 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
(Unaudited)
  
As of
 $ in thousands except share amounts
March 31, 2018
 
December 31, 2017
ASSETS
 
Mortgage-backed and credit risk transfer securities, at fair value (including pledged securities of $17,185,870 and $17,560,811, respectively)
17,622,234

 
18,190,754

Commercial loans, held-for-investment
184,255

 
191,808

Cash and cash equivalents
117,124

 
88,381

Restricted cash
2,400

 
620

Due from counterparties
5,375

 

Investment related receivable (including pledged securities of $189,263 and $0, respectively)
256,899

 
73,217

Derivative assets, at fair value
26,385

 
6,896

Other assets
107,372

 
105,580

Total assets
18,322,044

 
18,657,256

LIABILITIES AND EQUITY
 
 
 
Liabilities:
 
 
 
Repurchase agreements
13,911,137

 
14,080,801

Secured loans
1,650,000

 
1,650,000

Exchangeable senior notes, net

 
143,231

Derivative liabilities, at fair value
20,354

 
32,765

Dividends and distributions payable
50,199

 
50,193

Investment related payable
109,080

 
5,191

Accrued interest payable
18,238

 
17,845

Collateral held payable
27,553

 
7,327

Accounts payable and accrued expenses
1,712

 
2,200

Due to affiliate
11,415

 
10,825

Total liabilities
15,799,688

 
16,000,378

Commitments and contingencies (See Note 16):

 

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

 
135,356

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

 
149,860

7.50% Fixed-to-Floating Series C Cumulative Redeemable Preferred Stock: 11,500,000 shares issued and outstanding ($287,500 aggregate liquidation preference)
278,108

 
278,108

Common Stock, par value $0.01 per share; 450,000,000 shares authorized; 111,636,723 and 111,624,159 shares issued and outstanding, respectively
1,116

 
1,116

Additional paid in capital
2,384,626

 
2,384,356

Accumulated other comprehensive income
133,352

 
261,029

Retained earnings (distributions in excess of earnings)
(584,750
)
 
(579,334
)
Total stockholders’ equity
2,497,668

 
2,630,491

Non-controlling interest
24,688

 
26,387

Total equity
2,522,356

 
2,656,878

Total liabilities and equity
18,322,044

 
18,657,256

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 March 31,
$ in thousands, except share amounts
2018
 
2017
Interest Income

 

Mortgage-backed and credit risk transfer securities
149,003

 
118,873

Commercial loans
4,222

 
5,764

Total interest income
153,225

 
124,637

Interest Expense
 
 

Repurchase agreements
59,585

 
29,947

Secured loans
6,927

 
3,413

Exchangeable senior notes
1,621

 
5,008

Total interest expense
68,133

 
38,368

Net interest income
85,092

 
86,269

Other Income (loss)

 

Gain (loss) on investments, net
(160,370
)
 
(1,853
)
Equity in earnings (losses) of unconsolidated ventures
896

 
(1,534
)
Gain (loss) on derivative instruments, net
133,367

 
5,462

Realized and unrealized credit derivative income (loss), net
3,165

 
19,955

Net loss on extinguishment of debt
(26
)
 
(4,711
)
Other investment income (loss), net
3,102

 
1,329

Total other income (loss)
(19,866
)
 
18,648

Expenses
 
 
 
Management fee – related party
10,221

 
8,801

General and administrative
1,756

 
2,084

Total expenses
11,977

 
10,885

Net income
53,249

 
94,032

Net income attributable to non-controlling interest
671

 
1,186

Net income attributable to Invesco Mortgage Capital Inc.
52,578

 
92,846

Dividends to preferred stockholders
11,107

 
5,716

Net income attributable to common stockholders
41,471

 
87,130

Earnings per share:
 
 


Net income attributable to common stockholders
 
 

Basic
0.37

 
0.78

Diluted
0.37

 
0.73

Dividends declared per common share
0.42

 
0.40

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 (LOSS)
(Unaudited)
 
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Net income
53,249

 
94,032

Other comprehensive income (loss):
 
 
 
Unrealized gain (loss) on mortgage-backed and credit risk transfer securities, net
(132,317
)
 
16,289

Reclassification of unrealized (gain) loss on sale of mortgage-backed and credit risk transfer securities to gain (loss) on investments, net
9,237

 
850

Reclassification of amortization of net deferred (gain) loss on de-designated interest rate swaps to repurchase agreements interest expense
(6,539
)
 
(6,298
)
Currency translation adjustments on investment in unconsolidated venture
312

 
(615
)
Total other comprehensive income (loss)
(129,307
)
 
10,226

Comprehensive income (loss)
(76,058
)
 
104,258

Less: Comprehensive (income) loss attributable to non-controlling interest
959

 
(1,315
)
Less: Dividends to preferred stockholders
(11,107
)
 
(5,716
)
Comprehensive income (loss) attributable to common stockholders
(86,206
)
 
97,227


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 three months ended March 31, 2018
(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
 
Series C
Preferred Stock
 
 
 
 
$ in thousands 
except
share amounts
 
 
 
Common Stock
 
Total
Equity
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
Balance at December 31, 2017
5,600,000

 
135,356

 
6,200,000

 
149,860

 
11,500,000

 
278,108

 
111,624,159

 
1,116

 
2,384,356

 
261,029

 
(579,334
)
 
2,630,491

 
26,387

 
2,656,878

Net income

 

 

 

 

 

 

 

 

 

 
52,578

 
52,578

 
671

 
53,249

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 
(127,677
)
 

 
(127,677
)
 
(1,630
)
 
(129,307
)
Stock awards

 

 

 

 

 

 
12,564

 

 

 

 

 

 

 

Common stock dividends

 

 

 

 

 

 

 

 

 

 
(46,887
)
 
(46,887
)
 

 
(46,887
)
Common unit dividends

 

 

 

 

 

 

 

 

 

 

 

 
(599
)
 
(599
)
Preferred stock dividends

 

 

 

 

 

 

 

 

 

 
(11,107
)
 
(11,107
)
 

 
(11,107
)
Amortization of equity-based compensation

 

 

 

 

 

 

 

 
127

 

 

 
127

 
2

 
129

Rebalancing of ownership percentage of non-controlling interest

 

 

 

 

 

 

 

 
143

 

 

 
143

 
(143
)
 

Balance at March 31, 2018
5,600,000

 
135,356

 
6,200,000

 
149,860

 
11,500,000

 
278,108

 
111,636,723

 
1,116

 
2,384,626

 
133,352

 
(584,750
)
 
2,497,668

 
24,688

 
2,522,356

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)
  
Three Months Ended March 31,
$ in thousands
2018
 
2017
Cash Flows from Operating Activities
 
 
 
Net income
53,249

 
94,032

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Amortization of mortgage-backed and credit risk transfer securities premiums and (discounts), net
12,663

 
18,888

Realized and unrealized (gain) loss on derivative instruments, net
(145,479
)
 
(28,356
)
Realized and unrealized (gain) loss on credit derivatives, net
2,468

 
(14,148
)
(Gain) loss on investments, net
160,370

 
1,853

(Income) loss from investments in unconsolidated ventures in excess of distributions received
(352
)
 
1,760

Other amortization
(6,265
)
 
(5,736
)
Net loss on extinguishment of debt
26

 
4,711

(Gain) loss on foreign currency transactions, net
(1,800
)
 
(513
)
Changes in operating assets and liabilities:
 
 
 
(Increase) decrease in operating assets
1,334

 
(2,618
)
Increase (decrease) in operating liabilities
562

 
(7,103
)
Net cash provided by operating activities
76,776

 
62,770

Cash Flows from Investing Activities
 
 
 
Purchase of mortgage-backed and credit risk transfer securities
(298,859
)
 
(1,846,444
)
(Contributions to) distributions from investments in unconsolidated ventures, net
(1,532
)
 
(2,636
)
Purchase of exchange-traded fund

 
(3,508
)
Principal payments from mortgage-backed and credit risk transfer securities
488,123

 
562,190

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

 
180,809

Proceeds from/ (payments for) settlement or termination of forwards, swaps and futures, net
113,578

 
14,918

Net change in due from counterparties and collateral held payable
14,853

 
2,032

Principal payments from commercial loans held-for-investment
10,042

 

Origination and advances of commercial loans, net of origination fees
(698
)
 
(2,014
)
Net cash provided by (used in) investing activities
325,507

 
(1,094,653
)
Cash Flows from Financing Activities
 
 
 
Proceeds from repurchase agreements
35,711,164

 
30,147,699

Principal repayments of repurchase agreements
(35,880,828
)
 
(29,017,053
)
Extinguishment of exchangeable senior notes
(143,433
)
 
(153,750
)
Payments of deferred costs
(76
)
 

Payments of dividends and distributions
(58,587
)
 
(50,924
)
Net cash (used in) provided by financing activities
(371,760
)
 
925,972

Net change in cash, cash equivalents and restricted cash
30,523

 
(105,911
)
Cash, cash equivalents and restricted cash, beginning of period
89,001

 
161,788

Cash, cash equivalents and restricted cash, end of period
119,524

 
55,877

Supplement Disclosure of Cash Flow Information
 
 
 
Interest paid
73,811

 
51,058

Non-cash Investing and Financing Activities Information
 
 
 
Net change in unrealized gain (loss) on mortgage-backed and credit risk transfer securities
(123,080
)
 
(17,139
)
Dividends and distributions declared not paid
50,199

 
50,928

Net change in investment related payable (receivable)
80,688

 
174,217

Net change in repurchase agreements, not settled

 
(1,416
)
Change in due from counterparties and collateral held payable

 
86,450

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", "we") is a Maryland corporation primarily focused on investing in, financing and managing residential and commercial mortgage-backed securities and mortgage loans. We are externally managed and advised by Invesco Advisers, Inc. (our "Manager"), a registered investment adviser and an indirect, wholly-owned subsidiary of Invesco Ltd. ("Invesco"), a leading independent global investment management firm. We conduct our business through IAS Operating Partnership LP (the "Operating Partnership"), as its sole general partner. As of March 31, 2018, we owned 98.7% of the Operating Partnership, and a wholly-owned subsidiary of Invesco owned the remaining 1.3%. We have one operating segment.
We primarily invest in:
Residential mortgage-backed securities ("RMBS") that are guaranteed by a U.S. government agency such as the Government National Mortgage Association, or a federally chartered corporation such as the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation (collectively "Agency RMBS");
Commercial mortgage-backed securities ("CMBS");
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");
Residential and commercial mortgage loans; and
Other real estate-related financing agreements.
We elected to be taxed as a real estate investment trust ("REIT") for U.S. federal income tax purposes under the provisions of the Internal Revenue Code of 1986 commencing with our taxable year ended December 31, 2009. To maintain our REIT qualification, we are generally required to distribute at least 90% of our REIT taxable income to our stockholders annually. We operate our business in a manner that permits exclusion from the "Investment Company" definition under the Investment Company Act of 1940.
Note 2 – Summary of Significant Accounting Policies
Basis of Presentation and Consolidation
Certain disclosures included in our Annual Report on Form 10-K are not required to be included on an interim basis in our quarterly reports on Form 10-Q. We have condensed or omitted these disclosures. Therefore, this Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2017.
The condensed consolidated financial statements have been prepared in accordance with U.S. GAAP and consolidate the financial statements of the Company and our controlled subsidiaries. All significant intercompany transactions, balances, revenues and expenses are eliminated upon consolidation. In the opinion of management, the condensed consolidated financial statements reflect all adjustments, consisting of normal recurring accruals, which are necessary for a fair statement of our financial condition and results of operations for the periods presented.
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.

 
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Table of Contents


Significant Accounting Policies
There have been no changes to our accounting policies included in Note 2 to the consolidated financial statements of our Annual Report on Form 10-K for the year ended December 31, 2017, other than the significant accounting policy disclosed below.
Restricted Cash
Restricted cash represents cash posted with the Federal Home Loan Bank of Indianapolis ("FHLBI") as collateral for secured loans and cash posted with counterparties as collateral for various derivative instruments.  Cash held by counterparties as collateral is legally restricted and is not available for general corporate purposes.
Accounting Pronouncements Recently Adopted

Effective January 1, 2018, we adopted the accounting guidance that amends certain aspects of recognition, measurement, presentation, and disclosure of financial assets and liabilities. The standard requires that all equity investments, other than those accounted for as equity method investments, be measured at fair value with changes recognized in income. As of January 1, 2018, we had three types of equity investments: investments in unconsolidated ventures, an investment in an exchange traded fund, and an investment in FHLBI stock. Our investments in unconsolidated ventures are accounted for as equity method investments, and our investment in an exchange-traded fund is measured at fair value with changes recognized in income. While the standard eliminates the cost method for equity investments without readily determinable fair values, it does allow an election to record equity investments without readily determinable fair values at cost, less impairment, and plus or minus adjustments for observable price changes. We have elected to record our investment in FHLBI stock at cost, less impairment. As such, the adoption of this accounting guidance did not impact our financial condition or results of operations. The standard also amends certain disclosure requirements for financial instruments. Refer to Note 4 - "Mortgage-Backed and Credit Risk Transfer Securities" for a tabular summary of the fair value of our available-for-sale securities and securities accounted for under the fair value option by asset type.
Effective January 1, 2018, we adopted the accounting guidance that is intended to reduce diversity in how restricted cash and certain transactions are classified in the statement of cash flows. The new guidance requires that the statement of cash flows explain the difference during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents. We adopted the accounting standard on a retrospective basis, which required us to restate our statement of cash flows for the three months ended March 31, 2017. The adoption resulted in an $8.1 million decrease in net cash provided by operating activities, $10.1 million decrease in net cash used in investing activities and $2.0 million decrease in net cash provided by financing activities. We included restricted cash of $2.4 million and $620,000 as of March 31, 2018 and December 31, 2017, respectively, in our reconciliation of cash, cash equivalents and restricted cash on the condensed consolidated statements of cash flows.
Note 3 - Variable Interest Entities ("VIEs")
Our maximum risk of loss in VIEs in which we are not the primary beneficiary at March 31, 2018 is presented in the table below.
$ in thousands
Carrying Amount
 
Company's Maximum Risk of Loss
CMBS
3,189,281

 
3,189,281

Non-Agency RMBS
1,194,952

 
1,194,952

Investments in unconsolidated ventures
28,168

 
28,168

Total
4,412,401

 
4,412,401

Refer to Note 4 - "Mortgage-Backed and Credit Risk Transfer Securities" and Note 6 - "Other Assets" for additional details regarding these investments.

 
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Table of Contents


Note 4 – Mortgage-Backed and Credit Risk Transfer Securities
The following tables summarize our mortgage-backed securities ("MBS") and GSE CRT portfolio by asset type as of March 31, 2018 and December 31, 2017.
March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
$ in thousands
Principal/ Notional
Balance
 
Unamortized
Premium
(Discount)
 
Amortized
Cost
 
Unrealized
Gain/
(Loss), net
 
Fair
Value
 
Period-
end
Weighted
Average
Yield (1)
 
Quarterly
Weighted
Average
Yield (2)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
2,603,748

 
102,652

 
2,706,400

 
(96,848
)
 
2,609,552

 
2.22
%
 
2.04
%
30 year fixed-rate
7,546,645

 
290,890

 
7,837,535

 
(175,497
)
 
7,662,038

 
3.14
%
 
2.96
%
ARM*
227,154

 
1,419

 
228,573

 
(907
)
 
227,666

 
2.59
%
 
2.32
%
Hybrid ARM
1,617,558

 
24,314

 
1,641,872

 
(18,334
)
 
1,623,538

 
2.54
%
 
2.24
%
Total Agency pass-through
11,995,105

 
419,275

 
12,414,380

 
(291,586
)
 
12,122,794

 
2.85
%
 
2.65
%
Agency-CMO (3)
1,146,728

 
(880,126
)
 
266,602

 
(12,648
)
 
253,954

 
2.97
%
 
2.51
%
CMBS (4)
3,899,661

 
(703,191
)
 
3,196,470

 
(7,189
)
 
3,189,281

 
4.92
%
 
4.85
%
Non-Agency RMBS (5)(6)(7)
2,672,496

 
(1,606,280
)
 
1,066,216

 
128,736

 
1,194,952

 
7.19
%
 
7.08
%
GSE CRT (8)
750,873

 
23,609

 
774,482

 
86,771

 
861,253

 
2.61
%
 
3.00
%
Total
20,464,863

 
(2,746,713
)
 
17,718,150

 
(95,916
)
 
17,622,234

 
3.48
%
 
3.32
%
* Adjustable-rate mortgage ("ARM")
 
(1)
Period-end weighted average yield is based on amortized cost as of March 31, 2018 and incorporates future prepayment and loss assumptions.
(2)
Quarterly weighted average yield for the period was calculated by dividing interest income, including amortization of premiums and discounts, by the average balance of the amortized cost of the investments. All yields are annualized.
(3)
Agency collateralized mortgage obligation ("Agency-CMO") includes interest-only securities ("Agency IO"), which represent 81.4% of principal/notional balance, 19.4% of amortized cost and 17.6% of fair value.
(4)
CMBS includes interest-only securities which represent 15.6% of principal/notional balance, 0.5% of amortized cost and 0.6% of fair value.
(5)
Non-Agency RMBS held by us is 51.8% variable rate, 38.0% fixed rate and 10.1% floating rate based on fair value.
(6)
Of the total discount in non-Agency RMBS, $191.1 million is non-accretable calculated using the principal/notional balance and based on estimated future cash flows of the securities.
(7)
Non-Agency RMBS includes interest-only securities ("Non-Agency IO") which represent 51.9% of principal/notional balance, 2.0% of amortized cost and 1.8% of fair value.
(8)
GSE CRT weighted average yield excludes coupon interest associated with embedded derivatives not accounted for under the fair value option that is recorded as realized and unrealized credit derivative income (loss), net.


 
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December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
$ in thousands
Principal/Notional
Balance
 
Unamortized
Premium
(Discount)
 
Amortized
Cost
 
Unrealized
Gain/
(Loss), net
 
Fair
Value
 
Period-
end
Weighted
Average
Yield (1)
 
Quarterly
Weighted
Average
Yield (2)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
2,917,307

 
119,120

 
3,036,427

 
(61,645
)
 
2,974,782

 
2.17
%
 
1.98
%
30 year fixed-rate
7,354,211

 
295,977

 
7,650,188

 
(9,648
)
 
7,640,540

 
3.09
%
 
2.90
%
ARM
238,486

 
1,609

 
240,095

 
1,105

 
241,200

 
2.60
%
 
2.36
%
Hybrid ARM
1,696,148

 
26,066

 
1,722,214

 
(2,829
)
 
1,719,385

 
2.54
%
 
2.25
%
Total Agency pass-through
12,206,152

 
442,772

 
12,648,924

 
(73,017
)
 
12,575,907

 
2.79
%
 
2.58
%
Agency-CMO (3)
1,226,539

 
(942,290
)
 
284,249

 
(10,306
)
 
273,943

 
2.91
%
 
2.74
%
CMBS (4)
3,879,775

 
(704,097
)
 
3,175,678

 
40,739

 
3,216,417

 
4.92
%
 
4.77
%
Non-Agency RMBS (5)(6)(7)
2,785,704

 
(1,661,683
)
 
1,124,021

 
133,587

 
1,257,608

 
7.19
%
 
7.18
%
GSE CRT (8)
757,183

 
24,306

 
781,489

 
85,390

 
866,879

 
2.45
%
 
2.79
%
Total
20,855,353

 
(2,840,992
)
 
18,014,361

 
176,393

 
18,190,754

 
3.42
%
 
3.27
%
 
(1)
Period-end weighted average yield is based on amortized cost as of December 31, 2017 and incorporates future prepayment and loss assumptions.
(2)
Quarterly weighted average yield for the period was calculated by dividing interest income, including amortization of premiums and discounts, by the average balance of the amortized cost of the investments. All yields are annualized.
(3)
Agency collateralized mortgage obligation ("Agency-CMO") includes interest-only securities ("Agency IO"), which represent 81.8% of principal (notional) balance, 20.9% of amortized cost and 18.7% of fair value.
(4)
CMBS includes interest-only securities which represent 15.8% of principal/notional balance, 0.5% of amortized cost and 0.6% of fair value.
(5)
Non-Agency RMBS held by us is 52.2% variable rate, 37.8% fixed rate, and 10.0% floating rate based on fair value.
(6)
Of the total discount in non-Agency RMBS, $195.3 million is non-accretable calculated using the principal/notional balance and based on estimated future cash flows of the securities.
(7)
Non-Agency RMBS includes interest-only securities, which represent 51.5% of principal/notional balance, 2.0% of amortized cost and 1.8% of fair value.
(8)
GSE CRT weighted average yield excludes coupon interest associated with embedded derivatives not accounted for under the fair value option that is recorded as realized and unrealized credit derivative income (loss), net.
The following table presents the fair value of our available-for-sale securities and securities accounted for under the fair value option by asset type as of March 31, 2018 and December 31, 2017. We have elected the fair value option for all of our RMBS IOs, our MBS purchased on or after September 1, 2016 and our GSE CRTs purchased on or after August 24, 2015. As of March 31, 2018, $6.6 billion (December 31, 2017: $6.5 billion) or 37.6% (December 31, 2017: 35.6%) of our MBS and GSE CRT are accounted for under the fair value option.
 
March 31, 2018
 
December 31, 2017
$ in thousands
Available-for-sale Securities
 
Securities under Fair Value Option
 
Total
Fair Value
 
Available-for-sale Securities
 
Securities under Fair Value Option
 
Total
Fair Value
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
2,484,470

 
125,082

 
2,609,552

 
2,842,440

 
132,342

 
2,974,782

30 year fixed-rate
2,333,288

 
5,328,750

 
7,662,038

 
2,467,871

 
5,172,669

 
7,640,540

ARM*
227,666

 

 
227,666

 
241,200

 

 
241,200

Hybrid ARM
1,623,538

 

 
1,623,538

 
1,719,385

 

 
1,719,385

Total Agency pass-through
6,668,962

 
5,453,832

 
12,122,794

 
7,270,896

 
5,305,011

 
12,575,907

Agency-CMO
190,930

 
63,024

 
253,954

 
203,351

 
70,592

 
273,943

CMBS
2,339,249

 
850,032

 
3,189,281

 
2,376,413

 
840,004

 
3,216,417

Non-Agency RMBS
1,174,590

 
20,362

 
1,194,952

 
1,236,178

 
21,430

 
1,257,608

GSE CRT
629,952

 
231,301

 
861,253

 
635,537

 
231,342

 
866,879

Total
11,003,683

 
6,618,551

 
17,622,234

 
11,722,375

 
6,468,379

 
18,190,754


 
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The components of the carrying value of our MBS and GSE CRT portfolio at March 31, 2018 and December 31, 2017 are presented below. 
 
March 31, 2018
$ in thousands
MBS and GSE CRT Securities
 
Interest-Only Securities
 
Total
Principal/ notional balance
17,696,263

 
2,768,600

 
20,464,863

Unamortized premium
494,730

 

 
494,730

Unamortized discount
(559,366
)
 
(2,682,077
)
 
(3,241,443
)
Gross unrealized gains (1)
277,526

 
4,716

 
282,242

Gross unrealized losses (1)
(368,916
)
 
(9,242
)
 
(378,158
)
Fair value
17,540,237

 
81,997

 
17,622,234

 
December 31, 2017
$ in thousands
MBS and GSE CRT Securities
 
Interest-Only Securities
 
Total
Principal/ notional balance
17,974,390

 
2,880,963

 
20,855,353

Unamortized premium
521,626

 

 
521,626

Unamortized discount
(577,344
)
 
(2,785,274
)
 
(3,362,618
)
Gross unrealized gains (1)
336,543

 
5,113

 
341,656

Gross unrealized losses (1)
(155,146
)
 
(10,117
)
 
(165,263
)
Fair value
18,100,069

 
90,685

 
18,190,754

(1)
Gross unrealized gains and losses includes gains (losses) recognized in net income for securities accounted for as derivatives or under the fair value option as well as gains (losses) for available-for-sale securities which are recognized as adjustments to other comprehensive income. Realization occurs upon sale or settlement of such securities. Further detail on the components of our total gains (losses) on investments, net for the three months ended March 31, 2018 and 2017 is provided later in this Note 4.
The following table summarizes our MBS and GSE CRT portfolio according to estimated weighted average life classifications as of March 31, 2018 and December 31, 2017
$ in thousands
March 31, 2018
 
December 31, 2017
Less than one year
106,835

 
135,559

Greater than one year and less than five years
7,156,838

 
7,934,836

Greater than or equal to five years
10,358,561

 
10,120,359

Total
17,622,234

 
18,190,754



 
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The following tables present the estimated fair value and gross unrealized losses of our MBS and GSE CRTs by length of time that such securities have been in a continuous unrealized loss position at March 31, 2018 and December 31, 2017.
March 31, 2018
  
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
300,750

 
(3,026
)
 
71

 
2,072,058

 
(96,994
)
 
129

 
2,372,808

 
(100,020
)
 
200

30 year fixed-rate
5,816,164

 
(149,050
)
 
185

 
913,526

 
(45,945
)
 
56

 
6,729,690

 
(194,995
)
 
241

ARM
129,244

 
(1,776
)
 
14

 
754

 
(32
)
 
1

 
129,998

 
(1,808
)
 
15

Hybrid ARM
701,155

 
(10,134
)
 
84

 
480,849

 
(12,250
)
 
46

 
1,182,004

 
(22,384
)
 
130

Total Agency pass-through (1)
6,947,313

 
(163,986
)
 
354

 
3,467,187

 
(155,221
)
 
232

 
10,414,500

 
(319,207
)
 
586

Agency-CMO (2)
157,601

 
(11,414
)
 
46

 
76,278

 
(3,303
)
 
5

 
233,879

 
(14,717
)
 
51

CMBS (3)
1,617,640

 
(33,804
)
 
125

 
171,683

 
(7,753
)
 
16

 
1,789,323

 
(41,557
)
 
141

Non-Agency RMBS (4)
138,721

 
(1,284
)
 
28

 
85,870

 
(1,393
)
 
10

 
224,591

 
(2,677
)
 
38

Total
8,861,275

 
(210,488
)
 
553

 
3,801,018

 
(167,670
)
 
263

 
12,662,293

 
(378,158
)
 
816

(1)
Amounts disclosed includes Agency RMBS with a fair value of $5.3 billion for which the fair value option has been elected. Such securities have unrealized losses of $146.2 million.
(2)
Amounts disclosed includes Agency IO and Agency-CMO with fair value of $26.3 million and $18.4 million, respectively, for which the fair value option has been elected. These Agency IO and Agency-CMO securities have unrealized losses of $9.0 million and $694,000, respectively.
(3)
Amounts disclosed includes CMBS with a fair value of $769.0 million for which the fair value option has been elected. Such securities have unrealized losses of $22.4 million.
(4)
Amounts disclosed includes Non-Agency IO with a fair value of $12.5 million for which the fair value option has been elected. Such securities have unrealized losses of $204,000.


 
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December 31, 2017
  
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
111,020

 
(321
)
 
26

 
2,406,021

 
(67,285
)
 
133

 
2,517,041

 
(67,606
)
 
159

30 year fixed-rate
3,677,576

 
(20,730
)
 
107

 
963,547

 
(27,158
)
 
56

 
4,641,123

 
(47,888
)
 
163

ARM
101,173

 
(902
)
 
12

 

 

 

 
101,173

 
(902
)
 
12

Hybrid ARM
614,321

 
(4,189
)
 
73

 
517,642

 
(8,091
)
 
47

 
1,131,963

 
(12,280
)
 
120

Total Agency pass-through (1)
4,504,090

 
(26,142
)
 
218

 
3,887,210

 
(102,534
)
 
236

 
8,391,300

 
(128,676
)
 
454

Agency-CMO (2)
75,299

 
(10,433
)
 
44

 
81,988

 
(2,309
)
 
5

 
157,287

 
(12,742
)
 
49

CMBS (3)
892,553

 
(17,612
)
 
81

 
135,139

 
(3,792
)
 
12

 
1,027,692

 
(21,404
)
 
93

Non-Agency RMBS (4)
84,439

 
(709
)
 
15

 
96,263

 
(1,732
)
 
11

 
180,702

 
(2,441
)
 
26

Total
5,556,381

 
(54,896
)
 
358

 
4,200,600

 
(110,367
)
 
264

 
9,756,981

 
(165,263
)
 
622

(1)
Amounts disclosed includes Agency RMBS with a fair value of $3.4 billion for which the fair value option has been elected. Such securities have unrealized losses of 22.8 million.
(2)
Amounts disclosed includes Agency IO and Agency-CMO with fair value of $36.5 million and $9.5 million, respectively, for which the fair value option has been elected. These Agency IO and Agency-CMO securities have unrealized losses of $10.1 million and $88,000, respectively.
(3)
Amounts disclosed includes CMBS with a fair value of $596.0 million for which the fair value option has been elected. Such securities have unrealized losses of $8.9 million.
(4)
Amounts disclosed includes Non-Agency IO with a fair value of $530,000 for which the fair value option has been elected. Such securities have unrealized losses of $39,000.
Gross unrealized losses on our Agency RMBS and CMO were $319.2 million (December 31, 2017: $128.7 million) and $5.7 million (December 31, 2017: $2.7 million), respectively, at March 31, 2018. Due to the inherent credit quality of Agency RMBS and CMO, we determined that at March 31, 2018 and December 31, 2017, any unrealized losses on our Agency RMBS and CMO portfolio are not other than temporary.
Gross unrealized losses on our Agency IO, non-Agency RMBS, GSE CRT and CMBS were $53.3 million (December 31, 2017: $33.9 million) at March 31, 2018. We did not consider these unrealized losses to be credit related, but rather due to non-credit related factors such as interest rate spreads, prepayment speeds, and market fluctuations. These investment securities are included in our assessment for other-than-temporary impairment on a quarterly basis.
We assess our investment securities for other-than-temporary impairment ("OTTI") on a quarterly basis. When the fair value of an investment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated as either "temporary" or "other-than-temporary." This analysis includes a determination of estimated future cash flows through an evaluation of the characteristics of the underlying loans and the structural features of the investment. Underlying loan characteristics reviewed include, but are not limited to, delinquency status, loan-to-value ratios, borrower credit scores, occupancy status and geographic concentration.
The following table represents OTTI included in earnings for the three months ended March 31, 2018 and 2017:
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
RMBS interest-only securities
4,309

 
291

Non-Agency RMBS (1)
50

 
241

Total
4,359

 
532

(1)
Amounts disclosed relate to credit losses on debt securities for which a portion of an other-than-temporary impairment was recognized in other comprehensive income.
OTTI on RMBS interest-only securities was recorded as a reclassification from an unrealized to realized loss within gain (loss) on investments, net on the condensed consolidated statements of operations because we account for these securities under

 
12
 


Table of Contents


the fair value option. As of March 31, 2018, we did not intend to sell the securities and determined that it was not more likely than not that we will be required to sell the securities.
The following table summarizes the components of our total gain (loss) on investments, net for the three months ended March 31, 2018 and 2017.
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Gross realized gains on sale of investments

 
904

Gross realized losses on sale of investments
(9,237
)
 
(1,911
)
Other-than-temporary impairment losses
(4,359
)
 
(532
)
Net unrealized gains and losses on MBS accounted for under the fair value option
(147,195
)
 
(3,602
)
Net unrealized gains and losses on GSE CRT accounted for under the fair value option
434

 
3,279

Net unrealized gains and losses on trading securities
(13
)
 
9

Total gain (loss) on investments, net
(160,370
)
 
(1,853
)
The following tables present components of interest income recognized on our MBS and GSE CRT portfolio for the three months ended March 31, 2018 and 2017. GSE CRT interest income excludes coupon interest associated with embedded derivatives not accounted for under the fair value option that is recorded as realized and unrealized credit derivative income (loss), net.
For the three months ended March 31, 2018
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
108,317

 
(23,222
)
 
85,095

CMBS
37,293

 
1,426

 
38,719

Non-Agency
14,012

 
5,177

 
19,189

GSE CRT
6,525

 
(697
)
 
5,828

Other
172

 

 
172

Total
166,319

 
(17,316
)
 
149,003

For the three months ended March 31, 2017
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
91,231

 
(28,578
)
 
62,653

CMBS
29,676

 
(2,634
)
 
27,042

Non-Agency
20,614

 
4,387

 
25,001

GSE CRT
4,487

 
(371
)
 
4,116

Other
61

 

 
61

Total
146,069

 
(27,196
)
 
118,873



 
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Table of Contents


Note 5 – Commercial Loans Held-for-Investment
The following table summarizes purchased or originated commercial mezzanine loans held-for-investment as of March 31, 2018 and December 31, 2017.
$ in thousands
Number of
loans
 
Principal
Balance
 
Unamortized (fees)/
costs, net
 
Carrying
value
 
Weighted Average Coupon
 
Weighted Average Years to Maturity (1)
March 31, 2018
7

 
184,311

 
(56
)
 
184,255

 
8.72
%
 
1.1
December 31, 2017
8

 
191,894

 
(86
)
 
191,808

 
8.52
%
 
1.2
(1)
Weighted average years to maturity is based on the contractual maturity date. Certain loans may contain either an option to prepay or an option to extend beyond their contractual maturity dates as specified in the respective loan agreements.
These loans were not impaired, and no allowance for loan loss has been recorded as of March 31, 2018 and December 31, 2017 based on our analysis of credit quality factors as described in Note 2 - "Summary of Significant Accounting Policies" included in the consolidated financial statements of our Annual Report on Form 10-K for the year ended December 31, 2017.
Note 6 – Other Assets
The following table summarizes our other assets as of March 31, 2018 and December 31, 2017.
$ in thousands
March 31, 2018
 
December 31, 2017
FHLBI stock
74,250

 
74,250

Investments in unconsolidated ventures
28,168

 
25,972

Investment in exchange-traded fund
3,966

 
3,979

Prepaid expenses and other assets
988

 
1,379

Total
107,372

 
105,580

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

 
14
 


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Note 7 – Borrowings
We finance the majority of our investment portfolio through repurchase agreements, secured loans and exchangeable senior notes. The following tables summarize certain characteristics of our borrowings at March 31, 2018 and December 31, 2017. Refer to Note 8 - "Collateral Positions" for collateral pledged under our repurchase agreements and secured loans.
$ in thousands
March 31, 2018
 
 
 
 
Weighted
 
 
Weighted
 
Average
 
 
Average
 
Remaining
Amount
 
Interest
 
Maturity
Outstanding
 
Rate
 
(days)
Repurchase Agreements:
 
 
 
 
 
Agency RMBS
10,864,430

 
1.88
%
 
26

CMBS
1,482,869

 
2.97
%
 
13

Non-Agency RMBS
882,571

 
3.09
%
 
24

GSE CRT
681,267

 
3.02
%
 
26

Total Repurchase Agreements
13,911,137

 
2.13
%
 
25

Secured Loans
1,650,000

 
1.88
%
 
2,227

Total Borrowings
15,561,137

 
2.10
%
 
259

$ in thousands
December 31, 2017
 
 
 
 
Weighted
 
 
Weighted
 
Average
 
 
Average
 
Remaining
Amount
 
Interest
 
Maturity
Outstanding
 
Rate
 
(days)
Repurchase Agreements:
 
 
 
 
 
Agency RMBS
11,111,755

 
1.58
%
 
25

CMBS
1,396,330

 
2.61
%
 
9

Non-Agency RMBS
915,225

 
2.77
%
 
31

GSE CRT
657,491

 
2.78
%
 
24

Total Repurchase Agreements
14,080,801

 
1.82
%
 
25

Secured Loans
1,650,000

 
1.52
%
 
2,317

Exchangeable Senior Notes (1)
143,410

 
5.00
%
 
74

Total Borrowings
15,874,211

 
1.82
%
 
263

(1)
The carrying value of exchangeable senior notes was $143.2 million as of December 31, 2017. The carrying value was net of unamortized debt issuance costs of $179,000 as of December 31, 2017.
The following table shows the aggregate amount of maturities of our outstanding borrowings:
$ in thousands
As of
Borrowings maturing within:
March 31, 2018
4/1/2018 - 3/31/2019
13,911,137

4/1/2019 - 3/31/2020
300,000

4/1/2020 - 3/31/2021
100,000

4/1/2021 - 3/31/2022

4/1/2022 - 3/31/2023

Thereafter
1,250,000

Total
15,561,137


 
15
 


Table of Contents


The following tables summarize certain characteristics of our repurchase agreements and secured loans at March 31, 2018 and December 31, 2017.
March 31, 2018
 
 
 
 
 
$ in thousands
Amount Outstanding
 
Percent of Total Amount Outstanding
 
MBS and GSE CRT Pledged as Collateral (1)
Repurchase Agreement Counterparties:
 
 
 
 
 
HSBC
1,948,586

 
12.5
%
 
2,057,152

ING Financial Markets
1,411,676

 
9.1
%
 
1,489,621

RBC
1,098,363

 
7.1
%
 
1,329,727

E D & F Man Capital Markets
1,033,231

 
6.6
%
 
1,094,262

Industrial and Commercial Bank of China
987,568

 
6.3
%
 
1,042,653

Mirae Asset Securities
914,219

 
5.9
%
 
968,612

MUFG Securities
855,183

 
5.5
%
 
934,365

Citigroup
772,117

 
5.0
%
 
903,677

Amherst Pierpont Securities
571,116

 
3.7
%
 
612,022

JP Morgan
435,886

 
2.8
%
 
512,237

KGS-Alpha Capital Markets
435,707

 
2.8
%
 
467,214

South Street Securities
413,073

 
2.7
%
 
441,763

Societe Generale
379,575

 
2.4
%
 
482,370

BNP Paribas Securities
328,194

 
2.1
%
 
363,539

Goldman Sachs
311,477

 
2.0
%
 
405,701

Mizuho Securities
293,858

 
1.9
%
 
312,521

Guggenheim Liquidity Services
285,860

 
1.8
%
 
302,122

Natixis Securities
277,765

 
1.8
%
 
310,830

Bank of Nova Scotia
275,727

 
1.8
%
 
287,766

All other counterparties (2)
881,956

 
5.6
%
 
1,050,432

Total Repurchase Agreement Counterparties
13,911,137

 
89.4
%
 
15,368,586

Secured Loans Counterparty:
 
 
 
 
 
FHLBI
1,650,000

 
10.6
%
 
1,916,895

Total
15,561,137

 
100.0
%
 
17,285,481

(1)
Amount pledged as collateral is measured at fair value as described in Note 2 - "Summary of Significant Accounting Policies" included in the consolidated financial statements of our Annual Report on Form 10-K for the year ended December 31, 2017.
(2)
Represents amounts outstanding with seven counterparties.


 
16
 


Table of Contents


December 31, 2017
 
 
 
 
 
$ in thousands
Amount Outstanding
 
Percent of Total Amount Outstanding
 
MBS and GSE CRT Pledged as Collateral (1)
Repurchase Agreement Counterparties:
 
 
 
 
 
HSBC
1,745,684

 
11.2
%
 
1,839,411

ING Financial Markets
1,482,603

 
9.4
%
 
1,571,061

RBC
1,144,856

 
7.3
%
 
1,375,285

Industrial and Commercial Bank of China
1,038,844

 
6.6
%
 
1,102,543

E D & F Man Capital Markets
1,028,437

 
6.5
%
 
1,085,429

Mirae Asset Securities
958,756

 
6.1
%
 
1,018,664

MUFG Securities
865,201

 
5.5
%
 
936,071

Citigroup
724,094

 
4.6
%
 
841,977

Amherst Pierpont Securities
722,080

 
4.6
%
 
764,713

KGS-Alpha Capital Markets
461,098

 
2.9
%
 
491,313

JP Morgan
451,941

 
2.9
%
 
523,590

Societe Generale
386,737

 
2.5
%
 
495,093

BNP Paribas Securities
348,340

 
2.2
%
 
388,091

South Street Securities
332,623

 
2.1
%
 
354,689

Goldman Sachs
324,152

 
2.1
%
 
419,713

Mizuho Securities
310,835

 
2.0
%
 
330,555

Guggenheim Liquidity Services
306,081

 
1.9
%
 
322,452

Bank of Nova Scotia
289,705

 
1.8
%
 
301,715

Natixis Securities
275,764

 
1.8
%
 
302,291

All other counterparties (2)
882,970

 
5.5
%
 
1,058,759

Total Repurchase Agreement Counterparties
14,080,801

 
89.5
%
 
15,523,415

Secured Loans Counterparty:
 
 
 
 
 
FHLBI
1,650,000

 
10.5
%
 
1,927,496

Total
15,730,801

 
100.0
%
 
17,450,911


(1)
Amount pledged as collateral is measured at fair value as described in Note 2 - "Summary of Significant Accounting Policies" included in the consolidated financial statements of our Annual Report on Form 10-K for the year ended December 31, 2017.
(2)
Represents amounts outstanding with seven counterparties.
Repurchase Agreements
Repurchase agreements bear interest at a contractually agreed upon rate and have maturities ranging from one month to twelve months. Repurchase agreements are accounted for as secured borrowings since we maintain effective control of the financed assets. Repurchase agreements are subject to certain financial covenants. We were in compliance with these covenants at March 31, 2018.
Our repurchase agreement collateral ratio (MBS and GSE CRTs pledged as collateral/Amount Outstanding) was 110% as of March 31, 2018 (December 31, 2017: 110%).
Secured Loans
Our wholly-owned captive insurance subsidiary, IAS Services LLC, is a member of the FHLBI. As a member of the FHLBI, IAS Services LLC has borrowed funds from the FHLBI in the form of secured loans.
As of March 31, 2018, IAS Services LLC had $1.65 billion in outstanding secured loans from the FHLBI. These secured loans have floating rates that are based on the three-month FHLB swap rate plus a spread. For the three months ended March 31, 2018, IAS Services LLC had weighted average borrowings of $1.65 billion with a weighted average borrowing rate of 1.68% and a weighted average maturity of 6.1 years.

 
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The Federal Housing Finance Agency’s ("FHFA") final rule governing Federal Home Loan Bank membership (the "FHFA Rule") was effective on February 19, 2016. The FHFA Rule permits existing captive insurance companies, such as IAS Services LLC, to remain members until February 2021. New advances or renewals that mature after February 2021 are prohibited. The FHLBI has indicated it will honor the contractual maturity dates of existing advances to IAS Services LLC that were made prior to February 19, 2016 and extend beyond February 2021. We do not expect there to be any impact to our existing FHLBI borrowings under the FHFA rule. The ability to borrow from the FHLBI is subject to our continued creditworthiness, pledging of sufficient eligible collateral to secure advances, and compliance with certain agreements with FHLBI and FHFA rules.
As discussed in Note 6 - "Other Assets," IAS Services LLC is required to purchase and hold a certain amount of FHLBI stock, which is based, in part, upon the outstanding principal balance of secured loans from the FHLBI.
Exchangeable Senior Notes
In 2013, our wholly-owned subsidiary, IAS Operating Partnership LP, issued $400.0 million in aggregate principal amount of Exchangeable Senior Notes (the "Notes") due March 15, 2018. We retired a portion of the Notes prior to their maturity and fully retired the Notes upon their maturity on March 15, 2018.
The Notes were reported on our condensed consolidated balance sheets net of unamortized debt issuance costs. Debt issuance costs were amortized as an adjustment to interest expense using the effective interest method over the stated legal maturity of the Notes.
The following table summarizes retirements of the Notes during the three months ended March 31, 2018 and 2017.
$ in thousands
Three Months Ended March 31,
 
2018
 
2017
Reacquisition price
143,433

 
153,750

Less: Par value of Notes retired during the period
(143,410
)
 
(150,000
)
Add: Write off of unamortized debt issuance cost associated with Notes retired during the period
3

 
961

Net loss on extinguishment of debt
26

 
4,711

Accrued interest payable on the Notes was approximately $2.1 million as of December 31, 2017.

 
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Note 8 - Collateral Positions
The following table summarizes the fair value of collateral that we have pledged and held under our repurchase agreements, secured loans, interest rate swaps, futures contracts and currency forward contracts as of March 31, 2018 and December 31, 2017. Refer to Note 2 - "Summary of Significant Accounting Policies - Fair Value Measurements" of our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017 for a description of how we determine fair value. RMBS, CMBS and GSE CRT collateral pledged is included in mortgage-backed and credit risk transfer securities on our condensed consolidated balance sheets. Cash collateral pledged on secured loans, bilateral interest rate swaps and currency forward contracts is classified as restricted cash on our condensed consolidated balance sheets. Cash collateral pledged on futures contracts is classified as due from counterparties on our condensed consolidated balance sheets.
Cash collateral held on bilateral swaps that is not restricted for use is included in cash and cash equivalents on our condensed consolidated balance sheets and the liability to return the collateral is included in collateral held payable. Non-cash collateral held is only recognized if the counterparty defaults or if we sell the pledged collateral. As of March 31, 2018 and December 31, 2017, we did not recognize any non-cash collateral held.
$ in thousands
As of
Collateral Pledged
March 31, 2018
 
December 31, 2017
Repurchase Agreements:
 
 
 
Agency RMBS (1)
11,546,380

 
11,788,765

CMBS
1,856,165

 
1,737,831

Non-Agency RMBS
1,110,185

 
1,143,373

GSE CRT
855,856

 
853,446

Total repurchase agreements collateral pledged
15,368,586

 
15,523,415

Secured Loans:
 
 
 
Agency RMBS
638,181

 
623,181

CMBS
1,278,714

 
1,304,315

Cash
2,000

 

Total secured loans collateral pledged
1,918,895

 
1,927,496

Interest Rate Swaps, Futures Contracts and Currency Forward Contracts:
 
 
 
Agency RMBS (2)
89,652

 
109,900

Cash
5,775

 
620

Total interest rate swaps, futures contracts and currency forward contracts collateral pledged
95,427

 
110,520

Total:
 
 
 
Mortgage-backed and GSE CRT securities (1)
17,375,133

 
17,560,811

Cash
7,775

 
620

Total collateral pledged
17,382,908

 
17,561,431

 
 
 
 
Collateral Held
March 31, 2018
 
December 31, 2017
Interest Rate Swaps:
 
 
 
Cash
27,553

 
7,327

Total collateral held
27,553

 
7,327

(1)
Includes pledged securities of $189.3 million sold but not settled as of March 31, 2018 that are recorded as investment related receivable on our condensed consolidated balance sheet. Securities associated with unsettled trades remain legally pledged until the related repurchase agreement is repaid. There were no securities pledged as collateral associated with unsettled trades as of December 31, 2017.
(2)
During the first quarter of 2018, we determined that the amount disclosed as Agency RMBS collateral pledged on our interest rate swaps was understated by $86.2 million in our report on Form 10-K as of December 31, 2017. We concluded that the error in the amount disclosed was immaterial. We have revised the total amount of pledged securities disclosed parenthetically on our condensed consolidated balance sheet as of December 31, 2017 presented in this report on Form 10-Q and within the table above.

 
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Repurchase Agreements
Collateral pledged with our repurchase agreement counterparties is segregated in our books and records. The repurchase agreement counterparties have the right to resell and repledge the collateral posted but have the obligation to return the pledged collateral, or substantially the same collateral if agreed to by us, upon maturity of the repurchase agreement. Under the repurchase agreements, the respective lender retains the contractual right to mark the underlying collateral to fair value as determined by a pricing service agreed to by the respective lender and us. We would be required to provide additional collateral or fund margin calls if the value of pledged assets declined. We intend to maintain a level of liquidity that will enable us to meet margin calls.
Secured Loans
The ability to borrow from the FHLBI is subject to our continued creditworthiness, pledging of sufficient eligible collateral to secure advances, and compliance with certain agreements with FHLBI and FHFA rules. Collateral pledged with the FHLBI is held in trust for the benefit of the FHLBI and is not commingled with our other assets. The FHLBI does not have the right to resell or repledge collateral posted unless an event of default occurs. The FHLBI retains the right to mark the underlying collateral for FHLBI advances to fair value as determined by the FHLBI in its sole discretion. IAS Services LLC would be required to provide additional collateral or fund margin calls if the value of pledged assets declines.
Interest Rate Swaps
Collateral pledged with our interest rate swap counterparties is segregated in our books and records. We have two types of interest rate swap agreements: bilateral interest rate swaps that are governed by an International Swaps and Derivatives Association ("ISDA") agreement and interest rate swaps that are centrally cleared by a registered clearing organization the Chicago Mercantile Exchange ("CME") and LCH. Clearnet Limited ("LCH") through a Futures Commission Merchant ("FCM"). Interest rate swaps that are governed by an ISDA agreement provide for bilateral collateral pledging based on the counterparties' market value. The counterparties have the right to repledge the collateral posted, but have the obligation to return the pledged collateral, or substantially the same collateral, if agreed to by us, as the market value of the interest rate swaps change.
We are required to pledge initial margin and daily variation margin for our interest rate swaps that are centrally cleared. The FCM determines the fair value of our centrally cleared swaps, including daily variation margin. The daily variation margin payment for centrally cleared interest rate swaps is characterized as settlement of the derivative itself rather than collateral. Accordingly, cash collateral pledged on our centrally cleared interest rate swaps is settled against the fair value of these swaps.
Futures Contracts
We are required to pledge initial margin and daily variation margin for our futures contracts that is based on the fair value of our contracts as determined by our FCM. The daily variation margin payment for our futures contracts is characterized as settlement of the futures contract itself rather than collateral. Accordingly, cash collateral pledged on our futures contracts is settled against the fair value of these contracts.
Currency Forward Contracts
Collateral pledged with our currency forward counterparty is segregated in our books and records. Eligible collateral to be pledged can be in the form of cash or securities. Our currency forward contract provides for bilateral collateral pledging based on the counterparties' market value. The counterparties have the right to repledge the collateral posted, but have the obligation to return the pledged collateral, or substantially the same collateral, if agreed to by us, as the market value of the currency forward contracts change.



 
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Note 9 – Derivatives and Hedging Activities
The following table summarizes changes in the notional amount of our derivative instruments during 2018:
$ in thousands
Notional Amount as
of December 31, 2017
 
Additions
 
Settlement,
Termination,
Expiration
or Exercise
 
Notional Amount as
of March 31, 2018
Interest Rate Swaps (1) (2)
8,620,000

 
1,000,000

 
(350,000
)
 
9,270,000

Futures Contracts

 
430,000

 
(215,000
)
 
215,000

Currency Forward Contracts
76,859

 
77,837

 
(76,860
)
 
77,836

Credit Derivatives
553,493

 

 
(5,797
)
 
547,696

Total
9,250,352

 
1,507,837

 
(647,657
)
 
10,110,532

(1)
Notional amount as of March 31, 2018 excludes $1.3 billion of interest rate swaps with forward start dates.
(2)
Notional amount as of December 31, 2017 excludes $500.0 million of interest rate swaps with forward start dates.
Interest Rate Swaps
Our repurchase agreements are usually settled on a short-term basis ranging from one to twelve months. At each settlement date, we typically refinance each repurchase agreement at the market interest rate at that time. In addition, our secured loans have floating interest rates. As such, we are exposed to changing interest rates. Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposures to interest rate movements. To accomplish these objectives, we primarily use interest rate swaps as part of our interest rate risk management strategy. Interest rate swaps involve the receipt of variable-rate amounts from a counterparty in exchange for making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.
Amounts recorded in accumulated other comprehensive income ("AOCI") before we discontinued cash flow hedge accounting for our interest rate swaps 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. We reclassified $6.5 million as a decrease (March 31, 2017: $6.3 million as a decrease) to interest expense for the three months ended March 31, 2018. During the next 12 months, we estimate that $25.2 million will be reclassified as a decrease to interest expense, repurchase agreements. As of March 31, 2018, $117.4 million (December 31, 2017: $123.9 million) of unrealized gains on discontinued cash flow hedges, net are still included in accumulated other comprehensive income and will be reclassified to interest expense over a period of time through December 15, 2023.

 
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As of March 31, 2018, we had the following interest rate swaps outstanding:
$ in thousands
Counterparty
 
Notional
 
Maturity Date
 
Fixed Interest Rate
in Contract
UBS AG
 
500,000

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

 
6/5/2018
 
0.87
%
CME Central Clearing
 
300,000

 
2/5/2021
 
2.50
%
CME Central Clearing
 
300,000

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

 
3/15/2021
 
3.14
%
CME Central Clearing
 
500,000

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

 
5/25/2021
 
2.83
%
CME Central Clearing
 
500,000

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

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

 
6/9/2022
 
2.21
%
CME Central Clearing
 
1,000,000

 
8/14/2022
 
1.87
%
The Royal Bank of Scotland Plc
 
500,000

 
8/15/2023
 
1.98
%
CME Central Clearing
 
600,000

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

 
12/15/2023
 
2.20
%
CME Central Clearing
 
450,000

 
1/12/2024
 
2.10
%
CME Central Clearing
 
450,000

 
1/25/2024
 
2.15
%
LCH Central Clearing
 
1,000,000

 
2/6/2025
 
2.77
%
CME Central Clearing
 
100,000

 
4/2/2025
 
2.04
%
LCH Central Clearing
 
220,000

 
8/29/2027
 
2.12
%
Total
 
9,270,000

 
 
 
2.22
%
As of March 31, 2018, we had the following additional interest rate swaps outstanding with forward start dates:
$ in thousands
Counterparty
 
Notional
 
Maturity Date
 
Fixed Interest Rate
in Contract
LCH Central Clearing
(1)
600,000

 
2/5/2026
 
2.64
%
CME Central Clearing
(2)
250,000

 
5/24/2028
 
2.78
%
CME Central Clearing
(2)
250,000

 
5/24/2028
 
2.39
%
LCH Central Clearing
(3)
200,000

 
3/15/2031
 
2.74
%
Total
 
1,300,000

 
 
 
2.63
%
(1)
Forward start date of 2/5/2021
(2)
Forward start date of 5/24/2018
(3)
Forward start date of 3/15/2021
Refer to Note 8 - "Collateral Positions" for further information regarding our collateral pledged to and received from our interest rate swap counterparties.
Futures and Currency Forward Contracts
We purchase or sell U.S. Treasury futures contracts to help mitigate the potential impact of changes in interest rates on the performance of our investment portfolio. We recognize realized and unrealized gains and losses associated with the purchases or sales of U.S. Treasury futures contracts in gain (loss) on derivative instruments, net in our condensed consolidated statements of operations.
We use currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on our investments denominated in foreign currencies. We recognize realized and unrealized gains and losses associated with the purchases or sales of currency forward contracts in gain (loss) on derivative instruments, net in our condensed consolidated statements of operations. As of March 31, 2018, we have $51.4 million (December 31, 2017: $49.7 million) of notional amount of forward contracts denominated in Pound Sterling and $26.5 million (December 31, 2017: $27.2 million) of notional amount of forward contracts denominated in Euro.

 
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Credit Derivatives
Our GSE CRTs purchased prior to August 24, 2015 are accounted for as hybrid financial instruments consisting of a debt host contract and an embedded credit derivative. Embedded derivatives associated with GSE CRTs are recorded within mortgage-backed and credit risk transfer securities, at fair value, on the condensed consolidated balance sheets. At March 31, 2018 and December 31, 2017, terms of the GSE CRT embedded derivatives are:
$ in thousands
March 31, 2018
 
December 31, 2017
Fair value amount
42,932

 
45,400

Notional amount
547,696

 
553,493

Maximum potential amount of future undiscounted payments
547,696

 
553,493

Tabular Disclosure of the Effect of Derivative Instruments on the Balance Sheet
The table below presents the fair value of our derivative financial instruments, as well as their classification on the condensed consolidated balance sheets as of March 31, 2018 and December 31, 2017.
$ in thousands
Derivative Assets
 
Derivative Liabilities
 
 
As of March 31, 2018
 
As of December 31, 2017
 
 
 
As of March 31, 2018
 
As of December 31, 2017
Balance
Sheet
 
Fair Value
 
Fair Value
 
Balance
Sheet
 
Fair Value
 
Fair Value
Interest Rate Swaps Asset
 
26,280

 
6,896

 
Interest Rate Swaps Liability
 
18,558

 
31,548

Currency Forward Contracts
 
105

 

 
Currency Forward Contracts
 
184

 
1,217

 
 
 
 
 
 
Futures Contracts
 
1,612

 

Tabular Disclosure of the Effect of Derivative Instruments on the Income Statement
The tables below present the effect of our credit derivatives on the condensed consolidated statements of operations for the three months ended March 31, 2018 and 2017.
$ in thousands
 
Three months ended March 31, 2018
Derivative
not designated as
hedging instrument
 
Realized gain (loss), net
 
GSE CRT embedded derivative coupon interest
 
Unrealized gain (loss), net
 
Realized and unrealized credit derivative income (loss), net
GSE CRT Embedded Derivatives
 

 
5,633

 
(2,468
)
 
3,165

$ in thousands
 
Three months ended March 31, 2017
Derivative
not designated as
hedging instrument
 
Realized gain (loss), net
 
GSE CRT embedded derivative coupon interest
 
Unrealized gain (loss), net
 
Realized and unrealized credit derivative income (loss), net
GSE CRT Embedded Derivatives
 

 
5,807

 
14,148

 
19,955


 
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The following table summarizes the effect of interest rate swaps, futures contracts and currency forward contracts reported in gain (loss) on derivative instruments, net on the condensed consolidated statements of operations for the three months ended March 31, 2018 and 2017:

$ in thousands
 
Three months ended March 31, 2018
Derivative
not designated as
hedging instrument
 
Realized gain (loss) on derivative instruments, net
 
 Contractual net interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
 
122,273

 
(12,112
)
 
32,374

 
142,535

Futures Contracts
 
(5,277
)
 

 
(1,612
)
 
(6,889
)
Currency Forward Contracts
 
(3,418
)
 

 
1,139

 
(2,279
)
Total
 
113,578

 
(12,112
)
 
31,901

 
133,367

$ in thousands
 
Three months ended March 31, 2017
Derivative
not designated as
hedging instrument
 
Realized gain (loss) on derivative instruments, net
 
 Contractual net interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
 
15,994

 
(22,894
)
 
12,950

 
6,050

Currency Forward Contracts
 
(1,076
)
 

 
488

 
(588
)
Total
 
14,918

 
(22,894
)
 
13,438

 
5,462

Credit-risk-related Contingent Features
We have agreements with each of our bilateral derivative counterparties. Some of those agreements contain a provision whereby if we default on any of our indebtedness, including default whereby repayment of the indebtedness has not been accelerated by the lender, we could be declared in default on our derivative obligations.
At March 31, 2018, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for non-performance risk related to bilateral interest rate swap agreements, was $6.6 million. We have minimum collateral posting thresholds with certain of our derivative counterparties and have pledged collateral of $8.4 million of Agency RMBS as of March 31, 2018 related to bilateral interest rate swap agreements. If we had breached any of these provisions at March 31, 2018, we could have been required to settle our obligations under these agreements at their termination value.
We also have an agreement with a clearing counterparty for our interest rate swaps that includes cross default provisions. The fair value of our centrally cleared interest rate derivative contracts, which includes accrued interest and variation margin but excludes any adjustment for non-performance risk, was a net liability of $12.2 million as of March 31, 2018.
We were in compliance with all of the financial provisions of these counterparty agreements as of March 31, 2018.
Note 10 – Offsetting Assets and Liabilities
Certain of our repurchase agreements and derivative transactions are governed by underlying agreements that generally provide for a right of offset under master netting arrangements (or similar agreements) in the event of default or in the event of bankruptcy of either party to the transactions. Assets and liabilities subject to such arrangements are presented on a gross basis in the 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 our condensed consolidated balance sheets at March 31, 2018 and December 31, 2017. The daily variation margin payment for centrally cleared interest rate swaps is characterized as settlement of the derivative itself rather than collateral. As of March 31, 2018, our derivative liability of $12.2 million (December 31, 2017: derivative liability of $10.3 million) related to centrally cleared interest rate swaps is not included in the table below as a result of this change.

 
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Table of Contents


Offsetting of Derivative Assets
As of March 31, 2018
 
 
 
 
 
 
 
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
 
Cash Collateral
Received
 
Net Amount
Derivatives (1) (3)
26,385

 

 
26,385

 
(105
)
 
(26,280
)
 

Offsetting of Derivative Liabilities, Repurchase Agreements and Secured Loans
As of March 31, 2018
 
 
 
 
 
 
 
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)
 

Cash Collateral
Pledged
 
Net Amount
Derivatives (3)
8,204

 

 
8,204

 
(6,387
)
 
(1,691
)
 
126

Repurchase Agreements (4)
13,911,137

 

 
13,911,137

 
(13,911,137
)
 

 

Secured Loans (5)
1,650,000

 

 
1,650,000

 
(1,650,000
)
 

 

Total
15,569,341

 

 
15,569,341

 
(15,567,524
)
 
(1,691
)
 
126

Offsetting of Derivative Assets
As of December 31, 2017
 
 
 
 
 
 
 
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
 
Cash Collateral
Received
 
Net Amount
Derivatives (1) (3)
6,896

 

 
6,896

 

 
(6,896
)
 

Offsetting of Derivative Liabilities and Repurchase Agreements
As of December 31, 2017
 
 
 
 
 
 
 
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)
 

Cash Collateral
Pledged
 
Net Amount
Derivatives (3)
22,445

 

 
22,445

 
(21,169
)
 
(620
)
 
656

Repurchase Agreements (4)
14,080,801

 

 
14,080,801

 
(14,080,801
)
 

 

Secured Loans (5)
1,650,000

 

 
1,650,000

 
(1,650,000
)
 

 

Total
15,753,246

 

 
15,753,246

 
(15,751,970
)
 
(620
)
 
656


 
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Table of Contents


(1)
Amounts represent derivatives in an asset position which could potentially be offset against derivatives in a liability position at March 31, 2018 and December 31, 2017, subject to a netting arrangement.
(2)
Amounts represent collateral pledged that is available to be offset against liability balances associated with repurchase agreements, secured loans and derivatives.
(3)
The fair value of securities pledged against our derivatives was $89.7 million and $109.9 million at March 31, 2018 and December 31, 2017, respectively. Cash collateral received on our derivatives was $27.6 million and $7.3 million at March 31, 2018 and December 31, 2017, respectively. Cash collateral pledged by us on our derivatives was $5.8 million and $620,000 at March 31, 2018 and December 31, 2017, respectively. Cash collateral pledged on our centrally cleared interest rate swaps is settled against the fair value of these swaps and therefore excluded from the tables above at March 31, 2018 and December 31, 2017, respectively.
(4)
The fair value of securities pledged against our borrowing under repurchase agreements was $15.4 billion and $15.5 billion at March 31, 2018 and December 31, 2017, respectively.
(5)
The fair value of securities pledged against IAS Services LLC's borrowings under secured loans was $1.9 billion at March 31, 2018 and December 31, 2017, respectively. Cash collateral pledged by us on secured loans was $2.0 million at March 31, 2018.
Note 11 – Fair Value of Financial Instruments
A three-level valuation hierarchy exists for disclosure of fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions. The three levels are defined as follows:
Level 1 Inputs – Quoted prices for identical instruments in active markets.
Level 2 Inputs – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 Inputs – Instruments with primarily unobservable value drivers.
The following tables present our assets and liabilities measured at fair value on a recurring basis.
 
March 31, 2018
 
 
 
Fair Value Measurements Using:
 
 
$ in thousands
Level 1
 
Level 2
 
Level 3
 
NAV as a practical expedient (3)
 
Total at
Fair Value
Assets:
 
 
 
 
 
 
 
 
 
Mortgage-backed and credit risk transfer securities (1)(2)

 
17,579,302

 
42,932

 

 
17,622,234

Derivative assets

 
26,385

 

 

 
26,385

Other assets (4)
3,966

 

 

 
28,168

 
32,134

Total assets
3,966

 
17,605,687

 
42,932

 
28,168

 
17,680,753

Liabilities:
 
 
 
 
 
 
 
 
 
Derivative liabilities
1,612

 
18,742

 

 

 
20,354

Total liabilities
1,612

 
18,742

 

 

 
20,354


 
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December 31, 2017
 
 
 
Fair Value Measurements Using:
 
 
$ in thousands
Level 1
 
Level 2
 
Level 3
 
NAV as a practical expedient (3)
 
Total at
Fair Value
Assets:
 
 
 
 
 
 
 
 
 
Mortgage-backed and credit risk transfer securities (1)(2)

 
18,145,354

 
45,400

 

 
18,190,754

Derivative assets

 
6,896

 

 

 
6,896

Other assets (4)
3,979

 

 

 
25,972

 
29,951

Total assets
3,979

 
18,152,250

 
45,400

 
25,972

 
18,227,601

Liabilities:
 
 
 
 
 
 
 
 
 
Derivative liabilities

 
32,765

 

 

 
32,765

Total liabilities

 
32,765

 

 

 
32,765

(1)
For more detail about the fair value of our MBS and GSE CRTs, refer to Note 4 - "Mortgage-Backed and Credit Risk Transfer Securities."
(2)
Our GSE CRTs purchased prior to August 24, 2015 are accounted for as hybrid financial instruments with an embedded derivative. The hybrid financial instruments consist of debt host contracts classified as Level 2 and embedded derivatives classified as Level 3. As of March 31, 2018, the net embedded derivative asset position of $42.9 million includes $44.1 million of embedded derivatives in an asset position and $1.2 million of embedded derivatives in a liability position. As of December 31, 2017, the net embedded derivative asset position of $45.4 million includes $46.5 million of embedded derivatives in an asset position and $1.1 million of embedded derivatives in a liability position.
(3)
Investments in unconsolidated ventures are valued using the net asset value ("NAV") as a practical expedient and are not subject to redemption, although investors may sell or transfer their interest at the approval of the general partner of the underlying funds. As of March 31, 2018 and December 31, 2017, the weighted average remaining term of investments in unconsolidated ventures is 2.3 and 1.9 years, respectively.
(4)
Includes $4.0 million and $4.0 million of investment in an exchange-traded fund as of March 31, 2018 and December 31, 2017, respectively.
The following table shows a reconciliation of the beginning and ending fair value measurements of our GSE CRT embedded derivatives, which we have valued utilizing Level 3 inputs:
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Beginning balance
45,400

 
17,095

Unrealized credit derivative gains (losses), net
(2,468
)
 
14,148

Ending balance
42,932

 
31,243

The following tables summarize significant unobservable inputs used in the fair value measurement of our GSE CRT embedded derivatives:
 
Fair Value at
 
Valuation
 
Unobservable
 
 
 
Weighted
$ in thousands
March 31, 2018
 
Technique
 
Input
 
Range
 
Average
GSE CRT Embedded Derivatives
42,932

 
Market Comparables, Vendor Pricing
 
Weighted average life
 
2.5 - 6.6 years
 
4.6 years
 
Fair Value at
 
Valuation
 
Unobservable
 
 
 
Weighted
$ in thousands
December 31, 2017
 
Technique
 
Input
 
Range
 
Average
GSE CRT Embedded Derivatives
45,400

 
Market Comparables, Vendor Pricing
 
Weighted average life
 
2.6 - 6.8 years
 
4.8 years
These significant unobservable inputs change according to market conditions and security performance. We estimate the weighted average life of GSE CRTs in order to identify GSE corporate debt with a similar maturity. We obtain our weighted average life estimates from a third party provider. Although weighted average life is a significant input, changes in weighted average life may not have an explicit directional impact on the fair value measurement.

 
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The following table presents the carrying value and estimated fair value of our financial instruments that are not carried at fair value on the condensed consolidated balance sheets at March 31, 2018 and December 31, 2017:
 
March 31, 2018
 
December 31, 2017
$ in thousands
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
Financial Assets
 
 
 
 
 
 
 
Commercial loans, held-for-investment
184,255

 
184,510

 
191,808

 
191,930

Other assets
74,250

 
74,250

 
74,250

 
74,250

Total
258,505

 
258,760

 
266,058

 
266,180

Financial Liabilities
 
 
 
 
 
 
 
Repurchase agreements
13,911,137

 
13,910,631

 
14,080,801

 
14,080,460

Secured loans
1,650,000

 
1,650,000

 
1,650,000

 
1,650,000

Exchangeable senior notes

 

 
143,231

 
143,948

Total
15,561,137

 
15,560,631

 
15,874,032

 
15,874,408

The following describes our methods for estimating the fair value for financial instruments.
The estimated fair value of commercial loans held-for-investment is a Level 3 fair value measurement. Subsequent to the origination or purchase, commercial loan investments are valued on a monthly basis by an independent third party valuation agent using a discounted cash flow technique.
The estimated fair value of FHLBI stock, included in "Other assets," is a Level 3 fair value measurement. FHLBI stock may only be sold back to the FHLBI at its discretion at cost. As a result, the cost of the FHLBI stock approximates its fair value.
The estimated fair value of repurchase agreements is a Level 3 fair value measurement based on an expected present value technique. This method discounts future estimated cash flows using rates we determined best reflect current market interest rates that would be offered for repurchase agreements with similar characteristics and credit quality.
The estimated fair value of secured loans is a Level 3 fair value measurement. The secured loans have floating rates based on an index plus a spread and the spread is typically consistent with those demanded in the market. Accordingly, the interest rates on these secured loans are at market, and thus the carrying amount approximates fair value.
The estimated fair value of exchangeable senior notes is a Level 2 fair value measurement based on a valuation obtained from a third-party pricing service.
Note 12 – Related Party Transactions
Under the terms of our management agreement, our Manager and its affiliates provide us with our management team, including our officers and appropriate support personnel. Each of our officers is an employee of our Manager or one of its affiliates. We do not have any employees. Our Manager is not obligated to dedicate any of its employees exclusively to us, nor is our Manager obligated to dedicate any specific portion of time to our business. During the three months ended March 31, 2018, we reimbursed our Manager $214,000 (March 31, 2017: $185,000) for costs of support personnel that are fully dedicated to our business.
We have invested $68.8 million as of March 31, 2018 (December 31, 2017: $74.4 million) in money market or mutual funds managed by affiliates of our Manager. The investments are reported as cash and cash equivalents on our condensed consolidated balance sheets.
Management Fee Expense
We pay our Manager a management fee equal to 1.50% of our stockholders’ equity per annum. The fee is calculated and payable quarterly in arrears. For purposes of calculating the management fee, stockholders’ equity is equal to the sum of the net proceeds from all issuances of equity securities since inception including proceeds from the issuance of operating partnership units to an affiliate of our Manager, 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 excludes (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

 
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changes in U.S. GAAP; and (iv) certain non-cash items after discussions between our Manager and our independent directors and approval by a majority of our independent directors.
We do not pay any management fees on our investments in unconsolidated ventures that are managed by an affiliate of our Manager.
Expense Reimbursement
We are required to reimburse our Manager for our operating expenses incurred on our behalf, including directors and officers insurance, accounting services, auditing and tax services, filing fees, and miscellaneous general and administrative costs. Our reimbursement obligation is not subject to any dollar limitation.
The following table summarizes the costs incurred on our behalf by our Manager for the three months ended March 31, 2018 and 2017.
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Incurred costs, prepaid or expensed
1,492

 
1,468

Incurred costs, charged against equity as a cost of raising capital
165

 
77

Total incurred costs, originally paid by our Manager
1,657

 
1,545

Termination Fee
If we terminate our management agreement, we owe our Manager a termination fee equal to three times the sum of our average annual management fee during the 24-month period before termination, calculated as of the end of the most recently completed fiscal quarter.
Note 13 – Stockholders’ Equity
Preferred Stock
Holders of our Series A Preferred Stock are entitled to receive dividends at an annual rate of 7.75% of the liquidation preference of $25.00 per share or $1.9375 per share per annum. Dividends are cumulative and payable quarterly in arrears.
Holders of our Series B Preferred Stock are entitled to receive dividends at an annual rate of 7.75% of the liquidation preference of $25.00 per share or $1.9375 per share per annum until December 27, 2024. After December 27, 2024, holders are entitled to receive dividends at a floating rate equal to three-month LIBOR plus a spread of 5.18% of the $25.00 liquidation preference per annum. Dividends are cumulative and payable quarterly in arrears.
In August 2017, we completed a public offering of 11,500,000 shares of 7.50% Fixed-to-Floating Series C Cumulative Redeemable Preferred Stock (the "Series C Preferred Stock") at the price of $25.00 per share. Holders of our Series C Preferred Stock are entitled to receive dividends at an annual rate of 7.50% of the liquidation preference of $25.00 per share or $1.875 per share per annum until September 27, 2027. After September 27, 2027, holders are entitled to receive dividends at a floating rate equal to three-month LIBOR plus a spread of 5.289% of the $25.00 liquidation preference per annum. Dividends are cumulative and payable quarterly in arrears.
As of July 27, 2017, we have the option to redeem shares of Series A Preferred Stock for $25.00 per share, plus any accumulated and unpaid dividends through the date of redemption. We have the option to redeem shares of Series B Preferred Stock after December 27, 2024 and shares of Series C Preferred Stock after September 27, 2027 for $25.00 per share, plus any accumulated and unpaid dividends through the date of the redemption. Shares of Series B and Series C Preferred Stock are not redeemable, convertible into or exchangeable for any other property or any other securities of the Company prior to those times, except under circumstances intended to preserve our qualification as a REIT or upon the occurrence of a change in control.
Common Stock
In December 2017, we entered into an equity distribution agreement with a placement agent under which we may sell up to 17,000,000 shares of our common stock from time to time in at-the-market or privately negotiated transactions. These shares are registered with the SEC under our automatic shelf registration statement (as amended and/or supplemented). As of March 31, 2018, we have not sold any shares of common stock under the equity distribution agreement.

 
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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 units ("OP Units") for cash equal to the market value of an equivalent number of shares of common stock, or at our option, we may purchase their OP Units by issuing one share of common stock for each OP Unit redeemed. We also have an equity incentive plan which allows us to grant securities convertible into our common stock to our independent directors and employees of our Manager and its affiliates.
Share Repurchase Program
During the three months ended March 31, 2018 and three months ended March 31, 2017, we did not repurchase any shares of our common stock. As of March 31, 2018, we had authority to purchase 18,239,082 shares of our common stock through our share repurchase program. The share repurchase program has no stated expiration date.
Share-Based Compensation
We established the 2009 Equity Incentive Plan for grants of common stock and other equity based awards to our independent directors and officers and employees of our Manager and its affiliates (the "Incentive Plan"). Under the Incentive Plan, a total of 1,000,000 shares of common stock are authorized for issuance. Unless terminated earlier, the Incentive Plan will terminate in 2019, but will continue to govern the unexpired awards. As of March 31, 2018, 778,288 shares of common stock remain available for future issuance under the Incentive Plan.
We recognized compensation expense of approximately $93,000 (March 31, 2017: $85,000) for shares issued to our independent directors under the Incentive Plan for the three months ended March 31, 2018. During the three months ended March 31, 2018 and 2017, we issued 7,177 shares and 5,456 shares of common stock, respectively, to our independent directors. The fair market value of the shares granted was determined by the closing stock market price on the date of the grant. The grants vested immediately.
We recognized compensation expense of approximately $14,000 (March 31, 2017: $31,000) for the three months ended March 31, 2018 for restricted stock units awarded to employees of our Manager and its affiliates under the Incentive Plan. Our Manager reimburses us for the cost of these restricted stock awards under the terms of our management agreement. At March 31, 2018 there was approximately $306,000 of total unrecognized compensation cost related to restricted stock unit awards that is expected to be recognized over a period of up to 48 months, with a weighted-average remaining vesting period of 23 months.
The following table summarizes the activity related to restricted stock units awarded to employees of our Manager and its affiliates for the three months ended March 31, 2018.
 
Three Months Ended March 31,
 
2018
 
Restricted Stock Units
 
Weighted Average Grant Date Fair Value (1)
Unvested at the beginning of the period
19,827

 
$
14.35

Shares granted during the period
7,055

 
15.37

Shares vested during the period
(7,697
)
 
14.75

Unvested at the end of the period
19,185

 
$
14.56

(1)
The grant date fair value of restricted stock awards is based on the closing market price of our common stock at the grant date.

 
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Accumulated Other Comprehensive Income
The following tables present the components of total other comprehensive income (loss), net and accumulated other comprehensive income ("AOCI") for the three months ended March 31, 2018 and 2017. The tables exclude gains and losses on MBS and GSE CRTs that are accounted for under the fair value option.
 
Three Months Ended March 31, 2018
$ in thousands
Equity method investments
 
Available-for-sale securities
 
Derivatives and hedging
 
Total
Total other comprehensive income/(loss)
 
 
 
 
 
 
 
Unrealized gain (loss) on mortgage-backed and credit risk transfer securities, net

 
(132,317
)
 

 
(132,317
)
Reclassification of unrealized (gain) loss on sale of mortgage-backed and credit risk transfer securities to gain (loss) on investments, net

 
9,237

 

 
9,237

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

 

 
(6,539
)
 
(6,539
)
Currency translation adjustments on investment in unconsolidated venture
312

 

 

 
312

Total other comprehensive income/(loss)
312

 
(123,080
)
 
(6,539
)
 
(129,307
)
 
 
 
 
 
 
 
 
AOCI balance at beginning of period
947

 
136,188

 
123,894

 
261,029

Total other comprehensive income/(loss)
312

 
(123,080
)
 
(6,539
)
 
(129,307
)
Other comprehensive income/(loss) attributable to non-controlling interest
(4
)
 
1,552

 
82

 
1,630

AOCI balance at end of period
1,255

 
14,660

 
117,437

 
133,352

 
Three Months Ended March 31, 2017
$ in thousands
Equity method investments
 
Available-for-sale securities
 
Derivatives and hedging
 
Total
Total other comprehensive income/(loss)
 
 
 
 
 
 
 
Unrealized gain (loss) on mortgage-backed and credit risk transfer securities, net

 
16,289

 

 
16,289

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

 
850

 

 
850

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

 

 
(6,298
)
 
(6,298
)
Currency translation adjustments on investment in unconsolidated venture
(615
)
 

 

 
(615
)
Total other comprehensive income/(loss)
(615
)
 
17,139

 
(6,298
)
 
10,226

 
 
 
 
 
 
 
 
AOCI balance at beginning of period
95

 
144,458

 
149,115

 
293,668

Total other comprehensive income/(loss)
(615
)
 
17,139

 
(6,298
)
 
10,226

Other comprehensive income/(loss) attributable to non-controlling interest
8

 
(216
)
 
79

 
(129
)
AOCI balance at end of period
(512
)
 
161,381

 
142,896

 
303,765

Amounts recorded in AOCI before we discontinued cash flow hedge accounting for our interest rate swaps are reclassified to interest expense on repurchase agreements on the condensed consolidated statements of operations as interest is accrued and paid on the related repurchase agreements over the remaining original life of the interest rate swap agreements.

 
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Dividends
On March 15, 2018, we declared the following dividends:
a dividend of $0.42 per share of common stock to be paid on April 26, 2018 to stockholders of record as of the close of business on March 27, 2018; and
a dividend of $0.4844 per share of Series A Preferred Stock to be paid on April 25, 2018 to stockholders of record as of the close of business on April 1, 2018.
On February 15, 2018, we declared the following dividends:
a dividend of $0.4844 per share of Series B Preferred Stock payable on March 27, 2018 to stockholders of record as of the close of business on March 5, 2018; and
a dividend of $0.46875 per share of Series C Preferred Stock payable on March 27, 2018 to stockholders of record as of the close of business on March 5, 2018.
Note 14 – Earnings per Common Share
Earnings per share for the three months ended March 31, 2018 and 2017 is computed as follows: 
 
Three Months Ended March 31,
In thousands except per share amounts
2018
 
2017
Numerator (Income)
 
 
 
Basic Earnings:
 
 
 
Net income available to common stockholders
41,471

 
87,130

Effect of dilutive securities:
 
 
 
Income allocated to exchangeable senior notes
1,621

 
5,008

Income allocated to non-controlling interest
671

 
1,186

Dilutive net income available to stockholders
43,763

 
93,324

Denominator (Weighted Average Shares)
 
 
 
Basic Earnings:
 
 
 
Shares available to common stockholders
111,629

 
111,598

Effect of dilutive securities:
 
 
 
Restricted stock awards
20

 
19

Non-controlling interest OP units
1,425

 
1,425

Exchangeable senior notes
4,803

 
15,083

Dilutive Shares
117,877

 
128,125

Earnings per share:
 
 
 
Net income attributable to common stockholders
 
 
 
Basic
0.37

 
0.78

Diluted
0.37

 
0.73


 
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Note 15 – Non-controlling Interest - Operating Partnership
Non-controlling interest represents the aggregate ownership interest of a wholly-owned Invesco subsidiary in our Operating Partnership. The ownership percentage is determined by dividing the number of OP Units held by the Unit Holders by the total number of dilutive shares of common stock. The issuance or repurchase of common stock ("Share" or "Shares") or OP Units changes the percentage ownership of both the Unit Holders and the common stockholders. Since an OP unit is generally redeemable for cash or Shares at our option, it is deemed to be a Share equivalent. Therefore, such transactions are treated as capital transactions and result in a reallocation between stockholders’ equity and non-controlling interest in the accompanying condensed consolidated balance sheets. As of March 31, 2018 and December 31, 2017, non-controlling interest related to the outstanding 1,425,000 OP Units represented a 1.3% interest in the Operating Partnership.
Income allocated to the non-controlling interest is based on the Unit Holders' ownership percentage of the Operating Partnership. The following table presents the net income (loss) allocated and distributions paid to the Operating Partnership non-controlling interest for the three months ended March 31, 2018 and 2017.
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Net income allocated
671

 
1,186

Distributions paid
599

 
570

As of March 31, 2018 and December 31, 2017, distributions payable to the non-controlling interest were $598,500, respectively.
Note 16 – Commitments and Contingencies
Commitments and Contingencies
Commitments and contingencies may arise in the ordinary course of business. Our material off-balance sheet commitments as of March 31, 2018 are discussed below.
As discussed in Note 6 - "Other Assets", we have invested in unconsolidated ventures that are sponsored by an affiliate of our Manager. The unconsolidated ventures are structured as partnerships, and we invest in the partnerships as a limited partner. The entities are structured such that capital commitments are to be drawn down over the life of the partnership as investment opportunities are identified. As of March 31, 2018 and December 31, 2017, our undrawn capital and purchase commitments were $8.9 million and $10.2 million, respectively.
As discussed in Note 5 - "Commercial Loans Held-for-Investment", we purchase and originate commercial loans. As of March 31, 2018 and December 31, 2017, we have unfunded commitments on commercial loans held-for-investment of $4.1 million and $4.8 million, respectively.
We have entered into agreements with financial institutions to guarantee certain obligations of our subsidiaries. We would be required to perform under these guarantees in the event of certain defaults. We have not had prior claims or losses pursuant to these contracts and expect the risk of loss to be remote.
Note 17 – Subsequent Events
We have 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 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, monetary policy actions of the Federal Reserve, including actions relating to its agency mortgage-backed securities portfolio and the continuation of re-investment of principal payments, and our ability to respond to and comply with such actions, initiatives and changes;
the availability of financing sources, including our ability to obtain additional financing arrangements and the terms of such arrangements;
financing and advance rates for our target assets;
changes to our expected leverage;
our expected investments;
our expected book value per diluted common share;
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;

 
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rates of default or decreased recovery rates on our target assets;
modifications to whole loans or loans underlying securities;
the degree to which our hedging strategies may or may not protect us from interest rate volatility;
the degree to which derivative contracts expose us to contingent liabilities;
counterparty defaults;
compliance with financial covenants in our financing arrangements;
changes in governmental regulations, zoning, insurance, eminent domain and tax 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 adequacy of our disclosure controls and procedures and internal controls over financial reporting; and
market trends in our industry, interest rates, real estate values, the debt securities markets or the general economy.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. You should not place undue reliance on these forward-looking statements. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. Some of these factors are described under the headings “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. Our objective is to provide attractive risk-adjusted returns to our investors, primarily through dividends and secondarily through capital appreciation. To achieve this objective, we primarily invest in the following:
Residential mortgage-backed securities (“RMBS”) that are guaranteed by a U.S. government agency such as the Government National Mortgage Association or a federally chartered corporation such as the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation (collectively "Agency RMBS");
Commercial mortgage-backed securities (“CMBS”); 
RMBS that are not guaranteed by a U.S. government agency ("non-Agency RMBS");

 
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Credit risk transfer securities that are unsecured obligations issued by government-sponsored enterprises ("GSE CRT");
Residential and commercial mortgage loans; and
Other real estate-related financing arrangements.
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. 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. We are externally managed and advised by Invesco Advisers, Inc., our Manager, which is an indirect, wholly-owned subsidiary of Invesco Ltd.
Capital Activities
On March 15, 2018, we declared the following dividends:
a dividend of $0.42 per share of common stock to be paid on April 26, 2018 to stockholders of record as of the close of business on March 27, 2018; and
a dividend of $0.4844 per share of Series A Preferred Stock to be paid on April 25, 2018 to stockholders of record as of the close of business on April 1, 2018.
On February 15, 2018, we declared the following dividends:
a dividend of $0.4844 per share of Series B Preferred Stock payable on March 27, 2018 to stockholders of record as of the close of business on March 5, 2018; and
a dividend of $0.46875 per share of Series C Preferred Stock payable on March 27, 2018 to stockholders of record as of the close of business on March 5, 2018.
During the three months ended March 31, 2018, we did not repurchase any shares of our common stock.
Factors Impacting Our Operating Results
Our operating results can be affected by a number of factors and primarily depend on the level of our net interest income and the market value of our assets. Our net interest income, which includes the amortization of purchase premiums and accretion of purchase discounts, varies primarily as a result of changes in market interest rates and prepayment speeds, as measured by the constant prepayment rate (“CPR”) on our target assets. Interest rates and prepayment speeds vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. The market value of our assets can be impacted by credit spread premiums (yield advantage over U.S. Treasury notes) and the supply of, and demand for, target assets in which we invest.
Market Conditions
Macroeconomic factors that affect our business include credit spread premiums, market interest rates, governmental policy initiatives, residential and commercial real estate prices, credit availability, consumer personal income, corporate earnings, employment conditions, financial conditions and inflation.
Financial conditions tightened during the first quarter of 2018, reflecting weakness in equity markets, higher interest rates and an increase in volatility. The total return on the S&P 500 Index was negative 1.2% while the NASDAQ returned positive 2.3%. Interest rates on U.S. Treasuries were sharply higher across the maturity spectrum, with 2 year, 5 year and 10 year Treasury rates higher by 38, 35 and 33 basis points, respectively. Equity volatility returned during the quarter, as the CBOE SPX Volatility Index (VIX) reached a multi-year high in early February. While investors continued to be encouraged by the strength of the economy, the benefits of tax reform and easing regulatory burdens on business, concerns around the prospect of increased tariffs that could lead to continued strain in U.S. foreign relations captured investors’ attention.
The labor market showed continued strength during the quarter, with increases in non-farm payrolls averaging over 200,000 jobs per month, down from an average of 220,000 jobs the previous quarter. The strength in the labor market helped boost consumer confidence, as the University of Michigan Consumer Sentiment Index reached its highest level in over 15 years. The consensus forecast for full-year 2018 GDP has increased to 2.8%, after coming in at 2.3% for 2017.
Inflation remained relatively subdued, with the U.S. Personal Consumption Expenditure Core Price Index continuing to register below the Federal Reserve’s inflation target of 2%. Energy prices were higher during the quarter, with the price of WTI Crude up over 7%, while the broader CRB Commodity Price Index increased by 0.8%. Despite the benign inflation readings,

 
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the Federal Reserve’s Open Market Committee raised the Federal Funds target rate to a range of 1.50% to 1.75% during their March meeting, which caused interest rates along the front end of the yield curve to increase. The inflation outlook continues to have meaningful implications for future Federal Reserve monetary policy. We expect the interest rate environment to remain relatively volatile, as the Federal Reserve continues to signal a willingness to increase the Federal Funds rate.
During the quarter, the performance of Agency RMBS was negative. Both 15 and 30 year fixed-rate Agency RMBS underperformed similar duration Treasuries, while Hybrid ARM Agency RMBS were flat to similar duration Treasuries. The outlook for Agency RMBS remains mixed, as the potential for increased interest rate volatility and the continued tapering of reinvestment activity by the Federal Reserve weighs on the market. On the positive side, a higher interest rate environment has the potential to spur investment demand on the part of both foreign and domestic banks, while at the same time keeping refinancing activity muted.
During the first quarter of 2018, credit spreads (defined as the yield in excess of risk-free rates) on CMBS and GSE CRT securities tightened modestly, reflecting improving real estate values and strong investor demand. Financing markets remained steady during the quarter, though repurchase agreement rates moved higher in line with increases in the Federal Funds rate.
As we move into the second quarter of 2018, we expect that the U.S. will continue to experience moderate economic growth, and that core inflation will remain below the Federal Reserve’s policy objective of 2%, which should allow the Federal Reserve to continue its efforts to tighten monetary policy. Investor concerns include historically high valuations across both the equity and fixed income markets, the potential for additional protectionist trade policies, and the prospect of further increases in interest rates and price volatility.
Investment Activities
The table below shows the allocation of our equity as of March 31, 2018, December 31, 2017 and March 31, 2017:
 
As of
$ in thousands
March 31, 2018
 
December 31, 2017
 
March 31, 2017
Agency RMBS
44
%
 
45
%
 
39
%
Commercial Credit (1)
36
%
 
35
%
 
33
%
Residential Credit (2)
20
%
 
20
%
 
28
%
Total
100
%
 
100
%
 
100
%
(1)
CMBS, commercial loans and investments in unconsolidated ventures (which are included in Other Assets), are considered commercial credit.
(2)
Non-Agency RMBS and GSE CRT are considered residential credit.


 
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The table below shows the breakdown of our investment portfolio as of March 31, 2018, December 31, 2017 and March 31, 2017:
 
As of
$ in thousands
March 31, 2018
 
December 31, 2017
 
March 31, 2017
Agency RMBS:
 
 
 
 
 
30 year fixed-rate, at fair value
7,662,038

 
7,640,540

 
4,492,324

15 year fixed-rate, at fair value
2,609,552

 
2,974,782

 
3,418,231

Hybrid ARM, at fair value
1,623,538

 
1,719,385

 
2,101,319

ARM, at fair value
227,666

 
241,200

 
290,690

Agency CMO, at fair value
253,954

 
273,943

 
319,718

CMBS, at fair value
3,189,281

 
3,216,417

 
2,669,070

Non-Agency RMBS, at fair value
1,194,952

 
1,257,608

 
1,774,088

GSE CRT, at fair value
861,253

 
866,879

 
855,657

Commercial loans, at amortized cost
184,255

 
191,808

 
275,944

Investments in unconsolidated ventures
28,168

 
25,972

 
33,336

Total Investment portfolio
17,834,657

 
18,408,534

 
16,230,377

During the three months ended March 31, 2018, we purchased $381.5 million of 30 year fixed-rate Agency RMBS and $21.3 million of CMBS. We have continued to increase our holdings of 30 year fixed-rate Agency RMBS over the past 12 months as the return on equity profile for these securities remains attractive. As of March 31, 2018 our holdings of 30 year fixed-rate Agency RMBS represent approximately 43% of our total investment portfolio versus 42% as of December 31, 2017 and 28% as of March 31, 2017. We have also moderately increased our holdings of CMBS based on our view that these assets should continue to benefit from property price appreciation and limited supply. Available returns in non-Agency RMBS have declined relative to Agency RMBS and CMBS as a result of credit spread tightening, limiting our reinvestment in the sector.
We have continued to hold 15 year fixed-rate Agency RMBS and commercial real estate loans that have relatively low interest rate risk, which reduces our book value per diluted common share volatility. Additionally, we hold 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 ("IOs").
Our portfolio of investments that have credit exposure include CMBS, non-Agency RMBS, GSE CRTs and commercial real estate loans. Rather than relying on the rating agencies, we utilize proprietary models as well as third party applications to quantify and monitor the credit risk associated with our portfolio holdings. Our analysis generally begins at the underlying asset level, where we gather detailed information on loan, borrower, and property characteristics that inform our expectations for future performance. In addition to base case cash flow projections, we perform a range of scenario stresses to gauge the sensitivity of returns to potential deviations in underlying asset behavior. We perform this detailed credit analysis at the time of initial purchase and regularly throughout the holding period of each investment.
Our CMBS portfolio generally consists of assets originated during and after 2010. These assets continue to benefit from rating agency upgrades, property price appreciation and limited supply. CMBS investments represent approximately 18% of our total investment portfolio as of March 31, 2018.
With respect to our non-Agency RMBS portfolio, we primarily invest in securities 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 securitizations of reperforming mortgage loans ("RPL") 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, reducing our need to hedge interest rate risk. The majority of our GSE CRT holdings are concentrated in 2013 and 2014 vintages, where reference loans have significant embedded home price appreciation. From a fundamental perspective, we continue to view GSE CRT as an attractive asset class based on the strength of the U.S. housing market and the strong performance of reference mortgage loans to date.
As of March 31, 2018, our commercial real estate loan portfolio includes seven mezzanine loans that we either purchased or originated. Our commercial real estate loan portfolio represents approximately 1% of our total investment portfolio and has a weighted average maturity of 1.1 years. Our largely floating rate commercial real estate loan portfolio continues to benefit from favorable fundamentals and increasing LIBOR. The commercial real estate loan portfolio's weighted average loan-to-value ratio is approximately 68%, based on the most recently attained independent property appraisals and the relevant loan

 
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amounts. For further details on our commercial loan portfolio, see Note 5 - "Commercial Loans Held-for-Investment" of our condensed consolidated financial statements. We evaluate the collectibility of our commercial loans held-for investment using the factors described in Note 2 - "Summary of Significant Accounting Policies" of our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017. We determined that no allowance for loan losses for our commercial loans was required as of March 31, 2018.
Portfolio Characteristics
The table below illustrates the vintage distribution of our non-Agency RMBS, GSE CRT and CMBS portfolio as of March 31, 2018 as a percentage of the fair value: 
 
2003-2007
 
2008-2010
 
2011
 
2012
 
2013
 
2014
 
2015
 
2016
 
2017
 
2018
 
Total
Prime
23.0
%
 
2.7
%
 
%
 
%
 
12.8
%
 
10.9
%
 
2.4
%
 
0.4
%
 
%
 
%
 
52.2
%
Alt-A
31.7
%
 
%
 
%
 
%
 
%
 
%
 
%
 
%
 
%
 
%
 
31.7
%
Re-REMIC (1)
0.7
%
 
5.6
%
 
3.3
%
 
2.0
%
 
1.1
%
 
%
 
%
 
%
 
%
 
%
 
12.7
%
Subprime/RPL
0.2
%
 
%
 
%
 
%
 
%
 
%
 
3.2
%
 
%
 
%
 
%
 
3.4
%
Total Non-Agency
55.6
%
 
8.3
%
 
3.3
%
 
2.0
%
 
13.9
%
 
10.9
%
 
5.6
%
 
0.4
%
 
%
 
%
 
100.0
%
GSE CRT
%
 
%
 
%
 
%
 
31.3
%
 
36.0
%
 
7.2
%
 
22.0
%
 
3.5
%
 
%
 
100.0
%
CMBS
%
 
3.7
%
 
18.9
%
 
12.1
%
 
15.5
%
 
35.8
%
 
4.0
%
 
2.0
%
 
7.9
%
 
0.1
%
 
100.0
%
(1)
Reflects the year in which the re-securitizations were issued. The vintage distribution of the securities that collateralize our Re-REMIC investments is 7.9% for 2005, 6.4% for 2006, and 85.7% for 2007.
The following table summarizes the credit enhancement provided to our Re-REMIC holdings as of March 31, 2018 and December 31, 2017.
  
Percentage of Re-REMIC 
Holdings at Fair Value
Re-REMIC Subordination(1)
March 31, 2018
 
December 31, 2017
0% - 10%
38.4
%
 
34.5
%
10% - 20%
3.4
%
 
3.7
%
20% - 30%
13.3
%
 
12.3
%
30% - 40%
16.9
%
 
18.4
%
40% - 50%
6.9
%
 
9.6
%
50% - 60%
19.3
%
 
19.7
%
60% - 70%
1.8
%
 
1.8
%
Total
100.0
%
 
100.0
%
(1)
Subordination refers to the credit enhancement provided to the Re-REMIC tranche held by us by any junior Re-REMIC tranche or tranches in a resecuritization. This figure reflects the percentage of the balance of the underlying securities represented by any junior tranche or tranches at the time of resecuritization. Generally, principal losses on the underlying securities in excess of the subordination amount would result in principal losses on the Re-REMIC tranche held by us. 60.5% of our Re-REMIC holdings are not senior tranches.


 
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The tables below represent the geographic concentration of the underlying collateral for our non-Agency RMBS, GSE CRT and CMBS portfolio as of March 31, 2018: 
Non-Agency RMBS
State
 
Percentage
 
GSE CRT
State
 
Percentage
 
CMBS
State
 
Percentage
California
 
44.8
%
 
California
 
18.9
%
 
New York
 
15.4
%
New York
 
9.1
%
 
Texas
 
6.0
%
 
California
 
15.4
%
Florida
 
6.3
%
 
New York
 
4.5
%
 
Texas
 
9.5
%
New Jersey
 
4.0
%
 
Virginia
 
4.3
%
 
Florida
 
6.4
%
Virginia
 
3.4
%
 
Florida
 
4.3
%
 
Illinois
 
4.0
%
Massachusetts
 
3.0
%
 
Illinois
 
3.9
%
 
Pennsylvania
 
3.9
%
Maryland
 
3.0
%
 
Massachusetts
 
3.4
%
 
New Jersey
 
3.2
%
Illinois
 
2.4
%
 
Washington
 
3.3
%
 
Ohio
 
2.9
%
Washington
 
2.0
%
 
New Jersey
 
3.3
%
 
Michigan
 
2.8
%
Arizona
 
1.9
%
 
Pennsylvania
 
3.1
%
 
Virginia
 
2.8
%
Other
 
20.1
%
 
Other
 
45.0
%
 
Other
 
33.7
%
Total
 
100.0
%
 
Total
 
100.0
%
 
Total
 
100.0
%
Financing and Other Liabilities
We enter into repurchase agreements to finance the majority of our target assets. These agreements are secured by our Agency RMBS, CMBS, non-Agency RMBS and GSE CRTs. 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 refinance each repurchase agreement at the market interest rate at that time. As of March 31, 2018, we had entered into repurchase agreements totaling $13.9 billion (December 31, 2017: $14.1 billion).
Our wholly-owned captive insurance subsidiary, IAS Services, is a member of the Federal Home Loan Bank of Indianapolis ("FHLBI"). As a member of the FHLBI, IAS Services has borrowed funds from the FHLBI in the form of secured loans. As of March 31, 2018, IAS Services had $1.65 billion in outstanding secured loans. For the three months ended March 31, 2018, IAS Services had weighted average borrowings of $1.65 billion with a weighted average borrowing rate of 1.68% and a weighted average maturity of 6.1 years.
The following table presents the amount of collateralized borrowings outstanding under repurchase agreements and secured loans as of the end of each quarter, the average amount outstanding during the quarter and the maximum balance outstanding during the quarter:
$ in thousands
Collateralized borrowings under repurchase agreements and secured loans
Quarter Ended
Quarter-end balance
 
Average quarterly balance
 
Maximum balance of any quarter-end
March 31, 2017
13,939,899

 
13,901,254

 
14,086,600

June 30, 2017
13,768,948

 
13,716,749

 
13,768,948

September 30, 2017
15,738,838

 
15,010,514

 
15,738,838

December 31, 2017
15,730,801

 
15,762,094

 
15,815,972

March 31, 2018
15,561,137

 
15,536,093

 
15,561,137

In 2013, our wholly-owned subsidiary, IAS Operating Partnership LP, issued $400.0 million in aggregate principal amount of Exchangeable Senior Notes (the "Notes"). We retired a portion of the Notes prior to their maturity and fully retired the Notes upon their maturity on March 15, 2018. We utilized proceeds from repurchase agreement borrowings to retire the Notes.

 
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The following table summarizes retirements of the Notes during the three months ended March 31, 2018 and 2017.
$ in thousands
Three Months Ended March 31,
 
2018
 
2017
Reacquisition price
143,433

 
153,750

Less: Par value of Notes retired during the period
(143,410
)
 
(150,000
)
Add: Write off of unamortized debt issuance cost associated with Notes retired during the period
3

 
961

Net loss on extinguishment of debt
26

 
4,711

We have also committed to invest up to $123.1 million in unconsolidated ventures that are sponsored by an affiliate of our Manager. As of March 31, 2018, $114.2 million of our commitment to these unconsolidated ventures has been called. We are committed to fund $8.9 million in additional capital to fund future investments and cover future expenses should they occur.
Hedging Instruments.
As of March 31, 2018, we have entered into interest rate swap agreements designed to mitigate the effects of increases in interest rates under a portion of our borrowings. Under these swap agreements, we pay fixed interest rates and receive floating interest rates indexed off of one- or three-month LIBOR, effectively fixing the floating interest rates on $9.3 billion (December 31, 2017: $8.6 billion) of borrowings. During the three months ended March 31, 2018, we entered into a new swap with a notional amount of $1.0 billion to hedge the interest rates on the associated repurchase agreement debt and an existing swap with a notional amount of $350.0 million expired. In addition, we entered into forward starting swaps with a notional amount of $800.0 million that effectively extend the maturities of existing interest rate swaps at March 31, 2018.
As of March 31, 2018, we have entered into U.S. Treasury futures contracts that are designed to help mitigate the potential impact of changes in interest rates on the performance of our investment portfolio. During the three months ended March 31, 2018, we entered into contracts with a notional amount of $430.0 million and realized a net loss of $5.3 million. As of March 31, 2018 we held $215.0 million in notional amount of futures contracts as a liability with a fair value of $1.6 million. As of December 31, 2017, we have no outstanding futures contracts.
As of March 31, 2018, we held $77.8 million (December 31, 2017: $76.9 million) in notional amount of currency forward contracts. During the three months ended March 31, 2018, we settled currency forward contracts of $76.9 million (March 31, 2017: $65.6 million) in notional amount and realized a net loss of $3.4 million (March 31, 2017: $1.1 million net loss). As of March 31, 2018, we have $51.4 million (December 31, 2017: $49.7 million) of notional amount of forward contracts denominated in Pound Sterling and $26.5 million (December 31, 2017: $27.2 million) of notional amount of forward contracts denominated in Euro. 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.

 
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Book Value per Diluted Common Share
We calculate book value per diluted common share as follows:

As of
In thousands except per share amounts
March 31, 2018
 
December 31, 2017
Numerator (adjusted equity):
 
 
 
Total equity
2,522,356

 
2,656,878

Less: Liquidation preference of Series A Preferred Stock
(140,000
)
 
(140,000
)
Less: Liquidation preference of Series B Preferred Stock
(155,000
)
 
(155,000
)
Less: Liquidation preference of Series C Preferred Stock
(287,500
)
 
(287,500
)
Total adjusted equity
1,939,856

 
2,074,378

 
 
 
 
Denominator (number of shares - diluted):
 
 
 
Common stock outstanding
111,637

 
111,624

Non-controlling interest OP units
1,425

 
1,425

Number of shares - diluted
113,062

 
113,049

 
 
 
 
Book value per diluted common share
17.16

 
18.35

Our book value per diluted common share decreased 6.5% as of March 31, 2018 compared to December 31, 2017 primarily due to rising interest rates driving a decrease in the valuations of our mortgage-backed securities portfolio that exceeded the increase in the valuations of our interest rate hedges. Refer to Item 3. "Quantitative and Qualitative Disclosures About Market Risk" for interest rate risk and its impact on fair value.

 
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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.
There have been no significant changes to our critical accounting policies that are disclosed in our most recent Form 10-K for the year ended December 31, 2017, other than the significant accounting policy disclosed below.
Restricted Cash
Restricted cash represents cash posted with the FHLBI as collateral for secured loans and cash posted with counterparties as collateral for various derivative instruments.  Cash held by counterparties as collateral is legally restricted and is not available for general corporate purposes.
Recent Accounting Standards
See Part I, Item 1, Financial Statements Note 2 - "Accounting Pronouncements Recently Adopted."


 
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Results of Operations
The table below presents certain information from our condensed consolidated statements of operations for the three months ended March 31, 2018 and 2017. 
 
Three Months Ended March 31,
$ in thousands, except share data
2018
 
2017
Interest Income
 
 
 
Mortgage-backed and credit risk transfer securities
149,003

 
118,873

Commercial loans
4,222

 
5,764

Total interest income
153,225

 
124,637

Interest Expense
 
 
 
Repurchase agreements
59,585

 
29,947

Secured loans
6,927

 
3,413

Exchangeable senior notes
1,621

 
5,008

Total interest expense
68,133

 
38,368

Net interest income
85,092

 
86,269

Other Income (loss)
 
 
 
Gain (loss) on investments, net
(160,370
)
 
(1,853
)
Equity in earnings (losses) of unconsolidated ventures
896

 
(1,534
)
Gain (loss) on derivative instruments, net
133,367

 
5,462

Realized and unrealized credit derivative income (loss), net
3,165

 
19,955

Net loss on extinguishment of debt
(26
)
 
(4,711
)
Other investment income (loss), net
3,102

 
1,329

Total other income (loss)
(19,866
)
 
18,648

Expenses
 
 
 
Management fee – related party
10,221

 
8,801

General and administrative
1,756

 
2,084

Total expenses
11,977

 
10,885

Net income
53,249

 
94,032

Net income attributable to non-controlling interest
671

 
1,186

Net income attributable to Invesco Mortgage Capital Inc.
52,578

 
92,846

Dividends to preferred stockholders
11,107

 
5,716

Net income attributable to common stockholders
41,471

 
87,130

Earnings per share:
 
 
 
Net income (loss) attributable to common stockholders
 
 
 
Basic
0.37

 
0.78

Diluted
0.37

 
0.73

Dividends declared per common share
0.42

 
0.40

Weighted average number of shares of common stock:
 
 
 
Basic
111,629,105

 
111,598,459

Diluted
117,876,995

 
128,124,628


 
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Interest Income and Average Earning Asset Yields
The table below presents information related to our average earning assets and earning asset yields for the three months ended March 31, 2018 and 2017. 
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Average Balances (1):
 
 
 
Agency RMBS:
 
 
 
15 year fixed-rate, at amortized cost
2,879,696

 
3,516,699

30 year fixed-rate, at amortized cost
7,830,802

 
4,460,663

ARM, at amortized cost
231,303

 
290,812

Hybrid ARM, at amortized cost
1,666,890

 
2,291,634

Agency - CMO, at amortized cost
273,884

 
328,450

CMBS, at amortized cost
3,193,575

 
2,575,734

Non-Agency RMBS, at amortized cost
1,084,584

 
1,793,030

GSE CRT, at amortized cost
776,742

 
765,690

Commercial loans, at amortized cost
193,540

 
274,981

Average earning assets
18,131,016

 
16,297,693

Average Earning Asset Yields (2):
 
 
 
Agency RMBS:
 
 
 
15 year fixed-rate
2.04
%
 
2.03
%
30 year fixed-rate
2.96
%
 
2.64
%
ARM
2.32
%
 
2.31
%
Hybrid ARM
2.24
%
 
2.29
%
Agency - CMO
2.51
%
 
0.58
%
CMBS
4.85
%
 
4.20
%
Non-Agency RMBS
7.08
%
 
5.58
%
GSE CRT (3)
3.00
%
 
2.15
%
Commercial loans
8.85
%
 
8.50
%
Average earning asset yields
3.38
%
 
3.06
%
(1)
Average amounts for each period are based on weighted month-end balances.
(2)
Average earning asset yields for the period was calculated by dividing interest income, including amortization of premiums and discounts, by the average balance of the amortized cost of the investments. All yields are annualized.
(3)
GSE CRT average earning asset yields exclude coupon interest associated with embedded derivatives on securities not accounted for under the fair value option that is recorded as realized and unrealized credit derivative income (loss), net under U.S. GAAP.
Our primary source of income is interest earned on our investment portfolio. We had average earning assets of approximately $18.1 billion for the three months ended March 31, 2018 (March 31, 2017: $16.3 billion). Average earning assets increased primarily because we issued $287.5 million of Series C Preferred Stock in August 2017 and invested the proceeds in 30 year fixed-rate Agency RMBS and CMBS.

 
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We earned total interest income of $153.2 million (March 31, 2017: $124.6 million) for the three months ended March 31, 2018. Our interest income includes coupon interest and net premium amortization on MBS and GSE CRTs as well as interest income on commercial loans as shown in the table below.
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Interest Income
 
 
 
MBS and GSE CRT - coupon interest
166,319

 
146,069

MBS and GSE CRT - net premium amortization
(17,316
)
 
(27,196
)
MBS and GSE CRT - interest income
149,003

 
118,873

Commercial loans
4,222

 
5,764

Total interest income
153,225

 
124,637

MBS and GSE CRT coupon interest increased $20.3 million or 13.9% during the three months ended March 31, 2018 compared to 2017 primarily due to the purchase of 30 year Agency RMBS and CMBS with the proceeds from our August 2017 Series C Preferred Stock offering. Lower net premium amortization also contributed $9.9 million to interest income during the three months ended March 31, 2018.
Interest income on our floating rate commercial real estate loans decreased $1.5 million during the three months ended March 31, 2018 primarily due to commercial loan payoffs. The balance of our commercial loans held-for-investment decreased to $184.3 million as of March 31, 2018 compared to $275.9 million as of March 31, 2017.
Our average earning asset yields increased 32 basis points during the three months ended March 31, 2018 compared to 2017 primarily due to slower prepayment speeds and higher index rates on floating and adjustable rate non-Agency RMBS and GSE CRT securities.
Prepayment Speeds
Our RMBS and GSE CRT portfolio is subject to inherent prepayment risk primarily driven by changes in interest rates, which impacts the amount of premium and discount on the purchase of these securities that is recognized into interest income. Expected future prepayment speeds on our RMBS and GSE CRT portfolio are estimated on a quarterly basis. Generally, in an environment of falling interest rates, prepayment speeds will increase as homeowners are more likely to prepay their existing mortgage and refinance into a lower borrowing rate. If the actual prepayment speed during the period is faster than estimated, the amortization on securities purchased at a premium to par value will be accelerated, resulting in lower interest income recognized. Conversely, for securities purchased at a discount to par value, interest income will be reduced in periods where prepayment speeds were slower than expected. The standard measure of prepayment speeds is the constant prepayment rate, also known as the conditional prepayment rate or "CPR". CPR measures prepayments as a percentage of the current outstanding loan balance and is expressed as a compound annual rate. The tables below provide the three month constant prepayment rate for our RMBS and GSE CRTs as of March 31, 2018 and 2017.
 
Three Months Ended March 31,
 
2018
 
2017
15 year fixed-rate Agency RMBS
9.2

 
8.1

30 year fixed-rate Agency RMBS
7.1

 
10.8

ARM/ Hybrid ARM Agency RMBS
14.4

 
15.7

Non-Agency RMBS
11.6

 
13.3

GSE CRT
9.5

 
13.1

Weighted average CPR
9.2

 
11.7

We recognized $17.3 million and $27.2 million of net premium amortization during the three months ended March 31, 2018 and 2017, respectively, on our MBS and GSE CRT portfolio. Net premium amortization decreased compared to the same period in 2017 primarily due to slower prepayment speeds on Agency RMBS in the three months ended March 31, 2018 and purchases of CMBS securities at a discount over the last 12 months.
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.

 
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Interest Expense and the Cost of Funds
The table below presents the components of interest expense for the three months ended March 31, 2018 and 2017:
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Interest Expense
 
 
 
Interest expense on repurchase agreement borrowings
66,124

 
36,245

Amortization of net deferred (gain) loss on de-designated interest rate swaps
(6,539
)
 
(6,298
)
Repurchase agreements interest expense
59,585

 
29,947

Secured loans
6,927

 
3,413

Exchangeable senior notes
1,621

 
5,008

Total interest expense
68,133

 
38,368

We enter into repurchase agreements to finance the majority of our target assets. These agreements are secured by our Agency RMBS, non-Agency RMBS, GSE CRTs and CMBS. In addition, these agreements are generally settled on a short-term basis, usually from one to twelve months, and bear interest at rates that have historically moved in close relationship to LIBOR. At each settlement date, we typically refinance each repurchase agreement at the market interest rate at that time.
Our interest expense on repurchase agreement borrowings rose $29.9 million for the three months ended March 31, 2018 compared to 2017 primarily due to a $1.4 billion increase in average borrowings. We increased our average borrowings in the second half of 2017 after investing the proceeds of our August 2017 offering of Series C Preferred Stock. Interest expense on repurchase agreement borrowings was also impacted by increases in the Federal Funds target interest rate over the past 12 months.
Our repurchase agreement interest expense includes amortization of deferred gains and losses on de-designated interest rate swaps as summarized in the table above. Amortization of net deferred gains on de-designated interest rate swaps decreased our total interest expense by $6.5 million and $6.3 million, respectively, during the three months ended March 31, 2018 and 2017. Amounts recorded in AOCI before we discontinued cash flow hedge accounting for our interest rate swaps are reclassified to interest expense on repurchase agreements on the 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. During the next twelve months, we estimate that $25.2 million of net deferred gains on de-designated interest rate swaps will be reclassified from other comprehensive income and recorded as a decrease to interest expense.
During the three months ended March 31, 2018, interest expense for our secured loans increased $3.5 million compared to the same period in 2017 primarily due to higher borrowing rates. Borrowing rates on our secured loans are based on the three-month FHLB swap rate plus a spread. For the three months ended March 31, 2018, IAS Services LLC had a weighted average borrowing rate of 1.68% as compared to 0.83% for the three months ended March 31, 2017.
During the three months ended March 31, 2018, interest expense on exchangeable senior notes decreased $3.4 million compared to the same period in 2017 because we retired $256.6 million of the Notes during 2017 and the remaining balance of the Notes when they matured on March 15, 2018.
Our total interest expense during the three months ended March 31, 2018 increased $29.8 million from the same period in 2017 primarily due to the $33.4 million increases in interest expense on repurchase agreements borrowings and secured loans offset by a $3.4 million decrease in interest expense on the Notes as discussed above.

 
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The table below presents information related to our borrowings and cost of funds for the three months ended March 31, 2018 and 2017:
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Average Borrowings(1):
 
 
 
Agency RMBS (2)
11,427,614

 
9,716,908

CMBS (2)
2,542,722

 
2,172,234

Non-Agency RMBS
891,202

 
1,411,889

GSE CRT
674,555

 
600,223

Exchangeable senior notes
116,176

 
346,083

Total average borrowings
15,652,269

 
14,247,337

Maximum borrowings during the period (3)
15,674,202

 
14,484,038

Average Cost of Funds (4):
 
 
 
Agency RMBS (2)
1.65
%
 
0.87
%
CMBS (2)
2.28
%
 
1.34
%
Non-Agency RMBS
2.91
%
 
2.20
%
GSE CRT
2.87
%
 
2.27
%
Exchangeable senior notes
5.58
%
 
5.79
%
Cost of funds
1.74
%
 
1.08
%
Effective cost of funds (non-GAAP measure) (5)
2.22
%
 
1.90
%
(1)
Average amounts for each period are based on weighted month-end balances.
(2)
Agency RMBS and CMBS average borrowings and average cost of funds include borrowings under repurchase agreements and secured loans.
(3)
Amount represents the maximum borrowings at month-end during each of the respective periods.
(4)
Average cost of funds is calculated by dividing annualized interest expense excluding amortization of net deferred gain (loss) on de-designated interest rate swaps by our average borrowings.
(5)
For a reconciliation of cost of funds to effective cost of funds, see "Non-GAAP Financial Measures."
Total average borrowings rose $1.4 billion in the three months ended March 31, 2018 compared to 2017 primarily because we entered into repurchase agreements to finance our increased holdings of 30 year fixed-rate Agency RMBS and CMBS. The increase in our cost of funds for three months ended March 31, 2018 versus 2017 was primarily due to the increases in the Federal Funds target interest rate.

 
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Net Interest Income
The table below presents the components of net interest income for the three months ended March 31, 2018 and 2017:
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Interest Income
 
 
 
Mortgage-backed and credit risk transfer securities
149,003

 
118,873

Commercial loans
4,222

 
5,764

Total interest income
153,225

 
124,637

Interest Expense
 
 
 
Interest expense on repurchase agreement borrowings
66,124

 
36,245

Amortization of net deferred (gain) loss on de-designated interest rate swaps
(6,539
)
 
(6,298
)
Repurchase agreements interest expense
59,585

 
29,947

Secured loans
6,927

 
3,413

Exchangeable senior notes
1,621

 
5,008

Total interest expense
68,133

 
38,368

Net interest income
85,092

 
86,269

Net interest rate margin
1.64
%
 
1.98
%
Our net interest income, which equals interest income less interest expense, totaled $85.1 million (March 31, 2017: $86.3 million) for the three months ended March 31, 2018. The decrease in net interest income for the three months ended March 31, 2018 was primarily due to the increase in interest expense driven by higher average borrowings and borrowing rates exceeding the increase in interest income on higher average earning assets.
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 1.64% (March 31, 2017: 1.98%) for the three months ended March 31, 2018. The decrease in net interest rate margin for the three months ended March 31, 2018 compared to the same period in 2017 was primarily due to increases in the Federal Funds rate in 2017 and March 2018 that had a greater impact on our average cost of funds than on our average earning asset yields.
Gain (Loss) on Investments, net
The table below summarizes the components of gain (loss) on investments, net for the three months ended March 31, 2018 and 2017:
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Realized gains and losses on sale of investments
(9,237
)
 
(1,007
)
Other-than-temporary impairment losses
(4,359
)
 
(532
)
Net unrealized gains and losses on MBS accounted for under the fair value option
(147,195
)
 
(3,602
)
Net unrealized gains and losses on GSE CRT accounted for under the fair value option
434

 
3,279

Net unrealized gains and losses on trading securities
(13
)
 
9

Total gain (loss) on investments, net
(160,370
)
 
(1,853
)
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. During the three months ended March 31, 2018, we sold $198.5 million of mortgage-backed securities (March 31, 2017: $445.6 million) and realized losses of $9.2 million (March 31, 2017: net losses of $1.0 million).
We assess our investment securities for other-than-temporary impairment on a quarterly basis. When the fair value of an investment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated as either "temporary" or "other-than-temporary." For additional information regarding our assessment

 
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analysis of other-than temporary impairment on our investment securities, refer to Note 4 – “Mortgage-Backed and Credit Risk Transfer Securities” of our condensed consolidated financial statements.
We have elected the fair value option for all of our RMBS IOs, our MBS purchased on or after September 1, 2016 and our GSE CRTs purchased on or after August 24, 2015. Under the fair value option, changes in fair value are recognized in income in the condensed consolidated statements of operations and are reported as a component of gain (loss) on investments, net. As of March 31, 2018, $6.6 billion (December 31, 2017: $6.5 billion) or 37.6% (December 31, 2017: 35.6%) of our MBS and GSE CRT are accounted for under the fair value option.
Equity in Earnings (Losses) of Unconsolidated Ventures
For the three months ended March 31, 2018, we recorded equity in earnings of unconsolidated ventures of $896,000 (March 31, 2017: equity in losses of $1.5 million). We recorded equity earnings for the three months ended March 31, 2018 primarily due to realized and unrealized gains on the underlying portfolio investments. We recorded losses for the three months ended March 31, 2017 primarily due to unrealized losses on underlying portfolio investments.
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.
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.
The tables below summarize our realized and unrealized gain (loss) on derivative instruments, net for the following periods:
$ in thousands
 
Three months ended March 31, 2018
Derivative
not designated as
hedging instrument
 
Realized gain (loss) on derivative instruments, net
 
 Contractual net interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
 
122,273

 
(12,112
)
 
32,374

 
142,535

Futures Contracts
 
(5,277
)
 

 
(1,612
)
 
(6,889
)
Currency Forward Contracts
 
(3,418
)
 

 
1,139

 
(2,279
)
Total
 
113,578

 
(12,112
)
 
31,901

 
133,367

$ in thousands
 
Three months ended March 31, 2017
Derivative
not designated as
hedging instrument
 
Realized gain (loss) on derivative instruments, net
 
 Contractual net interest expense
 
Unrealized gain (loss), net
 
Gain (loss) on derivative instruments, net
Interest Rate Swaps
 
15,994

 
(22,894
)
 
12,950

 
6,050

Currency Forward Contracts
 
(1,076
)
 

 
488

 
(588
)
Total
 
14,918

 
(22,894
)
 
13,438

 
5,462

As of March 31, 2018 and December 31, 2017, we held the following interest rate swaps whereby we receive interest at a one-month and three-month LIBOR rate:
$ in thousands
 
As of March 31, 2018
 
As of December 31, 2017
Derivative instrument
 
Notional Amounts (1)
 
Average Fixed Pay Rate
 
Average Receive Rate
 
Average Maturity (Years)
 
Notional Amounts (2)
 
Average Fixed Pay Rate
 
Average Receive Rate
 
Average Maturity (Years)
Interest Rate Swaps
 
9,270,000

 
2.22
%
 
1.86
%
 
4.4
 
8,620,000

 
2.11
%
 
1.48
%
 
4.2
(1)
Excludes $1.3 billion of notional amount for interest rate swaps with forward start dates.
(2)
Excludes $500.0 million of notional amount for interest rate swaps with forward start dates.

 
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Realized and Unrealized Credit Derivative Income (Loss), net
The table below summarizes the components of realized and unrealized credit derivative income (loss), net for the three months ended March 31, 2018 and 2017.
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
GSE CRT embedded derivative coupon interest
5,633

 
5,807

Change in fair value of GSE CRT embedded derivatives
(2,468
)
 
14,148

Total
3,165

 
19,955

In the three months ended March 31, 2018, we recorded a $16.8 million decrease in realized and unrealized credit derivative income (loss), net compared to the same period in 2017 because the increases in valuation of the debt host contracts exceeded the increases in valuation of the hybrid financial instruments.
Net Loss on Extinguishment of Debt
The following table summarizes retirements of the Notes during the three months ended March 31, 2018 and 2017. We retired a portion of the Notes prior to their maturity and fully retired the Notes upon their maturity on March 15, 2018.
$ in thousands
Three Months Ended March 31,
 
2018
 
2017
Reacquisition price
143,433

 
153,750

Less: Par value of Notes retired during the period
(143,410
)
 
(150,000
)
Add: Write off of unamortized debt issuance cost associated with Notes retired during the period
3

 
961

Net loss on extinguishment of debt
26

 
4,711

Other Investment Income (Loss), net
Other investment income (loss), net consists of (i) quarterly dividends from FHLBI stock and an investment in an exchange-traded fund and (ii) foreign exchange rate gains and losses related to a commercial loan investment denominated in a foreign currency. The table below summarizes the components of other investment income (loss), net for the three months ended March 31, 2018 and 2017.
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Dividend income
1,288

 
816

Gain (loss) on foreign currency transactions, net
1,814

 
513

Total
3,102

 
1,329

We are required to purchase and hold a certain amount of FHLBI stock, which is based, in part, upon the outstanding principal balance of secured advances from the FHLBI. We earn dividend income on our investment in FHLBI stock, and the amount of our dividend income varies based upon the number of shares that we are required to own and the dividend declared per share.
We incurred foreign exchange gains (losses) on the revaluation of a commercial loan investment (notional amount of £34.5 million) for the three months ended March 31, 2018 and 2017 due to the fluctuation in the Pound Sterling/ U.S. Dollar foreign exchange rate. We enter into currency forward contracts as an economic hedge against our foreign currency exposure. Changes in the fair value of our currency forward contracts are recognized in gain (loss) derivative instruments, net in the condensed consolidated statements of operations. During the three months ended March 31, 2018, we recognized net losses of $2.3 million (March 31, 2017: net losses of $588,000) on our currency forward contracts.

 
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Expenses
For the three months ended March 31, 2018, we incurred management fees of $10.2 million (March 31, 2017: $8.8 million), which are payable to our Manager under our management agreement. Management fees increased for the three months ended March 31, 2018 compared to the same period in 2017 primarily because we issued preferred stock in August 2017. Refer to Note 12 – "Related Party Transactions" of our condensed consolidated financial statements for a discussion of our relationship with our Manager and a description of how our fees are calculated.
For the three months ended March 31, 2018, our general and administrative expenses not covered under our management agreement amounted to $1.8 million (March 31, 2017: $2.1 million). General and administrative expenses not covered under our management agreement primarily consist of directors and officers insurance, legal costs, accounting, auditing and tax services, and miscellaneous general and administrative costs. General and administrative costs were lower for the three months ended March 31, 2018 versus 2017 primarily due to higher professional fees in the 2017 period.
Net Income (Loss) attributable to Common Stockholders
For the three months ended March 31, 2018, our net income attributable to common stockholders was $41.5 million (March 31, 2017: $87.1 million) or $0.37 basic and diluted net income per average share available to common stockholders (March 31, 2017: $0.78 basic and $0.73 diluted net income per average share available to common stockholders). The change in net income attributable to common stockholders was primarily due to (i) net loss on investments of $160.4 million in the 2018 period versus net loss on investments of $1.9 million in the 2017 period, (ii) net gains on derivative instruments of $133.4 million in the 2018 period versus net gains on derivative instruments of $5.5 million in the 2017 period, (iii) net credit derivative income of $3.2 million in the 2018 period versus net credit derivative income of $20.0 million in the 2017 period and (iv) dividends to preferred stockholders of $11.1 million in the 2018 period versus $5.7 million in the 2017 period. Dividends to preferred stockholders for the three months ended March 31, 2018 increased compared to 2017 due to the issuance of $287.5 million of Series C Preferred Stock in August 2017.
For further information on the changes in net gains or losses on investments, changes in net gains on derivative instruments, realized and unrealized credit derivative income (loss), net and preferred dividends in the 2018 period versus 2017 period, see preceding discussion under "Gain (Loss) on Investments, net," "Gain (Loss) on Derivative Instruments, net," "Realized and Unrealized Credit Derivative Income (Loss), net," and "Capital Activities."
Non-GAAP Financial Measures
We use the following non-GAAP financial measures to analyze the Company's operating results and believe these financial measures are useful to investors in assessing our performance as further discussed below:
core earnings (and by calculation, core earnings per common share),
effective interest income (and by calculation, effective yield),
effective interest expense (and by calculation, effective cost of funds),
effective net interest income (and by calculation, effective interest rate margin), and
repurchase agreement debt-to-equity ratio. 
The most directly comparable U.S. GAAP measures are:
net income (loss) attributable to common stockholders (and by calculation, basic earnings (loss) per common share),
total interest income (and by calculation, earning asset yields),
total interest expense (and by calculation, cost of funds),
net interest income (and by calculation, net interest rate margin), and
debt-to-equity ratio. 
The non-GAAP financial measures used by management should be analyzed in conjunction with U.S. GAAP financial measures and should not be considered substitutes for U.S. GAAP financial measures In addition, the non-GAAP financial measures may not be comparable to similarly titled non-GAAP financial measures of our peer companies.

 
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Core Earnings
We calculate core earnings as U.S. GAAP net income (loss) attributable to common stockholders adjusted for (gain) loss on investments, net; realized (gain) loss on derivative instruments, net; unrealized (gain) loss on derivative instruments, net; realized and unrealized (gain) loss on GSE CRT embedded derivatives, net; (gain) loss on foreign currency transactions, net; amortization of net deferred (gain) loss on de-designated interest rate swaps; net loss on extinguishment of debt; and cumulative adjustments attributable to non-controlling interest. We may add and have added additional reconciling items to our core earnings calculation as appropriate.
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 exclude the impact of gains and losses because gains and losses are not accounted for consistently under U.S. GAAP. Under U.S. GAAP, certain gains and losses are reflected in net income whereas other gains and losses are reflected in other comprehensive income. For example, the majority of our mortgage-backed securities are classified as available-for-sale securities, and we record changes in the valuation of these securities in other comprehensive income on our condensed consolidated balance sheets. We elected the fair value option for our mortgage-backed securities purchased on or after September 1, 2016, and changes in the valuation of these securities are recorded in other income (loss) in our condensed consolidated statements of operations. In addition, certain gains and losses represent one-time events.
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.
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 March 31,
$ in thousands, except per share data
2018
 
2017
Net income (loss) attributable to common stockholders
41,471

 
87,130

Adjustments:
 
 
 
(Gain) loss on investments, net
160,370

 
1,853

Realized (gain) loss on derivative instruments, net (1)
(113,578
)
 
(14,918
)
Unrealized (gain) loss on derivative instruments, net (1)
(31,901
)
 
(13,438
)
Realized and unrealized (gain) loss on GSE CRT embedded derivatives, net (2)
2,468

 
(14,148
)
(Gain) loss on foreign currency transactions, net (3)
(1,814
)
 
(513
)
Amortization of net deferred (gain) loss on de-designated interest rate swaps(4) 
(6,539
)
 
(6,298
)
Net loss on extinguishment of debt
26

 
4,711

Subtotal
9,032

 
(42,751
)
Cumulative adjustments attributable to non-controlling interest
(114
)
 
539

Core earnings attributable to common stockholders
50,389

 
44,918

Basic income (loss) per common share
0.37

 
0.78

Core earnings per share attributable to common stockholders(5)
0.45

 
0.40


 
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(1)
U.S. GAAP gain (loss) on derivative instruments, net on the condensed consolidated statements of operations includes the following components:
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Realized gain (loss) on derivative instruments, net
113,578

 
14,918

Unrealized gain (loss) on derivative instruments, net
31,901

 
13,438

Contractual net interest expense
(12,112
)
 
(22,894
)
Gain (loss) on derivative instruments, net
133,367

 
5,462

(2)
U.S. GAAP realized and unrealized credit derivative income (loss), net on the condensed consolidated statements of operations includes the following components:
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Realized and unrealized gain (loss) on GSE CRT embedded derivatives, net
(2,468
)
 
14,148

GSE CRT embedded derivative coupon interest
5,633

 
5,807

Realized and unrealized credit derivative income (loss), net
3,165

 
19,955

(3)
U.S. GAAP other investment income (loss) net on the condensed consolidated statements of operations includes the following components:
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Dividend income
1,288

 
816

Gain (loss) on foreign currency transactions, net
1,814

 
513

Other investment income (loss), net
3,102

 
1,329

(4)
U.S. GAAP repurchase agreements interest expense on the condensed consolidated statements of operations includes the following components:
 
Three Months Ended March 31,
$ in thousands
2018
 
2017
Interest expense on repurchase agreements borrowings
66,124

 
36,245

Amortization of net deferred (gain) loss on de-designated interest rate swaps
(6,539
)
 
(6,298
)
Repurchase agreements interest expense
59,585

 
29,947

(5)
Core earnings per share attributable to common stockholders is equal to core earnings divided by the basic weighted average number of common shares outstanding.
Core earnings for the three months ended March 31, 2018 increased $5.5 million from the same period in 2017 primarily due to the net impact of investing the proceeds of our $287.5 million Series C Preferred Stock offering in August 2017 as well as a $2.4 million increase in income from our joint venture investments.


 
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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 as realized and unrealized credit derivative income (loss), net. We include our GSE CRT embedded derivative coupon interest in effective interest income because GSE CRT coupon interest is not accounted for consistently under U.S. GAAP. We account for GSE CRTs purchased prior to August 24, 2015 as hybrid financial instruments, but we have elected the fair value option for GSE CRTs purchased on or after August 24, 2015. Under U.S. GAAP, coupon interest on GSE CRTs accounted for using the fair value option is recorded as interest income, whereas coupon interest on GSE CRTs accounted for as hybrid financial instruments is recorded as realized and unrealized credit derivative income (loss). We add back GSE CRT embedded derivative coupon interest to our total interest income because we consider GSE CRT embedded derivative coupon interest a current component of our total interest income irrespective of whether we elected the fair value option for the GSE CRT or accounted for the GSE CRT as a hybrid financial instrument.
We calculate effective interest expense (and by calculation, effective cost of funds) as U.S. GAAP total interest expense adjusted for contractual net interest expense on our interest rate swaps that is recorded as gain (loss) on derivative instruments, net and the amortization of net deferred gains (losses) on de-designated interest rate swaps that is recorded as repurchase agreements interest expense. We view our interest rate swaps as an economic hedge against increases in future market interest rates on our floating rate borrowings. We add back the net payments we make on our interest rate swap agreements to our total U.S. GAAP interest expense because we use interest rate swaps to add stability to interest expense. We exclude the amortization of net deferred gains (losses) on de-designated interest rate swaps from our calculation of effective interest expense because we do not consider the amortization a current component of our borrowing costs.
We calculate effective net interest income (and by calculation, effective interest rate margin) as U.S. GAAP net interest income adjusted for net interest expense on our interest rate swaps that is recorded as gain (loss) on derivative instruments, amortization of net deferred gains (losses) on de-designated interest rate swaps that is recorded as repurchase agreements interest expense and GSE CRT embedded derivative coupon interest that is recorded as realized and unrealized credit derivative income (loss), net.
We believe the presentation of effective interest income, effective yield, effective interest expense, effective cost of funds, effective net interest income and effective interest rate margin measures, when considered together with U.S. GAAP financial measures, provide information that is useful to investors in understanding our borrowing costs and operating performance.
The following table reconciles total interest income to effective interest income and yield to effective yield for the following periods:
 
Three Months Ended March 31,
 
2018
 
2017
$ in thousands
Reconciliation
 
Yield/Effective Yield
 
Reconciliation
 
Yield/Effective Yield
Total interest income
153,225

 
3.38
%
 
124,637

 
3.06
%
Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net
5,633

 
0.12
%
 
5,807

 
0.14
%
Effective interest income
158,858

 
3.50
%
 
130,444

 
3.20
%
Our effective interest income increased in the three months ended March 31, 2018 versus the same period in 2017 primarily due to higher average earning assets. The increase in effective yield for the three months ended March 31, 2018 versus the same period in 2017 was primarily due to slower prepayment speeds and higher index rates on floating and adjustable rate assets.

 
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The following table reconciles total interest expense to effective interest expense and cost of funds to effective cost of funds for the following periods.
 
Three Months Ended March 31,
 
2018
 
2017
$ in thousands
Reconciliation
 
Cost of Funds / Effective Cost of Funds
 
Reconciliation
 
Cost of Funds / Effective Cost of Funds
Total interest expense
68,133

 
1.74
%
 
38,368

 
1.08
%
Add (Less): Amortization of net deferred gain (loss) on de-designated interest rate swaps
6,539

 
0.17
%
 
6,298

 
0.18
%
Add: Contractual net interest expense on interest rate swaps recorded as gain (loss) on derivative instruments, net
12,112

 
0.31
%
 
22,894

 
0.64
%
Effective interest expense
86,784

 
2.22
%
 
67,560

 
1.90
%
Our effective interest expense and effective cost of funds increased during the three months ended March 31, 2018 compared to the same period in 2017 primarily due to increased borrowings and higher interest rates. See the preceding caption "Interest Expense and Cost of Funds" for further discussion of these variances.
The following table reconciles net interest income to effective net interest income and net interest rate margin to effective interest rate margin for the following periods.
 
Three Months Ended March 31,
 
2018
 
2017
$ in thousands
Reconciliation
 
Net Interest Rate Margin / Effective Interest Rate Margin
 
Reconciliation
 
Net Interest Rate Margin / Effective Interest Rate Margin
Net interest income
85,092

 
1.64
 %
 
86,269

 
1.98
 %
Add (Less): Amortization of net deferred (gain) loss on de-designated interest rate swaps
(6,539
)
 
(0.17
)%
 
(6,298
)
 
(0.18
)%
Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net
5,633

 
0.12
 %
 
5,807

 
0.14
 %
Less: Contractual net interest expense on interest rate swaps recorded as gain (loss) on derivative instruments, net
(12,112
)
 
(0.31
)%
 
(22,894
)
 
(0.64
)%
Effective net interest income
72,074

 
1.28
 %
 
62,884

 
1.30
 %
Effective net interest income for the three months ended March 31, 2018 increased from the same period in 2017 primarily due to lower contractual net interest expense on interest rate swaps. Contractual net interest expense decreased from $22.9 million for the three months ended March 31, 2017 to $12.1 million for the three months ended March 31, 2018 primarily as a result of higher LIBOR.
Effective interest rate margin decreased for the three months ended March 31, 2018 compared to the same period in 2017 primarily due to increases in the Federal Funds rate in 2017 and March 2018 that had a greater impact on our average cost of funds than on our average earning asset yields.

 
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Repurchase Agreement Debt-to-Equity Ratio
The tables below show the allocation of our equity to our target assets, our debt-to-equity ratio, and our repurchase agreement debt-to-equity ratio as of March 31, 2018 and December 31, 2017. Our debt-to-equity ratio is calculated in accordance with U.S. GAAP and is the ratio of total debt (sum of repurchase agreements, secured loans and exchangeable senior notes) to total equity. We present a repurchase agreement debt-to-equity ratio, a non-GAAP financial measure of leverage, because the mortgage REIT industry primarily uses repurchase agreements, which typically mature within one year, to finance investments. We believe that presenting our repurchase agreement debt-to-equity ratio, when considered together with our U.S. GAAP financial measure of debt-to-equity ratio, 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.
Our debt-to-equity ratio increased to 6.2x as of March 31, 2018 from 6.0x as of December 31, 2017 reflecting lower equity due to declines in mortgage-backed security valuations. Our repurchase agreement debt-to-equity ratio increased to 6.8x as of March 31, 2018 from 6.1x as of December 31, 2017 primarily because we utilized repurchase agreement borrowings to retire our Notes on March 15, 2018.
March 31, 2018
$ in thousands
Agency
RMBS
Commercial Credit (1)
Residential Credit (2)
Other
Total
Investments
12,376,747

3,401,704

2,056,206


17,834,657

Cash and cash equivalents (3)
51,820

41,645

23,659


117,124

Restricted cash
666

1,734



2,400

Derivative assets, at fair value (4)
26,280

105



26,385

Other assets
268,033

63,585

5,894

3,966

341,478

Total assets
12,723,546

3,508,773

2,085,759

3,966

18,322,044

 
 
 
 
 
 
Repurchase agreements
10,864,431

1,482,869

1,563,837


13,911,137

Secured loans (5)
549,325

1,100,675



1,650,000

Derivative liabilities, at fair value (4)
20,170

184



20,354

Other liabilities
177,439

25,392

15,366


218,197

Total liabilities
11,611,365

2,609,120

1,579,203


15,799,688

 
 
 
 
 
 
Total equity (allocated)
1,112,181

899,653

506,556

3,966

2,522,356

Adjustments to calculate repurchase agreement debt-to-equity ratio:
 
 
 
 
 
Net equity in unsecured assets (6)

(212,423
)

(3,966
)
(216,389
)
Collateral pledged against secured loans
(638,847
)
(1,280,048
)


(1,918,895
)
Secured loans
549,325

1,100,675



1,650,000

Equity related to repurchase agreement debt
1,022,659

507,857

506,556


2,037,072

Debt-to-equity ratio (7)
10.3

2.9

3.1

NA

6.2

Repurchase agreement debt-to-equity ratio (8)
10.6

2.9

3.1

NA

6.8

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


 
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December 31, 2017
$ in thousands
Agency
RMBS
Commercial Credit (1)
Residential Credit (2)
Exchangeable Senior Notes and Other
Total
Investments
12,849,851

3,434,196

2,124,487


18,408,534

Cash and cash equivalents (3)
39,630

31,069

17,682


88,381

Restricted cash

620



620

Derivative assets, at fair value (4)
6,896




6,896

Other assets
77,893

64,284

6,669

3,979

152,825

Total assets
12,974,270

3,530,169

2,148,838

3,979

18,657,256

 
 
 
 
 
 
Repurchase agreements
11,111,755

1,396,330

1,572,716


14,080,801

Secured loans (5)
533,463

1,116,537



1,650,000

Exchangeable senior notes



143,231

143,231

Derivative liabilities, at fair value (4)
31,548

1,217



32,765

Other liabilities
51,840

24,742

14,888

2,111

93,581

Total liabilities
11,728,606

2,538,826

1,587,604

145,342

16,000,378

 
 
 
 
 
 
Total equity (allocated)
1,245,664

991,343

561,234

(141,363
)
2,656,878

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

(217,780
)

141,363

(76,417
)
Collateral pledged against secured loans
(623,181
)
(1,304,315
)


(1,927,496
)
Secured loans
533,463

1,116,537



1,650,000

Equity related to repurchase agreement debt
1,155,946

585,785

561,234


2,302,965

Debt-to-equity ratio (7)
9.3

2.5

2.8

NA

6.0

Repurchase agreement debt-to-equity ratio (8)
9.6

2.4

2.8

NA

6.1

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

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

 
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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, cash equivalents and restricted cash of $119.5 million at March 31, 2018 (March 31, 2017: $55.9 million). Our cash, cash equivalents and restricted cash increased due to normal fluctuations in cash balances related to the timing of principal and interest payments, repayments of debt, and asset purchases and sales. Our operating activities provided net cash of $76.8 million for the three months ended March 31, 2018 (March 31, 2017: $62.8 million).
Our investing activities provided net cash of $325.5 million in the three months ended March 31, 2018 compared to net cash used in investing activities of $1.1 billion in the three months ended March 31, 2017. We invested $298.9 million in mortgage-backed and credit risk transfer securities during the three months ended March 31, 2018 compared to investments of $1.8 billion in mortgage-backed and credit risk transfer securities in the three months ended March 31, 2017. We generated $488.1 million from principal payments of mortgage-backed and credit risk transfer securities during the three months ended March 31, 2018 compared to $562.2 million from principal payments of mortgage-backed and credit risk transfer securities and $180.8 million from the sales of mortgage-backed and credit risk transfer securities in the three months ended March 31, 2017. We also received net proceeds on settlement of derivative contracts of $113.6 million during the three months ended March 31, 2018 compared to $14.9 million in the three months ended March 31, 2017.
Our financing activities used net cash of $371.8 million for the three months ended March 31, 2018 compared to net cash provided by financing activities of $926.0 million in the three months ended March 31, 2017. We used cash of $143.4 million (March 31, 2017: $153.8 million) to extinguish the exchangeable senior notes and to pay dividends of $58.6 million (March 31, 2017: $50.9 million). We also used cash of $169.7 million to make net principal repayments on repurchase agreements (March 31, 2017: net proceeds of $1.1 billion).
As of March 31, 2018, our wholly-owned subsidiary, IAS Services, had $1.65 billion in outstanding secured loans from the FHLBI. As of March 31, 2018, the FHLBI advances were collateralized by CMBS and Agency RMBS with a fair value of $1.3 billion and $638.2 million, respectively and cash of $2.0 million.
As of March 31, 2018, the average margin requirement (weighted by borrowing amount), or the percentage amount by which the collateral value must exceed the loan amount (also refer to as the "haircut") under our repurchase agreements was 4.8% for Agency RMBS, 21.0% for non-Agency RMBS, 20.6% for GSE CRT and 19.4% for CMBS. Across our repurchase agreement facilities, the haircuts range from a low of 3.0% to a high of 27.5% for Agency RMBS, a low of 10.0% to a high of 35.0% for non-Agency RMBS, a low of 16.7% to a high of 27.5% for GSE CRT, a low of 10.0% to a high of 30.0% for CMBS. 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.
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 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

 
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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.
Contractual Obligations
We have entered into an agreement with our Manager pursuant to which our Manager is entitled to receive a management fee and the reimbursement of certain expenses. The management fee is calculated and payable quarterly in arrears in an amount equal to 1.50% of our stockholders’ equity, per annum. Refer to Note 12 - "Related Party Transactions" of our condensed consolidated financial statements for a description of adjustments made to our stockholders' equity for purposes of calculating our management fee. Our Manager uses the proceeds from its management fee in part to pay compensation to its officers and personnel who, notwithstanding that certain of those individuals are also our officers, receive no cash compensation directly from us. We are required to reimburse our Manager for operating expenses related to us incurred by our Manager, including certain salary expenses and other expenses relating to legal, accounting, due diligence and other services. Our reimbursement obligation is not subject to any dollar limitation. Refer to Note 12 – "Related Party Transactions" of our condensed consolidated financial statements for details of our reimbursements to our Manager.
As of March 31, 2018, we had the following contractual obligations:
 
Payments Due by Period
$ in thousands
Total
 
Less than 1
year
 
1-3 years
 
3-5 years
 
After 5
years
Repurchase agreements
13,911,137

 
13,911,137

 

 

 

Secured loans
1,650,000

 

 
400,000

 

 
1,250,000

Total (1)
15,561,137

 
13,911,137

 
400,000

 

 
1,250,000

 
(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.
As of March 31, 2018, we have approximately $37.5 million and $191.3 million in contractual interest payments related to our repurchase agreements and secured loans, respectively.
Off-Balance Sheet Arrangements
We have committed to invest up to $123.1 million in unconsolidated ventures that are sponsored by an affiliate of our Manager. As of March 31, 2018, $114.2 million of our commitment to these unconsolidated ventures has been called. We are committed to fund $8.9 million in additional capital to fund future investments and cover future expenses should they occur.
As of March 31, 2018, we have unfunded commitments on commercial loans of $4.1 million (December 31, 2017: $4.8 million).

 
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Share-Based Compensation
We established the 2009 Equity Incentive Plan for grants of common stock and other equity based awards to our independent directors and officers and employees of our Manager and its affiliates (the "Incentive Plan"). Under the Incentive Plan, a total of 1,000,000 shares of common stock are authorized for issuance. Unless terminated earlier, the Incentive Plan will terminate in 2019, but will continue to govern the unexpired awards. As of March 31, 2018, 778,288 shares of common stock remain available for future issuance under the Incentive Plan.
We recognized compensation expense of approximately $93,000 (March 31, 2017: $85,000) for shares issued to our independent directors under the Incentive Plan for the three months ended March 31, 2018 and 2017. During the three months ended March 31, 2018 and 2017, we issued 7,177 shares and 5,456 shares of stock, respectively, to our independent directors. The fair market value of the shares granted was determined by the closing stock market price on the date of the grant. The grants vested immediately.
We recognized compensation expense of approximately $14,000 (March 31, 2017: $31,000) for the three months ended March 31, 2018 for restricted stock units awarded to employees of our Manager and its affiliates under the Incentive Plan. Our Manager reimburses us for the cost of these restricted stock awards under the terms of our management agreement. At March 31, 2018 there was approximately $306,000 of total unrecognized compensation cost related to restricted stock unit awards that is expected to be recognized over a period of up to 48 months, with a weighted-average remaining vesting period of 23 months.
The following table summarizes the activity related to restricted stock units awarded to employees of our Manager and its affiliates for the three months ended March 31, 2018.
 
Three Months Ended March 31,
 
2018
 
Restricted Stock Units
 
Weighted Average Grant Date Fair Value (1)
Unvested at the beginning of the period
19,827

 
$
14.35

Shares granted during the period
7,055

 
15.37

Shares vested during the period
(7,697
)
 
14.75

Unvested at the end of the period
19,185

 
$
14.56

(1)
The grant date fair value of restricted stock awards is based on the closing market price of our common stock at the grant date.
Dividends
We intend to continue to make regular quarterly distributions to holders of our common stock and preferred stock. U.S. federal income tax law generally requires that a REIT distribute at least 90% of its REIT taxable income annually, determined without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its taxable income. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on our repurchase agreements and other debt payable. If our cash available for distribution is less than our taxable income, we could be required to sell assets or borrow funds to make cash distributions, or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.
Inflation
Virtually all of our assets and liabilities are sensitive to interest rates. As a result, interest rates and other factors influence our performance far more than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates.
Unrelated Business Taxable Income
We have not engaged in transactions that would result in a portion of our income being treated as unrelated business taxable income.

 
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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 March 31, 2018, and that our proposed method of operation will permit us to satisfy the asset tests, gross income tests, and distribution and stock ownership requirements for our taxable year that will end on December 31, 2018.
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 March 31, 2018, we conducted our business so as not to be regulated as an investment company under the 1940 Act.

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.

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

 
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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 March 31, 2018, 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%
 
(26.92
)%
 
(1.75
)%
+0.50%
 
(11.65
)%
 
(0.64
)%
-0.50%
 
5.86
 %
 
0.93
 %
-1.00%
 
0.27
 %
 
1.26
 %
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 March 31, 2018. 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 March 31, 2018, 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 securities purchased at a premium, and accretion of discount on our securities purchased at a discount. As a result, because this floor limits the positive impact of any interest rate decrease on our funding costs, hypothetical interest rate decreases could cause the fair value of our financial instruments and our net interest income to decline.
The information set forth in the interest rate sensitivity table above and all related disclosures constitutes forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Actual results could differ significantly from those estimated in the foregoing interest rate sensitivity table.
Real Estate Risk
Residential and commercial property values are subject to volatility and may be adversely affected by a number of factors, including, but not limited to: national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions (such as the supply of housing stock); changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; and retroactive changes to building or similar codes. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could also cause us to suffer losses.
Credit Risk
We believe that our investment strategy will generally keep our credit losses and financing costs low. However, we retain the risk of potential credit losses on all of our residential and commercial mortgage investments. We seek to manage this risk through our pre-acquisition due diligence process. In addition, we re-evaluate the credit risk inherent in our investments on a regular basis pursuant to fundamental considerations such as GDP, unemployment, interest rates, retail sales, store closings/openings, corporate earnings, housing inventory, affordability and regional home price trends. We also review key loan credit metrics including, but not limited to, payment status, current loan-to-value ratios, current borrower credit scores and debt yields. These characteristics assist in determining the likelihood and severity of loan loss as well as prepayment and extension expectations. We then perform structural analysis under multiple scenarios to establish likely cash flow profiles and credit enhancement levels relative to collateral performance projections. This analysis allows us to quantify our opinions of credit quality and fundamental value, which are key drivers of portfolio management decisions.

 
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Foreign Exchange Rate Risk
We have an investment in a commercial loan denominated in foreign currency and an investment in an unconsolidated joint venture whose net assets and results of operations are exposed to foreign currency translation risk when translated in U.S. dollars upon consolidation. We seek to hedge our foreign currency exposures by purchasing currency forward contracts.
Risk Management
To the extent consistent with maintaining our REIT qualification, we seek to manage risk exposure to protect our investment portfolio against the effects of major interest rate changes. We generally seek to manage this risk by:
monitoring and adjusting, if necessary, the reset index and interest rate related to our target assets and our financings;
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.
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 March 31, 2018. Based upon our evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.
Changes in Internal Control over Financial Reporting    
There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter ended March 31, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


 
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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 March 31, 2018, 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 for the year ended December 31, 2017, as filed with the SEC on February 20, 2018. 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.
During the three months ended March 31, 2018, we did not repurchase any shares of our common stock.
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.
 
 
 
May 3, 2018
By:
/s/ John M. Anzalone
 
 
John M. Anzalone
 
 
Chief Executive Officer
 
 
 
May 3, 2018
By:
/s/ R. Lee Phegley, Jr.
 
 
R. Lee Phegley, Jr.
 
 
Chief Financial Officer


 
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EXHIBIT INDEX
Item 6.        Exhibits
 
Exhibit
No.
  
Description
 
 
3.1

  
 
 
3.2

  
 
 
3.3

  
 
 
3.4

 
 
 
 
3.5

  
 
 
 
31.1

  
 
 
31.2

  
 
 
32.1

  
 
 
32.2

  
 
 
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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