10-K 1 a2017123110k.htm 10-K Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________________________________
FORM 10-K
________________________________________________________________
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission file number 001-33740
________________________________________________________________
CYS Investments, Inc.
________________________________________________________________
(Exact name of registrant as specified in its charter)
Maryland
 
20-4072657
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)
 
 
 
500 Totten Pond Road, 6th Floor, Waltham, Massachusetts
 
02451
(Address of principal executive offices)
 
(Zip Code)
(617) 639-0440
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common stock, $0.01 par value
 
New York Stock Exchange
7.75% Series A Cumulative Redeemable Preferred Stock, $25.00 Liquidation Preference
 
New York Stock Exchange
7.50% Series B Cumulative Redeemable Preferred Stock, $25.00 Liquidation Preference
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x  No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x    
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company"in Rule 12b-2 of the Exchange Act. Check one:
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
Emerging growth company
¨
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. ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨  No  x 
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was approximately 1,257,483,477 based on the closing price on the New York Stock Exchange as of June 30, 2017.
Number of the registrant's common stock outstanding as of January 31, 2018: 155,028,274
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement with respect to its 2018 Annual Meeting of Stockholders to be filed not later than 120 days after the end of the registrant's fiscal year are incorporated by reference into Part II, Item 5 and III hereof as noted therein.
 



CYS INVESTMENTS, INC.
INDEX
 
 
Page
 
PART I
 
 
 
 
 
PART II
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART III
 
 
 
 
 
 
 
 
PART IV
 
 
 
 



PART I
Item 1. Business

In this Annual Report on Form 10-K, we refer to CYS Investments, Inc. as "we," "us," "our company," or "our," unless we specifically state otherwise or the context indicates otherwise.
Please refer to the section titled “Glossary of Terms” located at the end of Part II. Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for definitions of some of the commonly used terms in this Annual Report on Form 10-K.
Forward Looking Statements
When used in this Annual Report on Form 10-K, in future filings with the Securities and Exchange Commission ("SEC") or in press releases or other written or oral communications, statements which are not historical in nature, including those containing words such as "believe," "expect," "anticipate," "estimate," "plan," "continue," "intend," "should," "may" or similar expressions, are intended to identify "forward-looking statements" 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, as such, may involve known and unknown risks, uncertainties and assumptions. The forward-looking statements we make in this Annual Report on Form 10-K include, but are not limited to, statements about the following:
the effect of movements in interest rates on our assets and liabilities (including our hedging instruments) and our net income;
our investment, financing and hedging strategies;
the effect of U.S. government and foreign central bank actions on interest rates and the housing and credit markets, government sponsored entities and the economy;
the effect of actual or proposed actions and anticipated progress announced by the Federal Housing Finance Agency (the "FHFA"), the Federal Housing Administration (the “FHA”) and the Consumer Financial Protection Bureau (the “CFPB”);
the effect of actual or proposed actions of the U.S. Federal Reserve (the "Fed") and the Fed Open Market Committee (the "FOMC") with respect to monetary policy, interest rates, inflation, GDP growth or unemployment;
the supply and availability of Agency Residential Mortgage-Backed Securities ("RMBS");
the effect of increased prepayment rates on the value of our assets;
our ability to convert our assets into cash and cash equivalents or extend the financing terms related to our assets;
the effect of widening credit spreads or shifts in the yield curve on the value of our assets and investment strategy;
the types of indebtedness we may incur;
our ability to achieve anticipated benefits from interest rate swaps, swaptions and caps;
our ability to quantify risks based on historical experience;
our ability to be taxed as a real estate investment trust ("REIT") and to maintain an exemption from registration under the Investment Company Act of 1940, as amended (the "Investment Company Act");
the tax limitations of capital loss carryforwards;
our assessment of counterparty risk and/or the rise of counterparty defaults;
our overall liquidity and ability to meet short-term liquidity requirements with our cash flow from operations and borrowings;
the effect of rising interest rates on unemployment, inflation and mortgage supply and demand;
our borrowing costs;
changes in our investment guidelines and the composition of our investment portfolio;
our asset valuation policies; and

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our dividend distribution policy.
Forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. The following describe some, but not all, of the factors that could cause actual results to vary from our forward-looking statements:
the factors referenced in this Annual Report on Form 10-K, including those set forth under the section captioned "Risk Factors";
changes in our investment, financing and hedging strategies;
the adequacy of our cash flow from operations and borrowings to meet our short- and long-term liquidity requirements;
unanticipated changes in our industry, interest rates, the credit markets, the general economy or the real estate market;
changes in interest rates and the market value of our Agency RMBS;
changes in the prepayment rates on the mortgage loans underlying our Agency RMBS;
our ability to borrow to finance our assets;
actions by the U.S. government, the Fed, and other government agencies that impact the value of our Agency RMBS or interest rates;
changes in government regulations affecting our business;
changes in the U.S. government's credit rating or ability to pay its debts;
our ability to maintain our qualification as a REIT for federal income tax purposes;
our ability to maintain our exemption from registration under the Investment Company Act and the availability of such exemption in the future; and
risks associated with investing in real estate assets, including changes in business conditions and the general economy.
These and other risks, uncertainties and factors, including those described elsewhere in this report, could cause our actual results to differ materially from those projected in any forward-looking statements we make. All forward-looking statements speak only as of the date on which they are made. New risks and uncertainties arise over time and it is not possible 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.
Our Company
We are a specialty finance company created with the objective of achieving consistent risk-adjusted investment income.  We have elected to be taxed as a REIT for federal income tax purposes. We were formed as a Maryland corporation on January 3, 2006, commenced operations in February 2006 and completed the initial public offering of our common stock in June 2009. We conduct all of our business through and hold all of our assets in CYS Investments, Inc. and its subsidiaries.
Investment Strategy
We invest in Agency RMBS collateralized by fixed rate single-family residential mortgage loans (primarily 15 and 30 years), adjustable-rate mortgages ("ARMs"), which have coupon rates that reset monthly, or Hybrid ARMs, which have a coupon rate that is fixed for an initial period (typically three, five, seven or ten years) and thereafter reset at regular intervals. In addition, our investment guidelines permit investments in collateralized mortgage obligations issued by a government agency or government-sponsored entity that are collateralized by Agency RMBS ("CMOs"), and credit risk transfer securities, such as Structured Agency Credit Risk (“STACR”) debt securities issued by Freddie Mac, Connecticut Avenue Securities ("CAS") issued by Fannie Mae, or similar securities issued or sponsored by a U.S. government-sponsored entity ("GSE") where their cash flows track the credit risk performance of a notional reference pool of mortgage loans. We had no investments in CMOs, STACRs, CAS, or other similar securities as of December 31, 2017 and 2016. In addition, we invest in debt securities issued by the United States Department of the Treasury (the "U.S. Treasury") or a government-sponsored entity that are not backed by collateral but, in the case of government agencies, are backed by the full faith and credit of the U.S. government ("U.S.

2


Treasuries"), and, in the case of government-sponsored entities, are backed by the integrity and creditworthiness of the issuer ("U.S. Agency Debentures").

We make investment decisions based on various factors, including, but not limited to, relative value, expected cash flow yield, supply and demand, costs of financing and hedging, liquidity, expected future interest rate volatility and the overall shape of the U.S. Treasury and interest rate swap yield curves. We do not attribute any particular quantitative significance to any of these factors, and the weight given to these factors varies depending on market conditions and economic trends. We believe that this strategy enables us to pay dividends and manage our book value throughout changing interest rate and credit cycles, and provide attractive long-term returns to investors.
Our investment strategy is designed to:
maintain an investment portfolio consisting primarily of Agency RMBS that generates risk-adjusted investment income;
manage financing, interest and prepayment rate risks;
capitalize on discrepancies in the relative valuations in the Agency RMBS market;
manage cash flow to provide for regular quarterly distributions to stockholders;
manage credit risk;
manage the impact that changing interest rates have on our net income and book value, or stockholders' equity;
invest opportunistically in assets within our investment guidelines;
maintain our qualification as a REIT; and
exempt us from the registration requirements of the Investment Company Act.
Our income is generated primarily from the difference between the interest income we earn on our investment portfolio and the cost of our borrowings and hedging activities, which difference is commonly referred to as net spread. We believe the most prudent approach to generating a positive net spread is to manage our liabilities to mitigate the interest rate risks of our investments. Generally, we seek to employ short-term financing for our Agency RMBS portfolio, and we utilize various hedging instruments, such as interest rate swaps, swaptions and caps to hedge the interest rate risk associated with the short-term financing of our portfolio. In the future, we may employ longer-term financing of our portfolio, and use other hedging techniques from time to time, including interest rate floors, collars and Eurodollar and U.S. Treasury futures, to protect against adverse interest rate movements.
Since our investments vary by interest rate, prepayment speed and maturity, the leverage we employ to fund our asset purchases cannot be precisely matched to the terms or performance of our assets. Based on our experience, because our assets are not match-funded, changes in interest rates may impact our net income and the market value of our assets. Our approach to managing our investment portfolio is to take a longer term view of assets and liabilities, such that our net income and mark-to-market valuations at the end of a financial reporting period will not significantly influence our strategy of maximizing cash distributions to stockholders and achieving capital appreciation over the long-term.
Investment Sourcing
We source the majority of our investments through relationships with a large and diverse group of financial intermediaries, ranging from major commercial and investment banks to specialty investment dealers and brokerage firms.
Investment Process
Management evaluates each of our investment opportunities based on its expected risk-adjusted investment income relative to the investment income available from other comparable investments. Management also evaluates new opportunities based on their relative expected returns compared to the securities held in our portfolio. The terms of any leverage available to us for use in funding an investment purchase are also taken into consideration, as are potential risks posed by illiquidity or correlations with other securities in our portfolio.
The key steps of our investment process are:
allocation of our capital to the attractive types of Agency RMBS;
review of our asset allocation plan for overall risk management and diversification;
research and selection of individual securities and financing strategies;

3


active portfolio monitoring within asset classes, together with ongoing risk management and periodic rebalancing, to maximize long-term income with capital stability; and
consideration of the impact on maintaining our REIT qualification and our exemption from registration under the Investment Company Act.
Financing Strategy
We employ leverage to finance a portion of our Agency RMBS portfolio and seek to increase potential returns to our stockholders. Our use of leverage may, however, have the effect of increasing losses when securities in our portfolio decline in value. Generally, we expect our leverage to be between five and ten times. Taking into account actions and guidance provided by the Board of Governors of the Fed about the future path of the target federal funds rate (the "Federal Funds Rate"), the Fed's goal of reducing asset purchases, the ongoing interest-rate volatility in the mortgage and bond markets, and prevailing global and U.S. economic market conditions, we currently expect our leverage to remain in the middle of this range. At December 31, 2017, our leverage ratio was approximately 7.33:1, up from 7.06:1 at December 31, 2016. We calculate our leverage by dividing (A) the sum of our (i) borrowings under repurchase agreements ("repo borrowings") plus, (ii) advances from the Federal Home Loan Bank of Cincinnati ("FHLBC" and "FHLBC Advances"), (iii) plus payable for securities purchased minus receivable for securities sold, and (iv) plus the net TBA contracts without having the contractual obligation to accept or make delivery ("TBA Derivative") positions by (B) our stockholders' equity.
We finance our Agency RMBS investments using repo borrowings with a diversified group of broker dealers and commercial and investment banks. Utilizing repo borrowings enables us to borrow against the value of our assets. Under repurchase agreements, we sell our assets to a counterparty and agree to repurchase the same assets from the counterparty at a price equal to the original sales price plus an interest factor. When we borrow from a counterparty, we over-collateralize our borrowings by providing the counterparty with an amount of assets equal to an agreed upon percentage over and above the amount financed. This over-collateralized percentage is commonly referred to as a "haircut". As a borrower, we are subject to margin calls from counterparties if the value of the collateral that we have posted has declined below the amount financed, plus the applicable "haircut", which may occur due to prepayments of the mortgages causing the face value of the mortgage pool provided as collateral to the counterparty to decline or when the value of the mortgage pool provided as collateral declines as a result of interest rate movements or spread widening. Currently, the "haircuts" on our repo borrowings are between 0% and 7%. Our repo borrowings are accounted for as debt for purposes of U.S. generally accepted accounting principles ("GAAP") and are secured by the underlying assets. During the period of a repo borrowing, we are entitled to and receive the principal and interest payments on the related assets.
We maintain formal relationships with counterparties that are generally broker dealers and commercial and investment banks for the purpose of obtaining financing on favorable terms and managing counterparty credit risk. As of December 31, 2017, we had agreements in place with 53 counterparties and had outstanding repo borrowings with 37 counterparties for an aggregate of approximately $10.1 billion at a weighted-average borrowing rate of 1.42%.
In March 2015, our wholly-owned captive insurance subsidiary, CYS Insurance Services, LLC ("CYS Insurance"), was granted membership in the Federal Home Loan Bank ("FHLB") system, specifically in the FHLBC. Membership in the FHLBC obligated CYS Insurance to purchase FHLBC membership stock and activity stock, the latter being a percentage of the advances it obtained from the FHLBC. CYS insurance sought both short-term advances and long-term advances (collectively, "FHLBC Advances") from the FHLBC. On January 12, 2016, the FHFA issued a final rule (the "Final Rule") amending its regulations governing FHLB membership criteria for captive insurance companies. The Final Rule defines "insurance company" to exclude "captive insurers". Under this Final Rule, which became effective on February 19, 2016, CYS Insurance's membership in the FHLBC was required to be terminated within one year of the effective date: it was not permitted to secure any new advances, and all FHLBC Advances were required to be repaid no later than February 19, 2017. The Company repaid all outstanding FHLBC Advances prior to September 30, 2016, and CYS Insurance's membership in the FHLBC was terminated on February 19, 2017.
In the future, we may utilize other financing techniques, which may include, but will not necessarily be limited to, the issuance of common or preferred stock, and secured or unsecured debt.
Interest Rate Hedging Strategy
We utilize derivative financial instruments to manage the interest rate risk associated with the financing of our investment portfolio. Our most common method of financing Agency RMBS is through repo borrowings, which generally have maturities between 30 and 180 days, but may be longer. The weighted-average life of the Agency RMBS we own is generally much longer than the maturities of our repo borrowings. The difference in maturities, in addition to prepayments, adjustable-rate features of ARMs and other potential changes in the timing and amount of cash flows, creates risk to the value of the Agency RMBS from changes in the interest rates. We engage in hedging activities in an attempt to manage interest rate changes that might impair our ability to finance assets we own at favorable rates. We employ hedges as a means to attempt to protect

4


the portfolio against declines in the market value of our assets that result from general trends in debt markets. Our hedges have historically consisted of interest rate swaps (a contract exchanging a variable rate for a fixed rate, or vice versa), including cancelable interest rate swaps (swaps that may be canceled at one party's option before expiry), interest rate swaptions (the right to enter into an interest rate swap at a specified notional and rate on a specified future date), and interest rate caps (a contract protecting against a rise in interest rates above a fixed level). In the future, our hedges will likely continue to consist of these types of transactions, but may also include interest rate floors (a contract protecting against a decline in interest rates below a fixed level), interest rate collars (a combination of caps and floors), and Eurodollar and U.S. Treasury futures.
Our repo borrowings generally carry interest rates that correspond to the London Interbank Offered Rate ("LIBOR") for the borrowing periods. Historically, we have sought to enter into interest rate swaps (cancellable and non-cancellable) and swaptions with options to enter into interest rate swaps, structured such that we receive payments based on a variable interest rate and make payments based on a fixed interest rate. The variable interest rate on which payments are received is calculated based on 3-Month LIBOR. Additionally, we have entered into interest rate caps structured such that we receive payments when interest rates exceed a contractual fixed interest rate. Our interest rate swaps and swaptions, to the extent exercised, and caps effectively "fix" or "cap" our borrowing costs to the extent of the corresponding notional amounts and maturity dates and are not held for speculative or trading purposes. As of December 31, 2017, the swap and cap notional was $10.0 billion and covered 98.9% of our repo borrowings, herein referred to as our "hedge ratio". As of December 31, 2016, the swap and cap notional was $9.0 billion and covered 92.3% of our repo borrowings and FHLBC Advances.
Our Portfolio
We invest principally in Agency RMBS. Our current portfolio of Agency RMBS is backed by fixed-rate mortgages and Hybrid ARMs that typically have a fixed coupon for three, five, seven or ten years, and then pay an adjustable coupon that generally resets annually over a predetermined interest rate index.
In addition to Agency RMBS, we invest in U.S. Treasuries. As of December 31, 2017, our Agency RMBS and U.S. Treasuries (collectively, "Debt Securities") portfolio consisted of the following:
  
Face Value
 
Fair Value*
 
Weighted-Average
Asset Type
(in thousands)
 
Cost/Face
 
Fair Value/Face
 
Yield(1)
 
Coupon
 
CPR(2)
15-Year Fixed Rate
$
2,975,397

 
$
3,037,625

 
$
102.26

 
$
102.09

 
2.42
%
 
3.07
%
 
9.7
%
20-Year Fixed Rate
30,692

 
32,748

 
102.53

 
106.70

 
2.55
%
 
4.50
%
 
23.8
%
30-Year Fixed Rate
8,180,601

 
8,479,862

 
103.59

 
103.66

 
2.93
%
 
3.70
%
 
8.7
%
Hybrid ARMs(3)
488,665

 
498,630

 
102.43

 
102.04

 
2.51
%
 
3.06
%
 
10.3
%
Total Agency RMBS
11,675,355

 
12,048,865

 
103.20

 
103.20

 
2.78
%
 
3.52
%
 
9.2
%
U.S. Treasuries
1,050,000

 
1,046,934

 
99.81

 
99.71

 
1.96
%
 
1.85
%
 
n/a

Total/Weighted-Average
$
12,725,355

 
$
13,095,799

 
$
102.92

 
$
102.91

 
2.71
%
 
3.38
%
 
9.2
%

(1)
Represents a forward yield and is calculated based on the cost basis of the security at December 31, 2017. Because the forward yield is based on a projected constant prepayment rate ("CPR") and assumes no turnover in the securities on the Company’s portfolio, the Company expects the yield it realizes after December 31, 2017 will vary from those in the table above. The projected CPR is calculated utilizing Yieldbook® software and may reflect adjustments based on our judgment.
(2)
Represents the actual experienced CPR for those bonds held at December 31, 2017. CPR is a method of expressing the prepayment rate for a mortgage pool that assumes a constant fraction of the remaining principal is prepaid each month. Specifically, the CPR is an annualized version of the experienced prior three-month prepayment rate. Securities with no prepayment history are excluded from this calculation.
(3)
The weighted-average months to reset of our Hybrid ARM portfolio was 86.08 at December 31, 2017. Months to reset is the number of months remaining before the fixed rate on a Hybrid ARM becomes a variable rate. At the end of the fixed-rate period, the variable rate will be determined by the margin and pre-specified caps of the Hybrid ARM and will reset thereafter annually.
*    Includes TBA Derivatives comprised of forward purchase and sales with a net fair value of $461.1 million at December 31, 2017.
Below is a summary of our Agency RMBS, as of December 31, 2017 by production year (i.e., year in which underlying mortgages were originated), which includes to-be-announced ("TBA") forward settling transactions:
Underlying Mortgage Production Year
2018 (1)
 
2017
 
2016
 
2015
 
2014
 
2013
 
2012
 
2011
 
2010
 
2009
 
Total
Percentage by Production Year
12.0%
 
39.4%
 
24.4%
 
2.0%
 
8.1%
 
8.4%
 
0.6%
 
3.2%
 
1.8%
 
0.1%
 
100.0%
(1)
Consists of forward settling transactions that will be 2018 production when settled.

5


We also held $9.8 million of other investments as of December 31, 2017. Other investments are mainly comprised of our net investment in real estate assets at fair value, inclusive of $3.7 million of corresponding mortgage debt, as of December 31, 2017.
Risk Management Strategy
Our Board of Directors exercises its oversight of risk management primarily through meetings of the Board of Directors and the Audit Committee of the Board of Directors (the "Audit Committee") with management.  The Board of Directors is responsible for oversight of our overall risk governance structure, risk management and risk assessment guidelines and policies, the nature and extent of risks we take and our capital, liquidity and financing activities.  The Audit Committee is responsible for oversight of the quality and integrity of our financial reporting and internal controls over financial reporting, including independent auditor selection, evaluation, review and oversight of the internal audit function (“Internal Audit”), which is outsourced to an independent third-party that reports directly to the Audit Committee.  Internal Audit is responsible for performing our internal audit activities, which includes assessing with management and independently validating key controls over financial reporting.
As part of our risk management process, we actively manage the interest rate, liquidity, prepayment and counterparty risks associated with our Agency RMBS portfolio. This process includes monitoring various stress test scenarios on our portfolio. We endeavor to manage our interest rate risk exposure by entering into various derivative instruments ("hedges") with the expectation of minimizing our exposure to potential interest rate mismatches between the interest we earn on our investments and our borrowing costs.
We seek to manage our liquidity risks by monitoring our liquidity position on a daily basis and maintaining a prudent level of leverage based on current market conditions and various other factors, including the health of the financial institutions that lend to us under our repurchase agreements.
We seek to manage our counterparty risk by (i) diversifying our exposure across a broad number of counterparties, (ii) limiting our exposure to any one counterparty, and (iii) monitoring the financial stability and creditworthiness of our counterparties.
While we hedge to attempt to manage our interest rate risk, we do not hedge all of our exposure to changes in interest rates. Our investments vary in interest rate and maturity compared with the rates and duration of the hedges we employ. As a result, it is not possible to insulate our portfolio from all potential negative consequences associated with changes in interest rates in a manner that will allow us to achieve attractive spreads on our portfolio. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income.
Competition
Our success depends, in large part, on our ability to acquire assets at favorable spreads over our borrowing costs. In acquiring Agency RMBS, we compete with other mortgage REITs, specialty finance companies, public and private funds, commercial and investment banks, the Fed, other governmental entities or government-sponsored entities, commercial finance companies, and other entities. Competition for these assets may result in higher prices and lower yields on our assets.
Employees
As of January 31, 2018, we had 16 employees.
Additional Information
We have made available on our website at www.cysinv.com copies of the committee charters of our Board of Directors, our code of business conduct and ethics, our corporate governance guidelines and all materials we file with the SEC. Information on our website is not part of this Annual Report on Form 10-K. All reports filed with the SEC may be read and copied at the SEC's public reference room at 100 F Street, N.E., Washington, D.C. 20549. Further information regarding the operation of the public reference room may be obtained by calling 1 (800) SEC-0330. In addition, all of our reports filed with the SEC may be obtained at the SEC's website at www.sec.gov.
Item 1A. Risk Factors

Investment in our stock involves significant risks. Our business, financial condition, liquidity, and results of operations could be materially and adversely affected by these risks. The risk factors set forth below do not encompass all risks that may affect us. Some statements in this report, including statements in the following risk factors, constitute forward looking statements. Please refer to the section entitled ”Forward Looking Statements."

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Risks Related To Our Business

Increases in interest rates and adverse market conditions may negatively affect the value of our investments and increase the cost of our borrowings, which may result in reduced earnings or losses and reduced cash available for distribution to our stockholders.

We invest indirectly in mortgage loans by purchasing Agency RMBS. Generally, an increase in interest rates will result in a decline in the value of Agency RMBS. In addition, net interest income could decrease as interest rates rise. Fannie Mae, Freddie Mac and Ginnie Mae guarantee the principal and interest payments related to the Agency RMBS we own, but we are not protected from declines in market value of our assets caused by changes in interest rates. Declines in the market value of our assets may result in losses to us, which may reduce earnings and negatively affect cash available for distribution to our stockholders.

A significant risk associated with our investment in Agency RMBS is a simultaneous increase of short and long-term interest rates. If long-term rates were to increase, either unexpectedly, significantly, or in an otherwise volatile manner, then the market value of our Agency RMBS would decline, and the duration and weighted-average life of the investments would increase. We could realize a loss if the securities were sold. At the same time, an increase in short-term interest rates would increase the amount of interest charged on our repo borrowings used to finance the purchase of Agency RMBS, which would decrease cash available for distribution to our stockholders. Under this business model, we are particularly susceptible to the negative effects on the value of our investments when short-term rates increase at a faster pace than long-term rates, or even worse, when short-term rates are higher than long-term rates, which is described as an inverted yield curve. Given the ongoing volatile nature of the U.S. economy and the Fed’s recent and expected 2018 increases in short-term interest rates, no guarantee can be given that the yield curve will not become and/or remain inverted.

The market value of our investments may decline without a general increase in interest rates due to adverse market conditions, including, without limitation, supply and demand for the securities, increases in voluntary prepayments for assets we own that are subject to prepayment risk, and widening of credit spreads, among other reasons. If the market value of our assets were to decline, the value of our stock could also decline.

We leverage our portfolio investments in Debt Securities, which may adversely affect our return on our investments and liquidity.

We leverage our portfolio investments in Debt Securities through repo borrowings, and prior to the Final Rule, FHLBC Advances, TBA transactions, and other secured forms of borrowings. Leverage can enhance our potential returns, but can also exacerbate losses and adversely affect our liquidity.

Our access to financing depends on factors over which we may have little to no control, including:

general market conditions;
the lender's view of the quality and value of our assets;
the lender's perception of the credit risk of the Company;
the extent of our liquidity as a result of changes in the market value of our investments and derivatives; and
the market price of our common stock.

Generally, a weakness or volatility in capital markets, residential mortgage markets, or the U.S. economy generally could adversely impact the factors listed above. In addition, such weakness or volatility could adversely affect one or more of our potential lenders. Should our existing lenders be unwilling or unable to provide us with financing, or increase the costs of such financing, our liquidity could be adversely affected.

An increase in our borrowing costs relative to the interest we receive on our assets may impair our profitability and thus our cash available for distribution to our stockholders.

As our repo borrowings mature, we must either enter into new borrowings or liquidate certain of our investments at times when we might not otherwise choose to do so. Lenders may seek to use a maturity date to demand additional terms or increased collateral requirements, which could have an adverse effect on our financial condition and results of operations. An increase in short-term interest rates when we seek new borrowings would reduce the spread between the yield we earn on our assets and the cost of our borrowings, resulting in a reduction to the returns on our assets, which could reduce earnings and in turn reduce the

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amount of distributions to our stockholders. We generally expect the interest rates tied to our borrowings will change more rapidly in response to a change in interest rates than the interest rates tied to our assets.

Differences in the stated maturity of our fixed rate assets, or in the timing of interest rate adjustments on our adjustable-rate assets, and our borrowings may adversely affect our profitability.

We rely primarily on short-term and/or variable rate borrowings to acquire fixed-rate securities with long-term maturities. In addition, we may have adjustable-rate assets with interest rates that vary over time based upon changes in an objective index, such as LIBOR or the U.S. Treasury rate. These indices generally reflect short-term interest rates but these assets may not reset in a manner that matches our borrowings.

The relationship between short-term and longer-term interest rates is often referred to as the "yield curve." Ordinarily, short-term interest rates are lower than longer-term interest rates. If short-term interest rates rise disproportionately relative to longer-term interest rates (a "flattening" of the yield curve), our borrowing costs may increase more rapidly than the interest income earned on our assets. Because our investments generally bear interest at longer-term rates than we pay on our borrowings, a flattening of the yield curve would tend to decrease our net interest income and the market value of our investment portfolio. Additionally, to the extent cash flows from investments that return scheduled and unscheduled principal are reinvested, the spread between the yields on the new investments and available borrowing rates may decline, which would likely decrease our net income. It is also possible that short-term interest rates may exceed longer-term interest rates (a yield curve "inversion"), in which event, our borrowing costs may exceed our interest income and we could incur operating losses and our ability to make distributions to our stockholders could be adversely affected.

Our lenders may require us to provide additional collateral, especially when the market value of our assets decline, which may restrict us from leveraging our assets as fully as desired and may adversely affect our financial condition and reduce our liquidity, earnings, and cash available for distribution to our stockholders.

We use repo borrowings and, prior to the January 19, 2016 effective date of the Final Rule, which precluded the Company from securing new FHLBC Advances, FHLBC Advances to finance our investments in Debt Securities. Our repurchase agreements allow the lenders, to varying degrees, to determine the market value of the collateral to reflect current market conditions. If the market value of the securities we pledge or sell to a funding source declines, the lender may require us to provide additional collateral or pay down a portion of the funds advanced with minimal notice, known as a margin call. Posting additional collateral reduces our liquidity and limits our ability to leverage our assets, which could adversely affect our earnings, financial condition and results of operations. Additionally, in order to meet a margin call, we may be required to liquidate assets at a disadvantageous time, which could cause us to incur losses and adversely affect our results of operations and financial condition, and may result in a decline in the level of distributions to our stockholders. Margin calls from repo borrowing counterparties are a regular and ordinary occurrence in our business. As of December 31, 2017, we had approximately $1.0 billion, or 64.6% of our stockholders' equity, in Agency RMBS, U.S. Treasuries, cash and cash equivalents available to satisfy future margin calls. In the event we do not have sufficient liquidity to satisfy these margin calls, lending institutions may accelerate the repayment of our indebtedness, increase our borrowing rates, liquidate our collateral or terminate our ability to borrow. Such a situation would likely result in a deterioration of our financial condition and possibly necessitate a filing for protection under the U.S. Bankruptcy Code.

Hedging against interest rate exposure may not insulate us from interest rate risk and may adversely affect our earnings, financial condition, and results of operations.

We engage in certain hedging transactions in an effort to limit our exposure to the rising cost of financing our borrowings in a rising interest rate environment and to minimize the impact rising rates may have on book value that results from a decrease in the value of our assets. Our hedging positions generally increase in value in a rising rate environment. Our hedging transactions may include, among other instruments, interest rate swaps, including cancellable swaps, swaptions, caps, collars and floors. Depending on market conditions, and their specific terms and conditions, swaps, swaptions and caps may increase or decrease the overall volatility of our portfolio. The most significant factor in the performance and value of swaps and caps is the change in the specific interest rate, and other factors that determine the amounts of payments due to and from us. If a swap calls for payments or collateral transfers by us, we are required to make such payments and transfers when due.

Hedging against changes in interest rates does not eliminate the possibility of fluctuations in book value or prevent losses if the values of our investments decline. In addition, our hedging transactions may limit the gain we experience if the values of our assets should increase. Moreover, it is not always possible to hedge against certain interest rate fluctuations or to hedge effectively at an acceptable price.


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Further, unanticipated changes in interest rates may result in lower net income than if we had not engaged in any hedging transactions. In addition, correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. For a variety of reasons, it is extremely difficult to establish perfect correlation between hedging transactions and the assets being hedged, and, as such, our hedging transactions may not achieve the intended hedge and could expose us to risk of loss.

Our hedging transactions vary in scope based on the level and volatility of interest rates, the type of assets held, our outlook, and other relevant and ever-changing market conditions. Hedging transactions may fail to protect or may adversely affect us due to, among other things:

interest rate hedging can be expensive, particularly during periods of volatile interest rates;
available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;
hedge duration of the hedge may not match the related liability duration;
the credit quality of the hedging counterparty may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and
the counterparty in the hedging transaction may default on its obligation to pay.

Our hedging transactions may adversely affect our financial condition and results of operations, which could reduce the amount of our distributions to our stockholders and negatively impact our stock price.

Our hedging transactions require us to make cash payments in the future under certain circumstances, such as the early termination of the hedging transaction caused by any event of default or other early termination event, or the decision by a counterparty to request margin securities it is contractually owed under the terms of the hedging transaction. When a hedging transaction is terminated prior to its maturity date, the amount due would be equal to the unrealized loss of the open derivative positions with the respective counterparty and could also include other fees and charges. Such potential payments would be contingent liabilities and therefore might not appear on our balance sheets. Any economic losses related to unforeseen contingent liabilities will be reflected in our financial results of operations, and our ability to fund these obligations will depend on our liquidity and access to capital at the time. The need to fund these obligations could adversely impact our financial condition.

Failure to procure adequate funding and capital would adversely affect our financial condition, results of operations and our ability to distribute cash to our stockholders, and would, in turn, negatively affect the value of our common stock.

We depend upon the availability of adequate funding and capital for our operations. To maintain our status as a REIT, we are required to distribute at least 90% of our REIT taxable income annually, determined without regard to the deduction for dividends paid and excluding net capital gain, to our stockholders and therefore are not able to retain our earnings for new investments. No assurance can be given that any funding or capital will be available to us in the future on terms that are acceptable to us. In the event that we cannot obtain sufficient funding and capital on acceptable terms, there may be a negative impact on the value of our common stock and our ability to make distributions to our stockholders, and our stockholders may lose part or all of their investment.

Clearing facilities or exchanges through which some of our hedging transactions are cleared may increase margin requirements in the event of adverse economic developments.

In response to events having or expected to have adverse economic consequences or which create market uncertainty, clearing facilities or exchanges upon which some of our hedging transactions, such as interest rate swaps, are traded may require us to post additional collateral. In the event that future adverse economic developments or market uncertainty result in increased margin requirements for our hedging transactions, it could materially adversely affect our financial condition and results of operations.

Our use of repo borrowings may give our lenders greater rights in the event that either we or any of our lenders file for bankruptcy, which may make it difficult for us to recover our collateral.

Our repo borrowings may qualify for special treatment under the U.S. Bankruptcy Code, giving our lenders the ability to avoid the automatic stay provisions of the U.S. Bankruptcy Code and take possession of and liquidate our collateral under the repurchase agreements without delay should we file for bankruptcy. In addition, the special treatment of repurchase agreements under the U.S. Bankruptcy Code may make it difficult for us to recover our pledged assets in the event that any of our lenders file for bankruptcy. Thus, the terms of repurchase agreements expose our pledged assets to risk in the event of a bankruptcy filing by either our lenders or us. In addition, if the lender is a broker or dealer subject to the Securities Investor Protection Act of 1970 or

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an insured depository institution subject to the Federal Deposit Insurance Act, our ability to exercise our rights to recover our collateral under a repurchase agreement, or to be compensated for any damages resulting from the lender's insolvency, may be further limited by those statutes.

Our use of certain hedging transactions may expose us to counterparty risks.

If a counterparty does not perform under the terms of a hedging transaction, we may not receive payments due thereunder, and thus, we may lose any unrealized gain associated with the hedging transaction. The hedged liability could cease to be hedged by the interest rate swap. Additionally, we risk the loss of any collateral we have pledged to secure our obligations under the interest rate swap if the counterparty becomes insolvent or files for bankruptcy. Similarly, if a counterparty fails to perform under the terms of the hedging transaction, we may not receive payments due thereunder that would offset our interest expense. We could then incur a loss for the then remaining fair market value of the hedging transactions.

If the lending institution under one or more of our repo borrowings defaults on its obligation to resell the underlying security back to us at the end of the borrowing term, we will incur a loss on our repurchase transactions.

When we engage in a repo borrowing, we initially sell securities to the counterparty under a master repurchase agreement in exchange for cash from the counterparty. The counterparty is obligated to resell the same securities back to us at the end of the term of the repo borrowing. If a counterparty in a repurchase transaction defaults on its obligation to resell the securities back to us, we will incur a loss on the transaction equal to the amount of the haircut (assuming no change in the value of the securities). Losses incurred on our repurchase transactions would adversely affect our earnings and the amount of our distributions to our stockholders.

If we default on our obligations under our repurchase agreements, we may be unable to establish a suitable replacement facility on acceptable terms or at all.

If we default on our obligations under a repurchase agreement, the counterparty may terminate the agreement, require repayment of all amounts borrowed thereunder, and cease entering into any new repo borrowings with us. In that case, we would likely need to replace any repo borrowings called by such counterparty with another financial institution in order to maintain the leverage of our investment portfolio and carry out our investment strategy. No assurance can be given that we would be able to establish a suitable replacement repurchase facility on acceptable terms or at all.

Loss of our exemption from regulation under the Investment Company Act would negatively affect the value of our common stock and our distributions to our stockholders.

We have operated and intend to continue to operate our business in order to be exempt from registration under the Investment Company Act because we are "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." Specifically, we invest and intend to have at least 55% of the assets that we own on an unconsolidated basis consist of qualifying mortgages and other liens and interests in real estate, which are collectively referred to as "qualifying real estate assets," and at least 80% of the assets we own on an unconsolidated basis consist of real estate related assets (including our qualifying real estate assets). We treat Fannie Mae, Freddie Mac and Ginnie Mae whole-pool residential mortgage pass-through securities issued with respect to an underlying pool of mortgage loans in which we hold all of the certificates issued by the pool as qualifying real estate assets.

If we fail to qualify for exemption under the Investment Company Act, or the SEC determines that companies that invest in RMBS can no longer rely on the exemption described above, we could be required to restructure our activities in a manner that, or at a time when, we would not otherwise choose, or we may be required to register as an investment company under the Investment Company Act, either of which would negatively affect the value of our common stock and the amount of distributions we could make to our stockholders.

The federal conservatorship of Fannie Mae and Freddie Mac and as related efforts, along with any potential or proposed changes in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the U.S. government, may adversely affect our business.

The payments we receive on Agency RMBS in which we invest depend upon payments on the mortgages underlying the securities and are guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac. Ginnie Mae is part of a U.S. government agency and its guarantees are backed by the full faith and credit of the United States. Fannie Mae and Freddie Mac are GSEs, but their guarantees are not backed by the full faith and credit of the United States.

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Since 2008, Fannie Mae and Freddie Mac have been in federal conservatorship. The future roles of Fannie Mae and Freddie Mac, if any, could be significantly reduced and the nature of their guarantees could be eliminated or considerably limited relative to historical standards. Any changes to the nature of the guarantees provided by Fannie Mae and Freddie Mac, if any, could redefine what constitutes Agency RMBS and could have broad adverse market implications, and negatively impact our business and results of operations.

Since Fannie Mae and Freddie Mac were placed into federal conservatorship, there have been numerous proposed legislation to restructure the U.S. housing finance system and the operations of Fannie Mae and Freddie Mac. If any new legislation reduces or eliminates the U.S. government's role in providing liquidity for the residential mortgage market, each of Fannie Mae and Freddie Mac could be dissolved and the U.S. government could decide to stop providing support of any kind to the mortgage market. If Fannie Mae or Freddie Mac were eliminated, or their structures were to change radically, we would not be able to acquire Agency RMBS from these entities, which would drastically reduce the amount and type of Agency RMBS available for investment. As of December 31, 2017, substantially all of our investments had the principal and interest guaranteed by either Fannie Mae, Freddie Mac, or Ginnie Mae, or were U.S. Treasuries.

Our income could be negatively affected in a number of ways depending on the manner in which any restructuring or changes to the U.S. housing finance system or the operations of Fannie Mae and Freddie Mac unfold. For example, the current credit support provided by the U.S. Treasury to Fannie Mae and Freddie Mac, and any additional support it may provide in the future, could have the effect of lowering the interest rate we receive from Agency RMBS, thereby tightening the spread between the interest we earn on our portfolio of targeted investments and our cost of financing that portfolio. A reduction in the supply of Agency RMBS could also increase the prices of Agency RMBS we seek to acquire, thereby reducing the spread between the interest we earn on our portfolio of targeted assets and our cost of financing that portfolio.

The effect of any proposed legislation or other actions taken by the U.S. government remains uncertain and continues to evolve. Future legislation, if any, could further change the relationship between Fannie Mae and Freddie Mac and the U.S. government, and could also nationalize or eliminate these GSEs entirely. Any law affecting the GSEs may create market uncertainty and have the effect of reducing the actual or perceived credit quality of securities, either existing or new, issued or guaranteed by Fannie Mae or Freddie Mac. As a result, such laws could increase the risk of loss on investments in Fannie Mae and Freddie Mac Agency RMBS. It is also possible that such laws, if any, could adversely impact the market for such securities and the spreads at which they trade. All of the foregoing could materially adversely affect the pricing, supply, liquidity and value of our target assets and otherwise materially adversely affect our business, operations and financial condition.

Purchases and sales of Agency RMBS by the Fed may adversely affect the price and return associated with Agency RMBS.

The Fed owns approximately $1.7 trillion of Agency RMBS as of December 31, 2017. The Fed's former policy was to reinvest principal payments from its holdings of Agency RMBS into new Agency RMBS purchases. During its meeting in September 2017, the FOMC directed the Open Market Trading Desk (the "Desk") at the Federal Reserve Bank of New York to initiate, in October 2017, the program to gradually reduce the reinvestment of principal payments from the Fed securities holdings. Specifically, the FOMC directed the Desk to reinvest each month’s principal payments from Treasury securities, agency debt, and Agency RMBS only to the extent that such payments exceed gradually rising caps. The Fed also announced at the September 2017 meeting that it would be reducing its holdings of Treasury bonds and mortgage-backed securities below set reinvestment caps, starting in October.

While we cannot predict the impact of these actions by the Fed on the prices and liquidity of Agency RMBS, we expect that during periods in which the Fed purchases significant volumes of Agency RMBS, yields on Agency RMBS may be lower and refinancing volumes may be higher than would have been absent their large scale purchases. The opposite may occur as the Fed begins to reduce its portfolio of Agency RMBS. As a result, returns on Agency RMBS may be adversely affected. There is also a risk that as the Fed reduces its purchases of Agency RMBS or if it decides to sell some or all of its holdings of Agency RMBS, the pricing of our Agency RMBS portfolio may be adversely affected.

We may be subject to adverse legislative or regulatory changes that could have an adverse effect on our financial condition and results of operations and potentially reduce the market price of our common stock.

Laws, regulations, and the administrative interpretations of laws and regulations that impact our business and Maryland corporations, may be amended at any time. In addition, the markets for Agency RMBS and derivatives, including swaps, have been the subject of intense scrutiny. We cannot predict when or if any new law, regulation or administrative interpretation, or any amendment to any existing law, regulation or administrative interpretation, will be adopted or promulgated, or will become effective.

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Additionally, revisions in these laws, regulations or administrative interpretations could cause us to make changes in our investments. We could be adversely affected by any such change in, or any new, law, regulation or administrative interpretation, which could reduce the market price of our common stock.

We cannot predict the impact, if any, on our earnings or cash available for distributions to our stockholders of the FHFA's proposed revisions to Fannie Mae's, Freddie Mac's and Ginnie Mae's existing infrastructures to align the standards and practices of these entities.

On February 21, 2012, the FHFA released its Strategic Plan for Enterprise Conservatorships, which set forth three objectives for the next phase of the Fannie Mae and Freddie Mac conservatorships: (i) build a new infrastructure for the secondary mortgage market, (ii) gradually contract Fannie Mae and Freddie Mac's presence in the marketplace while simplifying and shrinking their operations, and (iii) maintain foreclosure prevention activities and credit availability for new and refinanced mortgages. On October 4, 2012, the FHFA released its white paper entitled Building a New Infrastructure for the Secondary Mortgage Market, which proposes a new Fannie Mae and Freddie Mac infrastructure built around two principles.

The first principle is to replace Fannie Mae and Freddie Mac's current infrastructures with a common infrastructure that efficiently aligns the standards and practices of the two entities, beginning with overlapping core functions such as issuance, master servicing, bond administration, collateral management and data integration. The FHFA has taken steps to establish a common securitization platform ("CSP") for RMBS reflecting feedback from a broad cross-section of industry participants. In July 2016, the FHFA released an update on the CSP, detailing progress made in the development of a new infrastructure for the securitization of single-family mortgages by Fannie Mae and Freddie Mac. Developing the CSP is a key goal of FHFA's 2014 Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac, which details the organizational structure of Common Securitization Solutions, LLC, a joint venture company that was established by Fannie Mae and Freddie Mac to lead the work on this project. In December 2016, the FHFA announced that Release 1 of the CSP was successfully implemented on November 21, 2016. This means that Freddie Mac now uses the CSP for data acceptance, issuance support, and bond administration activities related to current single-class, fixed-rate, mortgage-backed securities. The FHFA announced in March 2017 that Release 2, which involves issuance by Freddie Mac and Fannie Mae of a common, single mortgage-backed security, which will be known as the Uniform Mortgage-Backed Security, is expected to occur in the second quarter of 2019. The second principle is to establish an operating framework for Fannie Mae and Freddie Mac that is consistent with housing finance reform progress that encourages and accommodates increased participation of private capital in assuming credit risk associated with the secondary mortgage market.

The FHFA recognizes challenges faced in these formative stages which may or may not be surmountable, such as the absence of meaningful secondary mortgage market mechanisms beyond Fannie Mae, Freddie Mac and Ginnie Mae. As a result, it is uncertain if the proposals will be enacted, what exactly will be enacted, and how they will be enacted. As a result, we cannot be certain what the effects of the enactment will have on our book value, earnings or cash available for distribution to stockholders. Additionally, leadership of the FHFA is set to be transferred in January of 2019, so the policies and priorities of future leadership are unknown at this juncture.

No assurance can be given that the actions taken by the U.S. government for the purpose of seeking to stimulate the economy will achieve their intended effect or will benefit our business, and further, government or market developments could adversely affect us.

The current administration of the U.S. government has announced that it may implement initiatives intended to stimulate the U.S. economy. To the extent these initiatives do not function as intended or interest rates increase as a result of these initiatives, the pricing, supply, liquidity and value of our assets and the availability of financing on attractive terms may be materially adversely affected.

Adoption of the Basel III standards and other proposed supplementary regulatory standards may negatively impact our access to financing or affect the terms of our future financing arrangements.

In response to financial crises and the volatility of financial markets, the Basel Committee on Banking Supervision adopted the Basel III standards several years ago. The final package of Basel III reforms was approved by the G20 leaders in November 2010. In January 2013, the Basel Committee agreed to delay implementation of the Basel III standards and expanded the scope of assets permitted to be included in a bank's liquidity measurement. In 2014, the Basel Committee announced that it would propose additional changes to capital requirements for banks over the next few years.


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U.S. regulators have elected to implement substantially all of the Basel III standards. Financial institutions have until 2019 to comply with the Basel III standards, which could cause an increase in capital requirements for, and could place constraints on, the financial institutions from which we borrow.

In April 2014, U.S. regulators adopted rules requiring enhanced supplementary leverage ratio standards that took effect in January 2018, which impose more stringent capital requirements than those of Basel III standards for the most systematically significant banking organizations in the U.S. U.S. regulatory bodies are currently reviewing the U.S. enhanced capital and liquidity standards. We have yet to see how these potentially new standards might change, if at all, and how they may affect our business.

Mortgage loan modification programs and future legislative action may adversely affect the value of, and the returns on, the Agency RMBS in which we invest.

Since 2008, the U.S. government, through the Federal Housing Administration ("FHA"), the U.S. Treasury and the Federal Deposit Insurance Corporation ("FDIC"), has implemented a variety of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. These and any future programs may involve, among other things, the modification of mortgage loans to reduce the principal amount of the loans or the rate of interest payable on the loans, or to extend the payment terms of the loans. Loan modifications likely would result in increased prepayments on some Agency RMBS. The rate of prepayment could adversely affect the value of our Agency RMBS, liquidity, and results of operations. These initiatives, any future loan modification programs and future legislative or regulatory actions, including amendments to the bankruptcy laws that result in the modification of outstanding mortgage loans, may adversely affect the value of our investments.

Prepayment rates could negatively affect the value of our Agency RMBS, which could result in reduced earnings or losses and negatively affect the cash available for distribution to our stockholders.

Residential mortgage loan terms seldom place restrictions on borrowers' prepayment. Homeowners tend to prepay mortgage loans when applicable mortgage interest rates decline. Consequently, owners of Agency RMBS must reinvest the capital received from prepayments at lower prevailing interest rates. Conversely, homeowners tend not to prepay mortgage loans when mortgage interest rates remain steady or increase. Fannie Mae, Freddie Mac or Ginnie Mae guarantees of principal and interest related to the Agency RMBS we own do not protect us against prepayment risks. The volatility in prepayment rates may affect our ability to maintain targeted amounts of leverage on our Agency RMBS portfolio and may result in reduced earnings or losses for us and negatively affect the cash available for distribution to our stockholders.

Our portfolio investments are recorded at fair value based on market quotations from pricing services and broker dealers. The price of our common stock could be adversely affected if our determinations regarding the fair value of these investments were materially higher than the values that we ultimately realize upon their disposal.

We value our investments each month at fair value as determined by our management based on market quotations from pricing services and brokers/dealers. If we were to liquidate a particular asset, the realized value may be more or less than the amount at which such asset is valued.

A small portion of our investments may be in the form of securities that are not actively traded. The fair value of securities and other investments that are not actively traded may not be readily determinable. Quotations and valuations for securities that are not actively traded may be based on estimates, and our determinations of fair value may differ materially from the values that would have been used if an active market for these securities existed.

The price of our common stock could be adversely affected if our determinations of the fair value of our investments were materially higher than the price that we realize upon their disposal.

It may be uneconomical to "roll" our TBA dollar roll transactions or we may be unable to meet margin calls on our TBA contracts, which could negatively affect our financial condition and results of operations.

We may utilize TBA dollar roll transactions as a means of investing in and financing Agency RMBS. TBA contracts enable us to purchase or sell, for future delivery, Agency RMBS with certain principal and interest terms and certain types of collateral, but the particular Agency RMBS to be delivered are not identified until shortly before the TBA settlement date. Prior to settlement of the TBA contract we may choose to move the settlement of the securities out to a later date by entering into an offsetting position (referred to as a "pair off"), net settling the paired off positions for cash, and simultaneously purchasing a similar TBA contract for a later settlement date, collectively referred to as a "dollar roll." The Agency RMBS purchased for a forward settlement date under the TBA contract are typically priced at a discount to Agency RMBS for settlement in the current month.

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This difference (or discount) is referred to as the "price drop." The price drop is the economic equivalent of net interest income earned from carrying the underlying Agency RMBS over the roll period (interest income less implied financing cost) and is commonly referred to as "dollar roll income." Consequently, dollar roll transactions and such forward purchases of Agency RMBS represent a form of off-balance sheet financing and increase our "at risk" leverage.

Under certain market conditions, TBA dollar roll transactions may result in negative carry income whereby the Agency RMBS purchased for a forward settlement date under the TBA contract are priced at a premium to Agency RMBS for settlement in the current month. Additionally, sales of some or all of the Fed's holdings of Agency RMBS or declines in purchases of Agency RMBS by the Fed could adversely impact the dollar roll market. Under such conditions, it may be uneconomical to roll our TBA positions prior to the settlement date and we could have to take physical delivery of the underlying securities and settle our obligations for cash. We may not have sufficient funds or alternative financing sources available to settle such obligations. In addition, pursuant to the margin provisions established by the Mortgage-Backed Securities Division ("MBSD") of the Fixed Income Clearing Corporation, we are subject to margin calls on our TBA contracts. Further, our prime brokerage agreements may require us to post additional margin above the levels established by the MBSD. Negative carry income on TBA dollar roll transactions or failure to procure adequate financing to settle our obligations or meet margin calls under our TBA contracts could result in defaults or force us to sell assets under adverse market conditions and adversely affect our financial condition and results of operations.

Our forward settling transactions, including TBA transactions, subject us to certain risks, including price risks and counterparty risks.

We purchase a substantial portion of our Agency RMBS through forward settling transactions, including TBAs. In a forward settling transaction, we enter into a forward purchase agreement with a counterparty to purchase either (i) an identified Agency RMBS, or (ii) a TBA, or to-be-issued, Agency RMBS with certain terms. As with any forward purchase contract, the value of the underlying Agency RMBS may decrease between the contract date and the settlement date. Furthermore, a transaction counterparty may fail to deliver the underlying Agency RMBS at the settlement date. If any of these risks were to occur, our financial condition and results of operations may be materially adversely affected.

We are dependent on our Chief Executive Officer, President, and Chief Investment Officer, and the loss of this individual could materially adversely affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders.

We depend on the efforts of our key officers and employees, especially Kevin E. Grant, our Chief Executive Officer, President and Chief Investment Officer. Although we have an employment agreement with Mr. Grant, we cannot be certain that he will remain employed with us. The loss of Mr. Grant's services could have a material adverse effect on our business, financial condition and results of operations and our ability to pay distributions to our stockholders.

We operate in a highly competitive market for investment opportunities.

Many enterprises engage in investing in or managing the types of investments that we make including mortgage REITs, specialty finance companies, public and private funds, commercial and investment banks, the Fed, other governmental entities or GSEs, commercial finance companies, and others. Some of these enterprises are substantially larger than we are, have access to greater financial resources, and employ more technical and marketing resources than we do. Several other REITs may have investment objectives that overlap with ours, which may create competition for investment opportunities. Some of these enterprises may have a lower cost of funds and access to funding sources than are available to us. In addition, some of these enterprises may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. We can provide no assurances that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. As a result, we may not be able to take advantage of attractive investment opportunities from time to time, and cannot offer assurance that we will be able to identify and make investments consistent with our investment objectives.

Our Board of Directors does not approve each of our investment decisions, and may change our investment guidelines without notice or stockholder consent, which may result in riskier investments and could materially adversely affect our business, financial condition, results of operations and our ability to pay distributions to our stockholders.

Our Board of Directors periodically reviews our investment guidelines, investment portfolio, and potential investment strategies. However, our directors do not pre-approve individual investments. Management is responsible for day-to-day portfolio composition within our investment guidelines, and within those guidelines, management has discretion to significantly change the composition of the portfolio. In addition, in conducting periodic reviews, the directors may rely primarily on information provided

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to them by our management. Our Board of Directors has the authority to change our investment guidelines at any time without notice to or consent of our stockholders. To the extent that our investment guidelines change in the future, we may make investments that are different from, and possibly riskier than, the investments described in this Annual Report on Form 10-K. A change in our investment guidelines may increase our exposure to interest rate and real estate market fluctuations.

Certain hedging instruments are not traded on regulated exchanges, guaranteed by an exchange or its clearing-house, or regulated by U.S. or foreign governmental authorities.

The cost of using hedging instruments increases as the period covered by the instrument lengthens and during periods of rising and/or volatile interest rates. Despite this, we may increase our hedging activity, and thus increase our hedging costs, during periods when interest rates are volatile or rising. In these cases, our hedging costs will increase.

In addition, certain hedging transactions involve greater risk because they are not traded on regulated exchanges, guaranteed by an exchange or its clearing-house, or regulated by U.S. or foreign governmental authorities. Consequently, there may be no, or limited, requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions. Furthermore, the enforceability of agreements underlying derivative transactions may depend on compliance with applicable statutory and commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. The business failure of a hedging counterparty with whom we enter into a hedging transaction may result in a default. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profits and force us to cover our resale commitments, if any, at the then current market price. In addition, we may not always be able to dispose of or close out a hedging transaction without the consent of the hedging counterparty, and we may not be able to enter into an offsetting contract to cover our risk. No assurance can be given that a liquid secondary market will exist for hedging instruments purchased or sold, and we may be required to maintain a position until exercise or expiration, which could result in losses.

We are highly dependent on communications and information systems operated by third parties, and systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our common stock and our ability to pay distributions to our stockholders.

Our business is highly dependent on sophisticated communications, information technology systems, networks and infrastructure (our "Systems") that allow us to monitor, value, buy, sell, finance, and hedge our investments, and manage our day-to-day operations. Our Systems are primarily operated by third parties and, as a result, we have limited ability to ensure their continued effective operation. In the event of failure or interruption to any of our Systems, we will have limited ability to affect the timing and success of restoration. Any failure or interruption to any of our Systems could create delays or other problems in our securities trading activities, including Agency RMBS trading activities, which could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our ability to make distributions to our stockholders.

If we issue debt securities or equity securities that are senior to our stock for the purposes of dividend and liquidating distributions, our operations may be restricted, we will be exposed to additional risk and the market price of our common stock could be adversely affected.

If we decide to issue debt securities in the future, it is likely that such securities will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock. We have issued and outstanding an aggregate of 3,000,000 shares of our 7.75% Series A Cumulative Redeemable Preferred Stock and 8,000,000 shares of our 7.50% Series B Cumulative Redeemable Preferred Stock. Other classes or series of our preferred stock, if issued, could have a preference on liquidating distributions or a preference on dividend payments that could limit our ability to make a distribution to the holders of our common stock. We, and indirectly our stockholders, will bear the cost of issuing and servicing such securities. Holders of debt securities may be granted specific rights, including, but not limited to, the right to hold a perfected security interest in certain of our assets, the right to accelerate payments due under the indenture, rights to restrict dividend payments and rights to approve the sale of assets. Such additional restrictive covenants, operating restrictions and preferential dividends could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our ability to pay distributions to our stockholders.

A security breach or a cyber-attack could adversely affect our business.

In addition to general cyber-security threats, the business we conduct with our vendors and counterparties exposes us to inherent cyber-security risks. Despite well-established cyber-security and other preventative measures, including training and testing to ensure business continuity, our Systems may be vulnerable to attacks or other events beyond our control that

15


could interrupt or interfere with our business continuity. Should such an attack or event occur, our ability to effectively utilize our Systems, and protect our information would be impaired, and could adversely affect our business.

CMOs may be subject to greater risks than whole-pool Agency RMBS.

Our investment guidelines allow us to invest in CMOs. CMOs are securitizations issued by a government agency or a GSE that are collateralized by Agency RMBS that are divided into various tranches with different characteristics (such as different maturities or different coupon payments), and, therefore, may carry greater risk than an investment in whole-pool Agency RMBS. For example, certain CMO tranches (such as interest-only securities, principal-only securities, support securities and securities purchased at a significant premium) are more sensitive to prepayment risks than other tranches or whole-pool Agency RMBS. In addition, the yield on floating interest rate tranches and inverse floating rate tranches are sensitive to changes in the interest rate index used to calculate the coupon on such classes. Although we have not invested in CMOs to date, if we were to invest in CMO tranches that were more sensitive to prepayment risks relative to other CMO tranches or whole-pool Agency RMBS, we may increase our portfolio-wide prepayment and interest rate risk.

We may invest in securities in the developing Credit risk transfer sector that are subject to mortgage credit risk.

We may invest in securities in the developing Credit risk transfer sector (“CRT Sector”). The CRT Sector is currently comprised of CAS and STACR debt securities, which are risk sharing transactions issued by Fannie Mae and Freddie Mac, respectively. The securities issued in the CRT Sector are designed to synthetically transfer mortgage credit risk from Fannie Mae and Freddie Mac to private investors. Currently, CAS and STACR transactions are structured, unsecured and unguaranteed bonds issued by Fannie Mae and Freddie Mac, respectively, whose principal payments are determined by the delinquency and prepayment experience of a reference pool of mortgages originated and guaranteed by Fannie Mae or Freddie Mac, respectively, in a particular quarter. The holder of these securities is subject to the risk that the borrowers may default on their obligations to make full and timely payments of principal and interest. Investments in securities in the CRT Sector could cause us to incur losses of income from, and/or losses in market value relating to, those assets if there are defaults of principal and/or interest on the pool of mortgages referenced in the transaction.

Failure to obtain and maintain an exemption from being regulated as a commodity pool operator could subject us to additional regulation and compliance requirements and may result in fines and other penalties, which could materially adversely affect our business, financial condition and results of operations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") established a comprehensive regulatory framework for derivative transactions commonly referred to as "swaps." As a result, an investment fund that trades in swaps may be considered a "commodity pool," which would cause its operators (and in some cases the fund's directors) to be regulated as "commodity pool operators" ("CPOs"). Under new rules adopted by the U.S. Commodity Futures Trading Commission (the "CFTC"), those funds that become commodity pools solely because of their use of swaps must register with the National Futures Association ("NFA"). Registration requires compliance with the CFTC's regulations and the NFA's rules with respect to capital raising, disclosure, reporting, recordkeeping and other business conduct. However, the CFTC's Division of Swap Dealer and Intermediary Oversight has issued a no-action letter saying, although it believes that mortgage REITs are properly considered commodity pools, it would not recommend that the CFTC take enforcement action against the operator of a mortgage REIT who does not register as a CPO if, among other things, the mortgage REIT limits the initial margin and premiums required to establish its swaps, futures and other commodity interest positions to not more than five percent of its total assets, the mortgage REIT limits the net income derived annually from those commodity interest positions that are not qualifying hedging transactions to less than five percent of its gross income and interests in the mortgage REIT are not marketed to the public as or in a commodity pool or otherwise as or in a vehicle for trading in the commodity futures, commodity options or swaps markets.

We do not currently engage in speculative derivative activities or other non-hedging transactions using swaps, futures or options on futures. We do not use these instruments for the purpose of trading in commodity interests, and we do not consider our Company or our operations to be a commodity pool as to which CPO registration or compliance is required. We have submitted the required filing to claim the no-action relief afforded by the above-described no-action letter. Consequently, we will be restricted to operating within the parameters discussed in the no-action letter and will not enter into hedging transactions covered by the no-action letter if they would cause us to exceed the limits set forth in the no-action letter.

The CFTC has substantial enforcement power with respect to violations of the laws over which it has jurisdiction, including its anti-fraud and anti-manipulation provisions. For example, the CFTC may suspend or revoke the registration of or the no-action relief afforded to a person who fails to comply with commodities laws and regulations, prohibit such a person from trading or doing business with registered entities, impose civil money penalties, require restitution and seek fines or imprisonment for criminal

16


violations. Additionally, a private right of action exists against those who violate the laws over which the CFTC has jurisdiction or who willfully aid, abet, counsel, induce or procure a violation of those laws. In the event that we fail to comply with statutory requirements relating to derivatives or with the CFTC's rules thereunder, including the no-action letter described above, we may be subject to significant fines, penalties and other civil or governmental actions or proceedings, any of which could have a materially adverse effect on our business, financial condition and results of operations.

We may enter into new lines of business, acquire other companies or engage in other strategic initiatives, each of which may result in additional risks and uncertainties in our businesses.
     We may pursue growth through acquisitions of other companies or other strategic initiatives that may require approval by our Board of Directors, stockholders, or both.  To the extent we pursue strategic investments or acquisitions, undertake other strategic initiatives or consider new lines of business, we will face numerous risks and uncertainties, including risks associated with: 
•    the availability of suitable opportunities;
•    the level of competition from other companies that may have greater financial resources;
•    our ability to value potential acquisition opportunities accurately and negotiate acceptable terms for those opportunities;
•    the required investment of capital and other resources;
•    the lack of availability of financing and, if available, the terms of any financings;
the possibility that we have insufficient expertise to engage in such activities profitably or without incurring inappropriate amounts of risk;
•    the diversion of management’s attention from our core businesses;
•    assumption of liabilities in any acquired business;
•    the disruption of our ongoing businesses;
•    the increasing demands on or issues related to combining or integrating operational and management systems and controls;
•    compliance with additional regulatory requirements; and
•    costs associated with integrating and overseeing the operations of the new businesses.
 
Entry into certain lines of business may subject us to new laws and regulations with which we are not familiar, or from which we are currently exempt, and may lead to increased litigation and regulatory risk.  In addition, if a new business generates insufficient revenues or if we are unable to efficiently manage our expanded operations, our results of operations will be adversely affected. Our strategic initiatives may include joint ventures, in which case we will be subject to additional risks and uncertainties in that we may be dependent upon, and subject to liability, losses or reputational damage relating to, systems, controls and personnel that are not under our control.
Risks Related to Our Organization and Structure
Our charter and bylaws contain certain anti-takeover provisions that may inhibit potential acquisition bids that stockholders may consider favorable.
Our charter and bylaws contain provisions that may have an anti-takeover effect and may have the effect of delaying, deferring or preventing a change in control of us or the removal of existing directors and, as a result, could prevent our stockholders from being paid a premium for their common stock over the then-prevailing market price. In order to qualify as a REIT, not more than 50% of the value of our outstanding capital stock may be owned, directly or constructively, by five or fewer individuals (as defined under the Internal Revenue Code of 1986, as amended (the "Code"), to include natural persons and certain entities) during the second half of any calendar year and our shares must be beneficially owned by 100 or more persons during at least 335 days of a taxable year of twelve months or during a proportionate part of a shorter taxable year. To assist us in meeting these requirements, subject to some exceptions, our charter generally prohibits any stockholder from beneficially or constructively owning more than 9.8% in value or number of shares, whichever is more restrictive, of any class or series of our outstanding capital stock unless an exemption is granted by our Board of Directors in its sole discretion.
This ownership restriction may:
discourage a tender offer or other transactions or a change in the composition of our Board of Directors or control that might involve a premium price for our shares or otherwise be in the best interests of our stockholders; or
result in shares issued or transferred in violation of such restriction being automatically transferred to a trust for a charitable beneficiary and thereby resulting in a forfeiture of such shares.

17



Our charter permits our Board of Directors to issue common or preferred stock with terms that may discourage a third party from acquiring us. Our charter permits our Board of Directors to amend our charter, without approval of our stockholders, to increase the total number of authorized shares of stock or the number of shares of any class or series, and to cause the issuance of common or preferred stock, having preferences, conversion or other rights, voting powers, restrictions, limitations as to distributions, qualifications, or terms or conditions of redemption as determined by our Board of Directors. Thus, our Board of Directors could authorize the issuance of common or preferred stock with terms and conditions that could have the effect of discouraging a takeover or other transaction in which holders of some or a majority of our shares might receive a premium for their shares over the then-prevailing market price of our shares.
Certain provisions of Maryland law could inhibit changes in control.
Certain provisions of the Maryland General Corporation Law ( the "MGCL") may have the effect of inhibiting a third party from making a proposal to acquire us or impeding a change of control under circumstances that otherwise could provide our stockholders with the opportunity to realize a premium over the then-prevailing market price of our common stock, including:
"business combination" provisions that, subject to limitations, prohibit certain business combinations between us and an "interested stockholder" (defined generally as any person who beneficially owns 10% or more of the voting power of our shares or an affiliate thereof) for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter special stockholder voting requirements on these combinations; and
"control share" provisions that provide that "control shares" of our Company (defined as shares which, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a "control share acquisition" (defined as the direct or indirect acquisition of ownership or control of "control shares") have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares.

We have elected to opt out of these provisions of the MGCL, in the case of the business combination provisions of the MGCL, by resolution of our Board of Directors, and in the case of the control share provisions of the MGCL, pursuant to a provision in our bylaws. However, our Board of Directors may by resolution elect to repeal the foregoing opt-outs from the business combination provisions of the MGCL, and we may, by amendment to our bylaws, opt in to the control share provisions of the MGCL in the future.
Our rights and the rights of our stockholders to take action against our directors and officers are limited, which could limit our stockholders’ recourse in the event of actions not in our stockholders’ best interests.
Our charter limits the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from:
actual receipt of an improper benefit or profit in money, property or services; or
a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated.

We have entered into indemnification agreements with our directors and executive officers that obligate us to indemnify them to the maximum extent permitted by Maryland law. In addition, our charter authorizes our company to obligate itself to indemnify our present and former directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. Our bylaws require us, to the maximum extent permitted by Maryland law, to indemnify each present or former director or officer who has been successful in the defense of any proceeding to which he or she is made, or threatened to be made, a party by reason of his or her service to us. In addition, we may be obligated to fund the defense costs incurred by our directors and officers.
Tax Risks
Our qualification as a REIT involves complying with highly technical and complex provisions of the Code.

Our qualification as a REIT involves the application of highly technical and complex provisions of the Code for which only limited judicial and administrative authorities exist. Even a technical or inadvertent violation could jeopardize our REIT qualification. Our qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution,

18


stockholder ownership and other requirements on a continuing basis. New legislation, court decisions or administrative guidance, in each case possibly with retroactive effect, may make it more difficult or impossible for us to qualify as a REIT. Certain rules applicable to REITs are particularly difficult to interpret or to apply.

Failure to qualify as a REIT would subject us to federal and state income tax at regular corporate rates, which could adversely affect our financial condition and results of operations, reduce the cash available for distribution to our stockholders, and potentially result in a decrease in the value of our common stock.

We operate in a manner that is intended to cause us to qualify as a REIT for federal income tax purposes. The federal income tax laws governing REITs are complex, and interpretations of the federal income tax laws governing qualification as a REIT are limited. Qualifying as a REIT requires us to meet various tests regarding the nature of our assets and our income, the ownership of our outstanding stock, and the amount of our distributions on an ongoing basis.
Our ability to satisfy the asset tests depends upon the characterization and fair market values of our assets, some of which may not be susceptible to a precise valuation, and for which we may not obtain independent appraisals. Our compliance with the REIT income and quarterly asset requirements also depends upon our ability to successfully manage the composition of our income and assets on an ongoing basis. Although we intend to operate so that we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance valuations, and the possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year.
If we fail to qualify as a REIT in any calendar year, we would be required to pay federal and state income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and dividends paid to our stockholders would not be deductible by us in computing our taxable income. Further, if we fail to qualify as a REIT, we might need to borrow money or sell assets in order to pay any resulting taxes. Our payment of income tax would decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to maintain our qualification as a REIT, we no longer would be required to distribute substantially all of our REIT taxable income to our stockholders. Unless our failure to qualify as a REIT was subject to relief under federal tax laws, we could not re-elect to qualify as a REIT until the fifth calendar year following the year in which we failed to qualify.
Our ability to invest in and dispose of securities through forward settling transactions could be limited by our REIT status, and we could lose our REIT status as a result of these investments.
We purchase a material portion of our Agency RMBS through contracts for forward settling transactions, including TBAs. In certain instances, rather than take delivery of the Agency RMBS subject to a contract for a forward settling transaction, we will dispose of the contract for a forward settling transaction through a dollar roll transaction in which we agree to purchase similar securities in the future at a predetermined price or otherwise, which may result in the recognition of income or gains. We account for dollar roll transactions as purchases and sales. The law is unclear regarding whether contracts for forward settling transactions will be qualifying assets for the 75% asset test and whether income and gains from dispositions of contracts for forward settling transactions will be qualifying income for the 75% gross income test.
Until such time as we seek and receive a favorable private letter ruling from the Internal Revenue Service (the "IRS"), or we are advised by counsel that contracts for forward settling transactions should be treated as qualifying assets for purposes of the 75% asset test, we will limit our net investment in contracts for forward settling transactions and any non-qualifying assets to no more than 25% of our assets at the end of any calendar quarter and will limit our investments in contracts for forward settling transactions with a single counterparty to no more than 5% of our total assets at the end of any calendar quarter. Further, until such time as we seek and receive a favorable private letter ruling from the IRS or we are advised by counsel that income and gains from the disposition of contracts for forward settling transactions should be treated as qualifying income for purposes of the 75% gross income test, we will limit our gains from dispositions of contracts for forward settling transactions and any non-qualifying income to no more than 25% of our gross income for each calendar year. Accordingly, our ability to purchase Agency RMBS through contracts for forward settling transactions and to dispose of contracts for forward settling transactions, through dollar roll transactions or otherwise, could be limited.
Moreover, even if we are advised by counsel that contracts for forward settling transactions should be treated as qualifying assets or that income and gains from dispositions of contracts for forward settling transactions should be treated as qualifying income, it is possible that the IRS could successfully take the position that such assets are not qualifying assets and such income is not qualifying income. In that event, we could be subject to a penalty tax or we could fail to qualify as a REIT if (i) the value of our contracts for forward settling transactions, together with our non-qualifying assets for the 75% asset test, exceeded 25% of our gross assets at the end of any calendar quarter or if the value of our investments in contracts for forward settling transactions

19


with a single counterparty exceeded 5% of our total assets at the end of any calendar quarter or (ii) our income and gains from the disposition of contracts for forward settling transactions, together with our non-qualifying income for the 75% gross income test, exceeded 25% of our gross income for any taxable year.
Complying with REIT requirements may cause us to forego otherwise attractive opportunities.
To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock. In order to meet these tests, we may be required to forego attractive business or investment opportunities. Thus, compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.
Liquidation of assets may jeopardize our REIT qualification.
To qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our investments to repay obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as dealer property or inventory.
Failure to make required distributions would subject us to tax, which would reduce the cash available for distribution to our stockholders.
In order to qualify as a REIT, an entity must distribute to its stockholders, each calendar year, at least 90% of its REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gain. To the extent that a REIT satisfies the 90% distribution requirement, but distributes less than 100% of its taxable income, it will be subject to federal corporate income tax on its undistributed income. In addition, a REIT will incur a 4% nondeductible excise tax on the amount, if any, by which its distributions in any calendar year are less than the sum of:
85% of its REIT ordinary income for that year;
95% of its REIT capital gain net income for that year; and
100% of its undistributed taxable income from prior years.

We intend to continue to make distributions in the future to our stockholders in a manner intended to satisfy the 90% distribution requirement and to avoid both federal corporate income tax and the 4% nondeductible excise tax. However, there is no requirement that taxable REIT subsidiaries ("TRSs") distribute their after-tax net income to their parent REIT or their stockholders, and if we utilize a TRS, it may determine not to make any distributions to us.
Our taxable income may substantially exceed our net income as determined based on GAAP because, for example, realized capital losses will be deducted in determining our GAAP net income, but may not be deductible in computing our taxable income. In addition, we may invest in assets that generate taxable income in excess of economic income or in advance of the corresponding cash flow from the assets, referred to as phantom income. Although some types of phantom income are excluded in determining the 90% distribution requirement, we will incur corporate income tax and the 4% nondeductible excise tax with respect to any phantom income items if we do not distribute those items on an annual basis. As a result of the foregoing, we may generate less cash flow than taxable income in a particular year. In that event, we may be required to use cash reserves, incur debt or liquidate non-cash assets at rates or times that we regard as unfavorable in order to satisfy the distribution requirement and to avoid federal corporate income tax and the 4% nondeductible excise tax in that year.
We may satisfy the 90% distribution test with taxable distributions of our stock or debt securities. On August 11, 2017, the IRS issued Revenue Procedure 2017-45 authorizing elective cash/stock dividends to be made by publicly offered REITs (e.g., REITs that are required to file annual and periodic reports with the SEC under the Exchange Act). Pursuant to Revenue Procedure 2017-45, effective for distributions declared on or after August 11, 2017, the IRS will treat the distribution of stock pursuant to an elective cash/stock dividend as a distribution of property under Section 301 of the Code (e.g., a dividend), as long as at least 20% of the total dividend is available in cash and certain other parameters detailed in the Revenue Procedure are satisfied. Although we have no current intention of paying dividends in our own stock, if in the future we choose to pay dividends in our own stock, our stockholders may be required to pay tax in excess of the cash that they receive.


20


Complying with REIT requirements may limit our ability to hedge effectively.

The REIT provisions of the Code limit our ability to hedge Agency RMBS and related borrowings. Under these provisions, we must limit our aggregate gross income from non-qualifying hedges, fees, and certain other non-qualifying sources to 5% or less of our annual gross income. As a result, we might in the future have to limit our use of advantageous hedging techniques or implement those hedges through a domestic TRS. This could increase the cost of our hedging activities, because a domestic TRS would be subject to tax on gains, or leave us exposed to greater risks associated with changes in interest rates than we would otherwise want to bear.

Legislative, regulatory or administrative changes could adversely affect us or our stockholders.

Legislative, regulatory or administrative changes could be enacted or promulgated at any time, either prospectively or with retroactive effect, and may adversely affect us and/or our stockholders.

The recently-enacted Tax Cuts and Jobs Act (the “TCJA”) makes significant changes to the U.S. federal income tax rules for taxation of individuals and corporations. In the case of individuals, the tax brackets have been adjusted, the top federal income rate has been reduced to 37%, special rules reduce taxation of certain income earned through pass-through entities and reduce the top effective rate applicable to ordinary dividends from REITs to 29.6% (through a 20% deduction for ordinary REIT dividends received) and various deductions have been eliminated or limited, including limiting the deduction for state and local taxes to $10,000 per year. Most of the changes applicable to individuals are temporary and apply only to taxable years beginning after December 31, 2017 and before January 1, 2026. The top corporate income tax rate has been reduced to 21%. There are only minor changes to the REIT rules (other than the 20% deduction applicable to individuals for ordinary REIT dividends received). The TCJA makes numerous other large and small changes to the tax rules that do not affect REITs directly but may affect our stockholders and may indirectly affect us. For example, the TCJA amends the rules for accrual of income so that income is taken into account no later than when it is taken into account on applicable financial statements, even if financial statements take such income into account before it would accrue under the original issue discount rules, market discount rules or other Code rules. Such rule may cause us to recognize income before receiving any corresponding receipt of cash. In addition, the TCJA reduces the limit for individual’s mortgage interest expense to interest on $750,000 of mortgages and does not permit deduction of interest on home equity loans (after grandfathering all existing mortgages). Such change and the reduction in deductions for state and local taxes (including property taxes) may adversely affect the residential mortgage markets in which we invest.

Prospective stockholders are urged to consult with their tax advisors with respect to the status of the TCJA and any other regulatory or administrative developments and proposals and their potential effect on investment in our common stock.

The taxation of corporate dividends may adversely affect the value of our stock.

The maximum tax rate applicable to "qualified dividend income" payable to U.S. stockholders that are taxed at individual rates is 20% (plus the 3.8% surtax on net investment income, if applicable). Dividends payable by REITs, however, are generally not eligible for the reduced rates on qualified dividend income. Rather, under the recently enacted TCJA, REIT dividends constitute “qualified business income” and thus a 20% deduction is available to individual taxpayers with respect to such dividends, resulting in a 29.6% maximum federal tax rate (plus the 3.8% surtax on net investment income, if applicable) for individual U.S. stockholders. Additionally, without further legislative action, the 20% deduction applicable to REIT dividends will expire on January 1, 2026. The more favorable rates applicable to regular corporate qualified dividends could cause investors who are taxed at individual rates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our stock.

The failure of Agency RMBS subject to a repurchase agreement to qualify as real estate assets would adversely affect our ability to qualify as a REIT.

We have entered into sale and repurchase agreements under which we nominally sold certain of our Agency RMBS to a counterparty and simultaneously entered into an agreement to repurchase the sold assets. We believe that we are treated for federal income tax purposes as the owner of the Agency RMBS that are the subject of any such agreement notwithstanding that such agreements may transfer record ownership of such assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could successfully assert that we did not own the Agency RMBS during the term of the sale and repurchase agreement, in which case we could fail to qualify as a REIT.


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Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.

Even if we remain qualified for federal income taxation as a REIT, we may be subject to certain federal, state and local taxes on our income and assets. Any of these taxes would decrease cash available for distribution to our stockholders.

Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our principal executive offices are located at 500 Totten Pond Road, 6th Floor, Waltham, Massachusetts 02451, and the telephone number of our main office is (617) 639-0440.  The Company also has an office at 60 Columbus Circle, 20th Floor, New York, New York 10023.
Item 3. Legal Proceedings
The Company is not currently subject to any material legal proceedings.
Item 4. Mine Safety Disclosures
None.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market and Dividend Information
Our common stock has been listed and is traded on the New York Stock Exchange ("NYSE") under the symbol "CYS" since June 12, 2009. We intend to continue to pay quarterly dividends to holders of shares of common stock. Future dividends will be at the discretion of the Board of Directors and will depend on our earnings and financial condition, maintenance of our REIT qualification, restrictions on making distributions under Maryland law and such other factors as our Board of Directors deems relevant. The following table presents the high and low sales prices for our common stock as reported by the NYSE and dividends declared for the period from January 1, 2016 to December 31, 2017.
 
 
High
 
Low
 
Common Dividends Declared Per Share
Quarter Ended December 31, 2017
 
$
8.72

 
$
7.88

 
$
0.25

Quarter Ended September 30, 2017
 
8.83

 
8.32

 
0.25

Quarter Ended June 30, 2017
 
8.92

 
7.95

 
0.25

Quarter Ended March 31, 2017
 
8.02

 
7.46

 
0.25

Quarter Ended December 31, 2016
 
8.72

 
7.42

 
0.25

Quarter Ended September 30, 2016
 
9.15

 
8.39

 
0.25

Quarter Ended June 30, 2016
 
8.54

 
7.97

 
0.25

Quarter Ended March 31, 2016
 
8.15

 
6.26

 
0.26

Holders of Our Common Stock
As of January 31, 2018, there were 298 record holders of our common stock, including shares held in "street name" by nominees who are record holders.
Issuer Purchases of Equity Securities
The following table summarizes purchases of equity securities during the quarter ended December 31, 2017 by the Company and affiliated purchasers (dollars in thousands except per share amounts):

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Period
 
Total Number of Shares Purchased (1)
 
Average Price Paid Per Share
 
Dollar Value of Shares That May Yet Be Purchased (1)
October 1, 2017 - October 31, 2017
 

 
$

 
$
155,502

November 1, 2017 - November 30, 2017
 

 

 
155,502

December 1, 2017 - December 31, 2017
 

 

 
155,502

Total
 

 
$

 
 
 __________________

(1)
The Company repurchases shares of its common stock in open-market transactions pursuant to its share repurchase program, authorized by its Board of Directors and publicly announced on July 21, 2014. Pursuant to this authority, the Company may repurchase shares of its common stock up to $250 million in aggregate value. Since July 21, 2014, the Company has repurchased approximately $94.5 million in aggregate value of its common stock, and accordingly, the Company was authorized to repurchase approximately $155.5 million in shares of its common stock as of December 31, 2017.

Performance Graph
The following graph and table set forth certain information comparing the yearly percentage change in cumulative total return on our common stock to the cumulative total return of the Standard & Poor's 500 Composite Stock Price Index (the "S&P 500"), the FTSE NAREIT Mortgage REIT Index ("FNMR") and CYS MREIT Peer Group, an index of selected issuers composed of Annaly Capital Management, Inc, American Capital Agency Corporation, Anworth Mortgage Asset Corporation, Capstead Mortgage Corporation, and Armour Residential REIT, Inc. The comparison is for the period from December 31, 2012 to December 31, 2017 and assumes (i) an investment of $100 on December 31, 2012, and (ii) the reinvestment of all dividends.

chart-5a53f026e4ed58989c3.jpg

23


During the period from December 31, 2012 to December 31, 2017 the cumulative total return on our common stock was 32.4%. The actual returns shown on the graph above are as follows:
 
 
12/31/2012
 
12/31/2013
 
12/31/2014
 
12/31/2015
 
12/31/2016
 
12/31/2017
CYS Investments, Inc.
 
$
100

 
$
73

 
$
99

 
$
92

 
$
113

 
$
132

FTSE NAREIT Mortgage REIT Index
 
100

 
98

 
116

 
105

 
129

 
155

CYS MREIT Peer Group
 
100

 
80

 
98

 
92

 
110

 
139

S&P 500 Total Return
 
100

 
132

 
150

 
153

 
171

 
208

The information in the share performance graph and table has been obtained from sources believed to be reliable. The historical information set forth above is not necessarily indicative of future performance. Accordingly, we do not make or endorse any predictions as to future share performance.
Equity Compensation Plans
Information about securities authorized for issuance under our equity compensation plans required for this Item 5 is incorporated by reference from our definitive Proxy Statement to be filed in connection with our 2018 annual meeting of stockholders.
Item 6. Selected Financial Data
The following table presents selected historical financial and operating information. The selected historical income statement and balance sheet data presented below as of and for the years ended December 31, 2017, 2016, 2015, 2014 and 2013 has been derived from our audited consolidated financial statements. The "Key Performance Metrics" have been derived from our underlying books and records.
The information presented below is only a summary and does not provide all of the information contained in our historical financial statements, including the related notes. You should read the information below in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," and our historical consolidated financial statements, including the related notes.

24



 
Year Ended December 31,
(In thousands, except per share numbers)
2017
 
2016
 
2015
 
2014**
 
2013**
Income Statement Data:
 
 
 
 
 
 
 
 
 
Interest income:
 
 
 
 
 
 
 
 
 
Agency RMBS
$
304,421

 
$
291,097

 
$
328,286

 
$
301,996

 
$
330,430

Other
6,362

 
3,440

 
2,909

 
15,080

 
1,481

Total interest income
310,783

 
294,537

 
331,195

 
317,076

 
331,911

Interest expense:
 
 
 
 
 
 
 
 
 
Repurchase agreements
114,616

 
70,230

 
40,700

 
33,825

 
52,763

FHLBC Advances

 
4,049

 
5,429

 

 

Total interest expense
114,616

 
74,279

 
46,129

 
33,825

 
52,763

Net interest income
196,167

 
220,258

 
285,066

 
283,251

 
279,148

Other income (loss):
 
 
 
 
 
 
 
 
 
Net realized gain (loss) on investments
(114,737
)
 
19,463

 
13,652

 
132,563

 
(595,116
)
Net unrealized gain (loss) on investments
94,463

 
(132,500
)
 
(129,764
)
 
233,763

 
(314,530
)
Net unrealized gain (loss) on FHLBC Advances

 
(1,299
)
 
1,299

 

 

Other income
163

 
1,361

 
867

 
269

 
120

Net realized and unrealized gain (loss) on investments, FHLBC Advances and other income
(20,111
)
 
(112,975
)
 
(113,946
)
 
366,595

 
(909,526
)
Interest rate hedge expense, net
(29,550
)
 
(55,798
)
 
(100,110
)
 
(90,812
)
 
(93,497
)
Net realized and unrealized gain (loss) on derivative instruments
57,750

 
(11,483
)
 
(54,932
)
 
(110,542
)
 
269,128

Net gain (loss) on derivative instruments
28,200

 
(67,281
)
 
(155,042
)
 
(201,354
)
 
175,631

Total other income (loss)
8,089

 
(180,256
)
 
(268,988
)
 
165,241

 
(733,895
)
Expenses:
 
 
 
 
 
 
 
 
 
Compensation and benefits
13,759

 
12,934

 
12,121

 
14,105

 
12,599

General, administrative and other
9,236

 
10,677

 
8,722

 
8,778

 
8,436

Total expenses
22,995

 
23,611

 
20,843

 
22,883

 
21,035

Net income (loss)
$
181,261

 
$
16,391

 
$
(4,765
)
 
$
425,609

 
$
(475,782
)
Dividend on preferred stock
(20,812
)
 
(20,812
)
 
(20,813
)
 
(20,812
)
 
(15,854
)
Net income (loss) available to common stockholders
$
160,449

 
$
(4,421
)
 
$
(25,578
)
 
$
404,797

 
$
(491,636
)
Net income (loss) per common share basic & diluted
$
1.05

 
$
(0.04
)
 
$
(0.17
)
 
$
2.50

 
$
(2.90
)
Dividends per common share
$
1.00

 
$
1.01

 
$
1.10

 
$
1.24

 
$
1.32

 
 
 
 
 
 
 
 
 
 
Key Balance Sheet Metrics
 
 
 
 
 
 
 
 
 
Average settled Debt Securities (1)
$
11,233,526

 
$
11,781,920

 
$
12,962,340

 
$
12,198,178

 
$
14,813,725

Average total Debt Securities (2)
$
12,701,093

 
$
13,212,278

 
$
14,223,921

 
$
13,910,227

 
$
17,806,279

Average repurchase agreements and FHLBC Advances (3)
$
9,697,163

 
$
10,290,967

 
$
11,395,383

 
$
10,559,856

 
$
12,836,246

Average Debt Securities liabilities (4)
$
11,164,730

 
$
11,721,325

 
$
12,656,964

 
$
12,271,905

 
$
15,828,800

Average stockholders' equity (5)
$
1,561,583

 
$
1,704,701

 
$
1,856,455

 
$
1,922,938

 
$
2,145,397


25


 
Year Ended December 31,
(In thousands, except per share numbers)
2017
 
2016
 
2015
 
2014**
 
2013**
Average common shares outstanding (6)
152,700

 
151,522

 
156,686

 
161,950

 
170,803

Leverage ratio (at period end) (7)
7.33:1

 
7.06:1

 
6.77:1

 
6.44:1

 
6.97:1

Liquidity as % of stockholders' equity (8)
65
%
 
61
 %
 
66
 %
 
67
%
 
63
 %
Hedge ratio (9)
99
%
 
92
 %
 
94
 %
 
90
%
 
91
 %
Book value per common share (at period end) (10)
$
8.38

 
$
8.33

 
$
9.36

 
$
10.50

 
$
9.24

Weighted-average amortized cost of Agency RMBS and U.S. Treasuries (11)
$
102.92

 
$
103.78

 
$
103.69

 
$
103.98

 
$
102.57

 
 
 
 
 
 
 
 
 
 
Key Performance Metrics*
 
 
 
 
 
 
 
 
 
Average yield on settled Debt Securities (12)
2.77
%
 
2.50
 %
 
2.56
 %
 
2.60
%
 
2.24
 %
Average yield on total Debt Securities including Drop Income (13)
2.68
%
 
2.48
 %
 
2.56
 %
 
2.72
%
 
2.39
 %
Average cost of funds(14)
1.18
%
 
0.72
 %
 
0.40
 %
 
0.32
%
 
0.41
 %
Average cost of funds and hedge (15)
1.49
%
 
1.26
 %
 
1.28
 %
 
1.18
%
 
1.14
 %
Adjusted average cost of funds and hedge (16)
1.29
%
 
1.11
 %
 
1.16
 %
 
1.02
%
 
0.92
 %
Interest rate spread net of hedge (17)
1.28
%
 
1.24
 %
 
1.28
 %
 
1.42
%
 
1.10
 %
Interest rate spread net of hedge including Drop Income (18)
1.39
%
 
1.37
 %
 
1.40
 %
 
1.70
%
 
1.47
 %
Operating expense ratio (19)
1.47
%
 
1.39
 %
 
1.12
 %
 
1.19
%
 
0.98
 %
Total stockholder return on common equity (20)
12.61
%
 
(0.21
)%
 
(0.38
)%
 
27.06
%
 
(20.66
)%
CPR (weighted-average experienced 1-month) (22)
8.6
%
 
12.1
 %
 
10.4
 %
 
7.9
%
 
11.6
 %
_________

(1)
The average settled Debt Securities is calculated by averaging the month end cost basis of settled Debt Securities during the period.
(2)
The average total Debt Securities is calculated by averaging the month end cost basis of total Debt Securities and unsettled Debt Securities (inclusive of TBA Derivatives) during the period.
(3)
The average repurchase agreements and FHLBC Advances are calculated by averaging the month-end repurchase agreements and FHLBC Advances balances during the period.    
(4)
The average Debt Securities liabilities are calculated by adding the average month-end repurchase agreements and FHLBC Advances balances plus average unsettled Debt Securities (inclusive of TBA Derivatives) during the period.            
(5)
The average stockholders' equity is calculated by averaging the month-end stockholders' equity during the period.            
(6)
The average common shares outstanding is calculated by averaging the daily common shares outstanding during the period.
(7)
The leverage ratio is calculated by dividing (i) the Company's repurchase agreements and FHLBC Advances balance plus payable for securities purchased minus receivable for securities sold, plus or minus the net TBA Derivatives positions by (ii) stockholders' equity.
(8)
Liquidity as % of stockholders' equity is calculated by dividing unencumbered liquid assets by stockholders' equity.
(9)
The hedge ratio for the period is calculated by dividing the combined total Interest Rate Swaps and Interest Rate Caps notional amount by total repurchase agreements and FHLBC Advances balances.
(10)
Book value per common share is calculated by dividing total stockholders' equity less the liquidation value of preferred stock at period end by common shares outstanding at period end.
(11)
The weighted-average amortized cost of Agency RMBS and U.S. Treasuries is calculated using the weighted-average amortized cost by security divided by the current face at period end.
(12)
The average yield on settled Debt Securities for the period is calculated by dividing total interest income by average settled Debt Securities.
(13)
Average yield on total Debt Securities including Drop Income for the period is calculated by dividing total interest income plus Drop Income by average total Debt Securities. Drop Income was $29.9 million, $32.9 million, $32.6 million, $60.7 million and $94.5 million for the years ended December 31, 2017, 2016, 2015, 2014 and 2013, respectively. Drop Income is a component of our net realized and unrealized gain (loss) on investments and derivative instruments in the Consolidated Statements of Operations. Drop Income is the difference between the spot price and the forward-settlement price for the same security on the trade date.
(14)
The average cost of funds for the period is calculated by dividing repurchase agreement and FHLBC Advances interest expense by average repurchase agreements and FHLBC Advances for the period.

26


(15)
The average cost of funds and hedge for the period is calculated by dividing repurchase agreement and FHLBC Advances interest expense and interest rate hedge expense, net by average repurchase agreements and FHLBC Advances.
(16)
The adjusted average cost of funds and hedge for the period is calculated by dividing repurchase agreement and FHLBC Advances interest expense and interest rate hedge expense, net by average Debt Securities liabilities.
(17)
The interest rate spread net of hedge for the period is calculated by subtracting average cost of funds and hedge from average yield on settled Debt Securities.
(18)
The interest rate spread net of hedge including Drop Income for the period is calculated by subtracting adjusted average cost of funds and hedge from average yield on total Debt Securities including Drop Income.
(19)
The operating expense ratio for the period is calculated by dividing operating expenses by average stockholders' equity.
(20)
The total stockholder return on common equity is calculated as the change in book value plus dividend distributions on common stock divided by book value at the beginning of the period.
(21)
CPR represents the weighted-average 1-month CPR of the Company's Agency RMBS during the period.
*
All percentages are annualized except total stockholder return on common equity.
** Previously reported under specialized accounting, ASC 946 – Financial Services – Investment Companies.  See Notes to consolidated financial statements, Note 2, Significant Accounting Policies, Basis of Presentation.
 
 
As of December 31,
(in thousands, except per share numbers)
 
2017
 
2016
 
2015
 
2014
 
2013
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
 
Investments in securities, at fair value
 
$
12,634,654

 
$
12,648,731

 
$
13,027,707

 
$
14,601,507

 
$
13,858,848

Total assets
 
13,145,582

 
13,245,268

 
14,330,704

 
14,895,863

 
14,633,064

Repurchase agreements and other debt
 
10,089,917

 
9,691,544

 
11,086,477

 
11,289,559

 
11,206,950

Stockholders' equity
 
1,574,247

 
1,535,719

 
1,694,614

 
1,975,168

 
1,768,656

Book value per common share
 
$
8.38

 
$
8.33

 
$
9.36

 
$
10.50

 
$
9.24

Core Earnings
"Core Earnings" represents a non-GAAP financial measure and is defined as net income (loss) available to common stockholders excluding net realized and unrealized gain (loss) on investments and derivative instruments, and net unrealized gain (loss) on FHLBC Advances. Management uses Core Earnings to evaluate the effective yield of the portfolio after interest and operating expenses. The Company believes that providing users of the Company's financial information with such measures, in addition to the related GAAP measures, gives investors and stockholders additional transparency and insight into the information used by the Company's management in its financial and operational decision-making.
The primary limitation associated with Core Earnings as a measure of the Company's financial performance over any period is that it excludes the effects of net realized and unrealized gain (loss) on investments and derivative instruments, and net unrealized gain (loss) on FHLBC Advances. In addition, the Company's presentation of Core Earnings may not be comparable to similarly-titled measures of other companies, which may use different calculations. As a result, Core Earnings should not be considered a substitute for the Company's GAAP net income (loss) as a measure of its financial performance or any measure of its liquidity under GAAP.
 
 
Year Ended December 31,
(in thousands, except per share numbers)
 
2017
 
2016
 
2015
 
2014
 
2013
Non-GAAP Reconciliation:
 
 
 
 
 
 
 
 
 
 
Net income (loss) available to common stockholders
 
$
160,449

 
$
(4,421
)
 
$
(25,578
)
 
$
404,797

 
$
(491,636
)
Net realized (gain) loss on investments
 
114,737

 
(19,463
)
 
(13,652
)
 
(132,563
)
 
595,116

Net unrealized (gain) loss on investments
 
(94,463
)
 
132,500

 
129,764

 
(233,763
)
 
314,530

Net realized and unrealized (gain) loss on derivative instruments
 
(57,750
)
 
11,483

 
54,932

 
110,542

 
(269,128
)
Net unrealized (gain) loss on FHLBC Advances
 

 
1,299

 
(1,299
)
 

 

Core Earnings
 
$
122,973

 
$
121,398

 
$
144,167

 
$
149,013

 
$
148,882


27



Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

CYS Investments, Inc. (the "Company", "we", "us", and "our") is a specialty finance company created with the objective of achieving consistent risk-adjusted investment income. Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide the reader of the Company's consolidated financial statements and accompanying notes with a narrative from management to provide its perspective on the business underlying those financial statements and its financial condition and results of operations during the periods presented. The Company's MD&A is comprised of four sections:

Executive Overview,
Financial Condition,
Results of Operations,
Liquidity and Capital Resources, and
Off-Balance Sheet Arrangements

The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes included in Item 8 of this Annual Report on Form 10-K.
Executive Overview
We are a specialty finance company created with the objective of achieving consistent risk-adjusted investment income. We seek to achieve this objective by investing on a leveraged basis primarily in Agency RMBS. These investments consist of residential mortgage pass-through securities for which the principal and interest payments are guaranteed by a government-sponsored enterprise, such as Fannie Mae, Freddie Mac, or by a U.S. government agency, such as Ginnie Mae(collectively referred to as "GSEs"). We may also invest in U.S. Treasuries, CMOs, STACRS, CAS, or other securities issued by a GSE that are not backed by collateral but, in the case of government agencies, are backed by the full faith and credit of the U.S. government, and, in the case of GSEs, are backed by the integrity and creditworthiness of the issuer ("U.S. Agency Debentures") or credit risk transfer securities, such as Structured Agency Credit Risk (“STACR”) debt securities issued by Freddie Mac, Connecticut Avenue Securities (“CAS”) issued by Fannie Mae, or similar securities issued by a GSE where their cash flows track the credit risk performance of a notional reference pool of mortgage loans.
We commenced operations in February 2006, and completed our initial public offering in June 2009. Our common stock, our 7.75% Series A Cumulative Redeemable Preferred Stock, $25.00 liquidation preference (the "Series A Preferred Stock"), and our 7.50% Series B Cumulative Redeemable Preferred Stock, $25.00 liquidation preference (the "Series B Preferred Stock"), trade on the New York Stock Exchange under the symbols "CYS," "CYS PrA" and "CYS PrB," respectively.
We earn income from our investment portfolio, currently comprised principally of Agency RMBS and U.S. Treasuries (collectively, "Debt Securities"). We finance our investments primarily through borrowings under repurchase agreements ("repo borrowings"), and, prior to the effective date of the Final Rule on January 19, 2016, loans from the Federal Home Loan Bank of Cincinnati ("FHLBC"), which provides short-term and long-term secured loans ("FHLBC Advances") to its members. We use leverage to seek to enhance our returns, although leverage may also exacerbate losses. Our economic net interest income, a non-GAAP measure, described in "Results of Operations" below, is generated primarily from the net spread, or difference, between the interest income we earn on our investment portfolio and the cost of our borrowings and hedging activities. The amount of economic net interest income we earn on our investments depends in part on our ability to control our financing costs, which comprise a significant portion of our operating expenses. Economic Interest Expense is comprised of interest expense, as computed in accordance with GAAP, plus interest rate hedge expense, net, which consists of swap, swaption and cap interest expense used to hedge our cost of funds, a component of net gain (loss) on derivative instruments in the Company’s Consolidated Statements of Operations. The Company uses interest rate swaps (cancellable and non-cancellable), swaptions and caps to manage its exposure to changes in interest rates on its interest bearing liabilities by economically hedging cash flows associated with these borrowings. Presenting the contractual interest payments on interest rate swaps and caps and the amortization of premiums paid on caps and swaptions with the interest paid on interest-bearing liabilities reflects the total contractual interest payments. Economic Interest Expense depicts the economic cost of our financing strategy. Although we leverage our portfolio investments in Debt Securities to seek to enhance our potential returns, leverage also may exacerbate losses.
While we hedge to attempt to manage our interest rate risk, we do not hedge all of our exposure to changes in interest rates. Our investments vary in interest rate and maturity compared with the rates and duration of the hedges we employ. As a result, it is not possible to insulate our portfolio from all potential negative consequences associated with changes in interest

28


rates in a manner that will allow us to achieve attractive spreads on our portfolio. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net income.
In addition to investing in issued pools of Agency RMBS, we regularly utilize forward settling transactions to purchase and sell certain securities, including forward settling purchases and sales of Agency RMBS where the pool is "to-be-announced" ("TBA"). Pursuant to a TBA transaction, we agree to purchase or sell for future delivery, Agency RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular Agency RMBS to be delivered is not specifically identified until shortly before the TBA settlement date.  For TBA securities that meet the regular-way securities scope exception from derivative accounting under ASC 815 - Derivatives and Hedging, the Company records TBAs on the trade date utilizing information associated with the specified terms of the transaction. TBAs are carried at fair value and begin earning interest on the settlement date. At times, the Company may enter into TBA Derivatives as a means of investing in and financing Agency RMBS via "dollar roll" transactions. TBA dollar roll transactions are accounted for as a series of derivative transactions. For other forward settling transactions, we agree to purchase or sell, for future delivery, Agency RMBS. However, unlike TBA Derivatives, these forward settling transactions reference an identified Agency RMBS.
In March 2015, our captive insurance subsidiary, CYS Insurance Services, LLC ("CYS Insurance"), was granted membership in the FHLBC and commenced obtaining FHLBC Advances from the FHLBC in the form of secured borrowings. Membership in the FHLBC permitted CYS Insurance to access a variety of products and services offered by the FHLBC, and obligated CYS Insurance to purchase FHLBC membership and activity stock, the latter being a percentage of the advances the Company obtained from the FHLBC. As with our repo borrowings, if the value of any assets pledged to FHLBC as collateral for advances decreased, the FHLBC could require posting of additional collateral. On January 12, 2016, the Federal Housing Finance Agency ("FHFA") issued a final rule (the "Final Rule") amending its regulations governing FHLB membership criteria for captive insurance companies. The Final Rule defines "insurance company" to exclude "captive insurers". Under this Final Rule, which became effective on February 19, 2016, CYS Insurance's membership in the FHLBC was required to be terminated within one year of the effective date, it was not permitted to secure any new advances, and all FHLBC Advances were required to be repaid no later than February 19, 2017. The Company repaid all outstanding FHLBC Advances prior to September 30, 2016, and CYS Insurance's membership in the FHLBC was terminated on February 19, 2017.
We have elected to be treated as a REIT for U.S. federal income tax purposes, and have complied with, and intend to continue to comply with, the provisions of the Code, with respect thereto. Accordingly, we generally do not expect to be subject to federal income tax on our REIT taxable income that we currently distribute to our stockholders if certain asset, income and ownership tests and recordkeeping requirements are fulfilled. Even if we maintain our qualification as a REIT, we may be subject to some federal, state and local taxes on our income.
Factors that Affect our Results of Operations and Financial Condition
A variety of industry and economic factors may impact our results of operations and financial condition. These factors include:
interest rate trends;
prepayment rates on mortgages underlying our Agency RMBS, and credit trends insofar as they affect prepayment rates;
competition for investments in Agency RMBS;
actions or inactions taken by the U.S. government, including the Federal Reserve (the "Fed"), the FHFA, the FOMC and the U.S. Treasury;
credit rating downgrades of the United States' and certain European countries' sovereign debt; and
other market developments.
In addition, a variety of factors relating to our business may also impact our results of operations and financial condition. These factors include:
our degree of leverage;
our access to funding and borrowing capacity;
our borrowing costs;
our hedging activities;
the market value of our investments; and
the REIT requirements and the requirements to qualify for a registration exemption under the Investment Company Act.

29


Changes in interest rates may significantly influence our net income and book value, or stockholders' equity.
Prepayments on loans and securities may be influenced by changes in market interest rates and homeowners' ability and desire to refinance their mortgages. To the extent we have acquired assets at a premium or discount to face value, changes in prepayment rates will impact our anticipated yield.

Trends and Recent Market Activity

Overview

Our business is largely influenced by interest rates and credit conditions principally in the United States, and, to a lesser extent, globally. Changes in trends, and the outlook for, economic growth and inflation, as well as global central bank policies and supply and demand metrics significantly impact short-term and long-term interest rates and the yield curve. Our earnings power benefits from a steep yield curve, and our book value is largely influenced by movements in interest rates, mortgage rates, and swap rates.

We characterize 2017 as a year of relative stability and low volatility, as compared to 2016, which was a year of "surprise" (highlighted by Brexit and the U.S. Presidential election). Longer-term rates were range-bound during 2017 as shorter-term rates began a steady climb during the second half of the year. Markets moved through the Presidential transition as the new U.S. President began to layout a policy agenda and initiated changes in leadership across a number of regulatory and policy positions. Further, prior to her exit as Chair of the Fed, Janet Yellen established a well-defined and clearly communicated plan for both balance sheet normalization and interest rate normalization, which the markets accepted. Jerome (Jay) Powell was nominated and confirmed as the next Fed leader and has been labeled as "Yellen-like" with a perspective leaning toward some modest financial deregulation. Meanwhile, overseas, French and German elections went as expected and the other Central banks maintained their easy monetary policies while hinting that they would follow the Fed’s lead toward modest tightening in the coming years.

Despite success in reducing the overall level of regulation, through most of 2017, the administration struggled to effect legislation intended to stimulate the economy. However, on December 22, 2017, President Trump signed into law H.R. 1, comprehensive tax reform informally titled the Tax Cuts and Jobs Act (the "TCJA" or the "Act"). The markets and many economists believe that the TCJA should boost economic growth in the next few years, but the sustainability of that increase remains open for debate. Higher deficits and inflation are other likely anticipated effects of the legislation that markets and policy-makers, including the Fed, will have to consider. In addition to tax reform, the administration has installed policy leaders who favor financial deregulation and the Senate has introduced a bi-partisan bill that will provide regulatory relief for smaller banks, among other reforms. These actions should help to lift economic growth, at least in the near term.

Record low levels of volatility was a key market theme in 2017. Throughout the year, financial markets continued to follow established trends without much agitation. Equities continued their advance and completed one of their best years in the last fifteen, credit spreads continued to tighten and 10-year U.S. Treasuries traded within their narrowest one-year bands in nearly 50 years. The low volatility environment benefited Agency RMBS, which performed quite well despite a flattening yield curve in 2017.

The Federal Open Market Committee ("FOMC") increased the Federal Funds Rate three separate times in 2017. It was the first year in three that the FOMC met its own expectations on the pace of rate tightening. After introducing its normalization policy in late 2014, the FOMC raised rates by only 25 bps each in 2015 and 2016 after having predicted multiple hikes in each of those years. In 2017, the FOMC raised rates by 25 bps, in March, June and December, and closed the year with the Federal Funds rate in the 1.25-1.50% range, still considerably below its longer-term target of 2.75%. Notably, in September of 2017, the FOMC also announced its balance sheet normalization plan, which it initiated in October of 2017 and which will reach its maximum monthly run-off targets by October of 2018.

As inflation failed to materialize at an expected pace during the year, and with the Fed apparently still committed to normalizing rates on a gradual yet consistent basis, yield curve flattening was one of the few new trends that commenced in 2017. Although longer-maturity 10-year U.S. Treasury yields were range-bound within 2.04%-2.63%, shorter term rates climbed steadily through the later part of the year beginning in mid-September. The yield on 5-year U.S. Treasuries rose 28 bps to end the year at 2.21% and the yield on 10-year U.S. Treasuries fell a modest 3 bps to 2.41% on December 31, 2017. Prices of Agency RMBS followed and 30-year Agency RMBS 3.5% rose from $102.33 at December 31, 2016 to $102.73 at December 31, 2017 while 15-year Agency RMBS 3.0% fell from $102.48 at December 31, 2016 to $101.89 at December 31, 2017.


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Despite the flattening yield curve, we were able to maintain what we believe to be attractive risk-adjusted returns in 2017 due to several factors. The most significant contributor was the repositioning of our Agency RMBS portfolio that we implemented in late 2016 following the presidential election-induced increase in rates by recycling capital out of 15-year Agency RMBS with a higher cost basis and prepayment characteristics and into 30-year Agency RMBS with a lower cost basis and a more favorable prepayment profile. Low levels of prepayments also supported returns throughout 2017. Additional contributors to our returns in 2017 included Agency RMBS outperformed U.S. Treasury and swap rates. In anticipation of an increase in rates, we significantly expanded our hedge portfolio. In addition, increases in LIBOR rates outpaced our funding rates, contributing to asset yields and better hedge performance. Consequently, we ended the year better hedged and at a lower cost than when we started the year.

We expect 2018 to be a volatile year for interest rates, and we anticipate that Agency RMBS performance will be adversely impacted in a rising rate environment. Markets are still monitoring inflation metrics carefully as the actual rate of inflation has failed to meet the Fed’s targets for the last several years. Additionally, a newly composed FOMC will have to grapple with inflation fluctuations, market reactions and how best to implement monetary policy. The Fed has acknowledged its concern about the lack of reappearance of inflation and has pointed to some ‘transitory’ factors that have contributed to lower-than-targeted inflation levels in 2017. During 2017, Fed officials have increasingly discussed alternatives to their explicit 2% inflation target, which the Fed has consistently had trouble reaching since setting the goal in 2012. Any unanticipated changes in plans for other global central bank participant’s policies could also affect U.S. interest rates. Finally, as balance sheet normalization takes full-effect and markets are faced with significant net supply of U.S. Treasury securities and Agency RMBS, these valuations could be vulnerable.

The Fed is sensitive to the flattening yield curve as reflected in comments by several Fed governors who have noted concerns about inverting the yield curve. We note that the FOMC composition in 2018 is quite different from what it has been in recent years. In 2018, the organization will be led by a new Chair and, once named and confirmed, a new Vice Chair. Additionally, only four voters (Brainard, Dudley, Powell and Quarles) who voted in 2017 will be voting in 2018. Consequently, we could see seven new voting members in 2018. Although it is anticipated that the FOMC will continue to operate on the existing set course, we have yet to see how the new leadership might react to shocks in the economy or financial markets.

Although we continued to take advantage of the forward TBA market throughout 2017, we did so to a lesser extent as this market provided less attractive implied financing rates, also referred to as “specialness”, resulting in a decrease in Drop Income to $29.9 million in 2017 from $32.9 million in 2016.

The charts below illustrate key market and Company-specific interest rate and spread movements for the periods illustrated:
chart-838330494dae5fc4b76.jpg

31


        chart-9141e330a2db8c04c36.jpg

        chart-8dd83f813bee76c9977.jpg


32


- Interest Rates, Unemployment and Other Macroeconomic Trends

A key focus of the bond and equity markets over the past few years has been the timing and magnitude of Fed rate hikes. During 2017, the Fed signaled, and markets accepted, three rate hikes. 2017 was unlike prior years, when markets reacted with more volatility to geopolitical and other news and the Fed held off rate decisions until December of 2015 and 2016 for fear of further roiling markets. Ultimately, the FOMC’s decision to raise rates three times in 2017 reflected continued improvement in labor market conditions and a reasonable confidence that inflation will rise to its 2% objective. The FOMC has indicated another three 25 bps rate hikes in the Federal Funds Rate are likely during 2018; however, we believe that this will remain contingent on inflation and other data as well as market stability.

Set forth below are graphs of yield curves showing trends from 2015 through 2017 and the four quarters of 2017:
annualyieldcurves.jpg

33


quarterlyyieldcurves.jpg
    
U.S. economic performance improved in 2017 and is projected to improve again in 2018. After generating lackluster growth of sub-2.0% in 2016, we started 2017 with another soft first quarter GDP growth rate of 1.2%. Since then, however, growth has increased to just over 3% in the second and third quarters of 2017 and fourth quarter growth was 2.6%. For 2017 as a whole, GDP growth was 2.3%, better than 2016’s 1.5% growth rate and slightly better than the preceding five-year (2012-2016) average of 2.2%. The consensus estimate for 2018 GDP growth is currently 2.6%, an improvement over 2017 on the back of tax reform, but still a modest pace compared to prior growth periods and considerably lower than during the 1990s when the economy grew an average 3.4% per year.

We have yet to see the effects of the TCJA and other potential fiscal policies that might promote incremental economic growth. At the December 2017 press conference, Chair Yellen noted that most Fed officials have factored in growth and some reduction in unemployment due to tax reform into their economic projections. The FOMC, with a number of new members with their own views, will continue to assess incoming economic data and to adjust their models as the effects of fiscal policies emerge and as new policies are introduced.

Policy issues other than tax reform have yet to be addressed by the presidential administration or Congress. We are expecting some that are relevant to our industry including, but not limited to, the following: review of the Dodd-Frank Act, banking regulations and how reforms may impact our lenders; policies overseen by the Consumer Financial Protection Bureau (“CFPB”) and whether residential mortgage originators may be impacted; the status of the Federal Housing Finance Agency (“FHFA”) and whether any of its rules that impact our sector would be affected; the status and capital structure of the GSEs (i.e., Fannie Mae and Freddie Mac), and several others. Several bills that address mortgage finance reform are expected to be introduced by the Senate and House, respectively, in early 2018. Additionally, with a new leader at the helm, the CFPB is reportedly reviewing QM rules and has the power to define QM. Policy changes here could help widen the credit box for mortgage originators, making mortgages available to a larger group of borrowers. To date, the Senate has introduced a bi-partisan bill that will provide regulatory relief, including qualified mortgage ("QM") relief, for smaller banks, among other reforms. This bill could be enacted into law by the summer of 2018. It's not clear what the details on these potential reforms will be.




34


chart-f8943889e1a05678a46.jpg
Although monetary policy has been beneficial in returning the economy to, or close to, full employment, the second of the Fed's two mandates, inflation, has consistently tracked lower than its 2% target. The core personal consumption expenditure inflation index was around 1.5% for 2017. This metric has shown signs of an increase several times since the 2008 financial crisis, but these have not proven durable. FOMC members attributed the undershot in inflation in 2017 to "transitory" factors and in her December press conference, Chair Yellen noted that the FOMC expects inflation to increase and stabilize around the 2% target over the next couple of years. She also noted that the FOMC will carefully monitor actual and expected inflation developments and adjust policy as needed to achieve objectives. In the December 2017 FOMC minutes, a few committee participants suggested that further study of potential alternative frameworks for the conduct of monetary policy such as price-level targeting or nominal GDP targeting or looking at ranges of inflation could be useful. We believe inflation will continue to be a key focus area in 2018.

Global growth outlooks for 2018 are brighter than 2017 due to monetary and fiscal stimulus but inflation globally still remains scant. Europe and Japan’s growth outlooks are significantly improved from recent years, but both are expected to maintain their quantitative easing programs through 2018. Markets anticipate that these central banks may taper these programs over the next few years, assuming growth improves and inflation resurfaces. Any changes in foreign central bank policies that surprise markets could cause volatility in U.S. as well as global rates.
- Interest Rate Spreads
The spread between Agency RMBS and interest rate swaps tightened considerably during 2017, as shown in the graph below. The spread between Fannie Mae 30-year securities and 7-year interest rate swaps tightened 28 bps, and Fannie Mae 15-year and 5-year interest rate swaps tightened 23 bps during 2017. In general, this had a positive impact on our asset values relative to our hedges during 2017, especially in the third quarter.
Agency RMBS performed well versus their hedges, as the Agency RMBS spread to swap rates tightened. This occurred even after the Fed’s balance sheet normalization plan announcement, due to: (i) the Fed’s normalization plans having been well-telegraphed and understood by the market; (ii) a plan to commence balance sheet normalization modestly, beginning with an initial $4 billion per month with gradually increasing Agency RMBS paring reaching its $20 billion monthly cap in October 2018; and (iii) the securities were in demand by a wide variety of investors, notably some mortgage REIT investors raising equity and money managers receiving cash inflows, as they offered attractive returns relative to corporate bonds and other credit products.

35


chart-5b740cd2d7915496838.jpg
Generally, when spreads between Agency RMBS and swaps narrow, our book value increases, but it also limits our investment and reinvestment opportunities in the short-term. Notably, if the yield curve continues to flatten with the short-end rising, we expect that this may have the effect of reducing our yield on new investments. During the twelve months ended December 31, 2017, and December 31, 2016, the weighted-average yield on the Company's Debt Securities was 2.77% and 2.50%, respectively.

The table below shows generic Agency RMBS investments and their respective net interest margins and related swap and hedge ratio assumptions as of January 12, 2018:
Net Interest Margin (1)
30-Yr. 3.5%
 
30-Yr. 4.0%
 
15-Yr. 3.0%
 
15-Yr. 3.5%
Asset Yield
3.36
%
 
3.47
%
 
2.86
%
 
2.85
%
Financing Rate
1.62
%
 
1.62
%
 
1.62
%
 
1.62
%
Hedge Cost
0.44
%
 
0.35
%
 
0.40
%
 
0.33
%
Net interest margin
1.30
%
 
1.50
%
 
0.84
%
 
0.90
%
 
 
 
 
 
 
 
 
Key Assumptions
 
 
 
 
 
 
 
Swap
7-Year

 
7-Year

 
5-Year

 
5-Year

Hedge Ratio
50
%
 
40
%
 
50
%
 
40
%
_______________________________________ 
(1) The examples in this table are for illustrative purposes only and do not reflect our projections or forecasts. Any assumptions and estimates used may not be accurate and cannot be relied upon. Our net interest margin for any given period may differ materially from these examples.
We benefited from a generally favorable financing environment throughout 2017. Even after three separate 25 bps rate hikes, the Federal Funds Rate remains at low levels. The Company generally borrows in the 30-180 day repo markets, which historically have been highly correlated to LIBOR. Access to repurchase agreements ("Repo Borrowings") collateralized with our Agency RMBS was stable during 2017 and funding capacity was widely available. In addition, prior to the Final Rule, the Company had access to FHLBC Advances.
At December 31, 2017, the interest rates on our Repo Borrowings ranged from 1.07% to 1.64% for 30-90 day repo borrowings, with a weighted-average interest rate of 1.42% and a weighted-average remaining maturity of 51 days. During 2017,

36


our weighted-average cost of funds was 1.18%, compared to 0.72% in 2016, reflecting the higher interest rate environment and the expectation for continued rate hikes.
Date
 
1-Month LIBOR
 
3-Month LIBOR
 
6-Month LIBOR
 
Federal Funds Rate
December 31, 2017
 
1.564
%
 
1.694
%
 
1.837
%
 
1.50
%
September 30, 2017
 
1.232
%
 
1.334
%
 
1.506
%
 
1.25
%
June 30, 2017
 
1.224
%
 
1.299
%
 
1.448
%
 
1.25
%
March 31, 2017
 
0.983
%
 
1.150
%
 
1.423
%
 
1.00
%
December 31, 2016
 
0.772
%
 
0.998
%
 
1.318
%
 
0.75
%
September 30, 2016
 
0.531
%
 
0.854
%
 
1.240
%
 
0.50
%
June 30, 2016
 
0.465
%
 
0.654
%
 
0.924
%
 
0.50
%
March 31, 2016
 
0.437
%
 
0.629
%
 
0.900
%
 
0.50
%
December 31, 2015
 
0.430
%
 
0.613
%
 
0.846
%
 
0.50
%
For much of the year, debt ceiling dynamics as well as money market reform helped keep repo rates subdued. A notable reduction in U.S. Treasury bill issuance throughout the year, in response to the U.S. debt ceiling requirements, created a relative shortage of short-dated U.S. Treasuries available for the large pool of government money funds looking to invest in short-dated government securities. The money funds turned to Agency RMBS repo, among a short list of other eligible options, which helped to moderate repo rates. During the fourth quarter of 2017, LIBOR rates rose considerably. Year-end funding dynamics (demand for dollar funding by some foreign banks) in addition to expectations of rising short-term rates pushed 3-month LIBOR up 36 bps in the fourth quarter to end the year at 1.69%, the highest level reached since 2008.

In 2017, policymakers announced that LIBOR will be replaced by 2021. The directive was spurred by the fact that banks are uncomfortable contributing to the LIBOR panel given the shortage of underlying transactions on which to base levels and the liability associated with submitting an unfounded level. LIBOR will be replaced with a new Secured Overnight Financing Rate (SOFR), a rate based on U.S. repo trading. The new benchmark rate will be based on overnight Treasury General Collateral ("GC") repo rates. The rate-setting process will be managed and published by the Fed and the Treasury’s Office of Financial Research. Daily publication of the rate will begin in the first half of 2018 and a May 2018 launch is anticipated. Futures trading will begin soon afterward. Many banks believe that it may take four to five years to complete the transition to SOFR, despite the 2021 deadline. We will monitor the emergence of this new rate carefully as it will likely become the new benchmark for hedges and a range of interest rate investments.

- Investing and Reinvestment Environment and Agency RMBS Supply and Demand

In recent years, the investing and reinvesting environment for Agency RMBS has been characterized by tight supply and strong demand led by the Fed’s asset purchase and reinvestment programs. While home sales and new single-family and multi-family home construction continued to improve in 2017 as home prices continued to rise at a measured pace, mortgage lending rules remained constrained due to the Dodd-Frank Act and bank conservatism in efforts to prevent future mortgage "put-backs,” and mortgage availability, particularly to less creditworthy borrowers.

We expect some of the dynamics on the demand side of the equation may begin to change in 2018 as the Fed reduces its purchases of Agency RMBS as part of its balance sheet normalization plan initiated in October 2017. At December 31, 2017, the Fed held a portfolio of approximately $1.7 trillion, or 27%, of the $6.2 trillion Agency RMBS market. According to its plan formally announced in September of 2017, the Fed has set a gradually increasing set of monthly caps, or limits above which U.S. Treasuries and agency securities in its portfolio may be reinvested. Beginning with $4 billion per month in October 2017, the monthly cap on Agency RMBS will increase in increments of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month in October 2018. As a result, a significant amount of new Agency RMBS supply must be absorbed by an investor group that will now largely exclude the Fed, which had been its biggest supporter since the financial crisis. We anticipate this market activity will cause renewed volatility in Agency RMBS markets and a likelihood of spread widening in 2018.

Mortgage interest rates remained at relatively low levels in 2017 versus historical measures. 2017 mortgage originations were lower than 2016 measures and comparable to 2015 gross issuance as the overall level of rates was higher in 2017 relative to 2016 and 2015. Refinancings tend to decline as rates rise. Overall, new Agency RMBS issuances generally remain low compared to 2012 through mid-2013. The limited supply of Agency RMBS continued to be a factor in the TBA market in 2017 as it has in recent years, but we expect this to change as balance sheet normalization takes effect and the Fed becomes less involved in the Agency RMBS market and the supply of mortgage securities available to the market increases.

37


chart-11057f3919796044aeb.jpg

    

38


Agency RMBS prices remained relatively steady throughout 2017 following the notable post-election decline in late 2016. The graph below illustrates price movements for securities that make up a large concentration of our investment portfolio:

chart-1cc8a506e0bd500c918.jpg
Mortgage rates held relatively steady throughout 2017 with a slight drop to sub-4.0% levels after the first quarter. As a result of the generally higher rate environment relative to 2016, and the fact that we repositioned our Agency RMBS portfolio into higher-coupon new production securities beginning late in 2016 through much of 2017, prepayments in our portfolio proved relatively benign throughout 2017. During 2017, prepayment rates increased modestly in the second half of the year, yet remained at subdued levels, especially for 30-year Agency RMBS. Due to the continued tight regulatory environment, absent any meaningful deregulation in the housing finance sector from the presidential administration, and the slight recent increase in mortgage rates, we expect prepayments to remain relatively subdued in 2018. The following charts shows the actual 1-month prepayment rates on our Agency RMBS the historical refinance index, and the 30-year mortgage national average rate.

39


    
chart-ce30c32275415efe85c.jpg

40


chart-cb6aa0487a985cbab6b.jpg
- Government Activity

Ongoing regulatory uncertainty and inconsistency continue to be a drag on home lending and related securitization activity. The presidential administration has made statements of its intentions to reform housing finance, but many potential policy changes will require Congressional action while some may be made through changes in leadership at various regulatory agencies. A review of the Dodd-Frank Act could affect banking regulations, and ultimately, our lenders.

Mortgage availability may somewhat improve due to changes to the FHFA's and FHA’s representation and warranty rules, but originators have not been given sufficient protection to originate loans that pose greater risk of defaults. With a new leader at the helm, the CFPB is reportedly reviewing QM rules, and has the power to define Qualified Mortgages. Policy changes on this front, including easing some QM requirements for lenders, could help expand the pool of potential borrowers for mortgage originators. Given the required coordination of a number of regulatory agencies and the limited headway to date, we continue to believe that opportunities to promote housing recovery through a significant boost in originations may be limited during 2018. We have yet to see any details on potential reforms, however.

Since the financial crisis, the FHFA and both houses of Congress have discussed and considered separate measures to restructure the U.S. housing finance system and the operations of Fannie Mae and Freddie Mac. Although factions in Congress have held divergent views on housing finance reform, these opposing views seem to be converging on some issues. Separate House and bi-partisan Senate bills that address mortgage finance reform are expected to be introduced in early 2018. The Senate version

41


would require restructuring of Fannie and Freddie and allow the entities, stripped of their federal charters, along with new guarantors to issue government-guaranteed mortgage securities, purportedly to use the Common Securitization Platform. The House plan would reportedly build on the Ginnie Mae platform, while Fannie and Freddie would be transitioned to privately owned utilities with private capital that would issue securities with a Ginnie Mae guarantee.

On January 30, 2018, legislation was introduced in the Senate that would permit captive insurance companies that were FHLB members prior to January 19, 2016, like CYS Insurance, to restore their membership in the FHLB. In June 2017, legislation was introduced in the House of Representatives that would permit a captive insurance company that was admitted to the FHLB prior to September 12, 2014 to continue its membership in the FHLB. The Company joined the FHLBC after September 12, 2014, so the House version of the legislation would not permit the Company to rejoin the FHLBC. It is still uncertain whether legislation on FHLB membership will be adopted, and if so, whether it would permit us to rejoin the FHLB.
- CYS Activity in Response to These Trends -
We continue to actively monitor, reposition, and manage our investment portfolio, the structure of our borrowings, and our hedge positions. To illustrate, following the U.S. presidential election and the back-up in interest rates in 2017, we repositioned our investment portfolio, selling lower coupon Agency RMBS and buying higher coupon, current production Agency RMBS, while simultaneously reducing our cost basis. The securities we purchased offered more attractive yields and prepayment protection. The increase in rates also resulted in a decrease in prepayment speeds. Collectively, the decline in prepayment speeds and the investment portfolio repositioning allowed us to keep the dividend unchanged throughout 2017, despite 3 separate 25 bps rate hikes. During the first half of 2017, we continued to sell lower yielding 15-year Agency RMBS, and purchase higher yielding 30-year Agency RMBS resulting in an increase in the average yield and a simultaneous decrease in the weighted average amortized cost of our Debt Securities portfolio. As a result of continually monitoring and repositioning our investment portfolio, coupled with the decline in prepayment speeds resulting from higher levels of prevailing interest rates, we were able to maintain a relatively stable average yield on Debt Securities. The average yield was 2.73% in the fourth quarter of 2017, up slightly from 2.71% recorded in the first quarter of 2017, despite three separate 25 bps hikes in the Federal Funds Rate and a flattening yield curve during 2017. During the second half of the year, we also replaced some of our 15-year Agency RMBS holdings with 3-year U.S. Treasuries as the market provided for "special" financing on U.S. Treasuries in the form of negative interest rates. This repositioning not only lowered our cost of financing, it enhanced our investment portfolio yield and simultaneously reduced the price volatility in our investment portfolio.

The size of our investment portfolio (including gross TBA Derivatives) increased to $13.1 billion (inclusive of TBA Derivative positions with a net fair value of $461.1 million) at December 31, 2017 from $12.3 billion (inclusive of TBA Derivative positions with a net fair value of $308.8 million) at December 31, 2016. Although we continued to take advantage of the TBA market throughout 2017, we did so to a lesser extent as this market provided less "special" pricing, or implied financing rates. As a result, Drop Income decreased to $29.9 million in 2017 from $32.9 million in 2016.

During 2017, we also took advantage of market opportunities to expand and reposition our hedge portfolio in anticipation of an increase in interest rates. At multiple times throughout the year, we opportunistically repositioned the hedge portfolio using a combination of interest rate swaps, cancellable swaps and swaptions. In the aggregate, during the course of 2017, we terminated swaps with a combined notional of $2.5 billion, a weighted-average pay rate of 1.50% and a weighted-average maturity of June 2020, and entered into new swaps with a combined notional of $3.5 billion, a weighted-average pay rate of 2.19%, and a weighted-average maturity of November 2023. We also continued to benefit from an increase in 3-month LIBOR throughout 2017, the receive leg of our swaps, which had the effect of reducing our net swap and cap pay rates during the year. Additionally, most of our interest rate caps became cashflow positive during 2017 as 3-month LIBOR increased to levels that exceeded the respective cap rates. The net effect of repositioning the hedge portfolio and increase in 3-month LIBOR resulted in an expansion of the hedge portfolio and an extension of the duration, in addition to a meaningful reduction in our hedging costs as measured by the net pay rate. The net pay rate on our hedge portfolio was 0.08% at December 31, 2017, down from 0.60% at December 31, 2016.

We also continued to proactively manage our borrowing costs by utilizing our extensive sources of financing and our ability to effectively identify and capitalize on opportunities in our markets. We continually seek to maintain and grow our financing sources, ending 2017 with a broad and diverse group of more than 50 lenders. Our extensive base of available sources of financing, combined with our collective years of experience with these sources, affords us an ability to understand the repo market and limits the possibility of paying a lender off-market rates. In addition, at various times during 2017, we identified and seized opportunities to finance our U.S. Treasuries at significant negative rates, effectively allowing us to maintain attractive asset yield levels, while we reduced book value exposure to rising rates. Lastly, for much of the year, debt ceiling dynamics as well as money market reform helped keep repo rates subdued. A notable reduction in U.S. Treasury bill issuance throughout the year, in response to the U.S. debt ceiling requirements, created a relative shortage of short-dated U.S. Treasuries available for the large pool of government

42


money funds looking to invest in short-dated government securities. The money funds turned to agency RMBS repo, among a short list of other eligible options, and this demand helped to moderate repo rates.

During 2017, our book value per share increased 0.60% to $8.38 at December 31, 2017 from $8.33 at December 31, 2016, after declaring dividends totaling $1.00 per share, and in the face of a flattening yield curve and three separate 25 bps hikes in the Federal Funds Rate. Leverage increased modestly to 7.33:1 from 7.06:1 year-over-year. As of December 31, 2017, we had substantial available liquidity of $1.0 billion, or 64.6% of our equity. We increased the duration and size of our hedge book to $10.0 billion at December 31, 2017 from $9.0 billion at December 31, 2016, which boosted the hedge ratio to 98.9% from 92.3% for the same respective periods.

In summary, during 2017, we benefited from a tailwind of low volatility even as short term rates began to ratchet up during the second half of the year and the yield curve flattened. We continued to transition our portfolio to a heavier weighting in 30-year Agency RMBS from 15-year Agency RMBS. The former set of securities is higher-yielding and should be less sensitive to yield curve flattening. The increase in interested rates led to a decline in prepayments. We also expanded and extended the duration of our hedge portfolio, taking advantage of low rates to strike new hedge positions as the markets presented opportunities. At December 31, 2017, our hedge portfolio was larger and had a longer duration profile than a year ago and should serve us better into a potentially more volatile 2018. Our financing costs remain manageable and our availability of repo financing remains broad and widely available.

Financial Condition
Our Agency RMBS were purchased at a net premium to their face values, generally due to the average interest rates on these investments being higher than the prevailing market rates at the time of purchase. As of December 31, 2017 and December 31, 2016 we had approximately $371.9 million and $452.3 million, respectively, of net unamortized premium included in the cost basis of our investments. Our Debt Securities portfolio, including TBA Derivative positions (with a net fair value of $461.1 million and $(308.8) million at December 31, 2017 and 2016, respectively), consisted of the following assets as of December 31, 2017 and 2016:

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(dollars in thousands)
 
 
 
 
 
Weighted-Average
Coupon
 
Face Value
 
Fair Value
 
Amortized Cost Basis per Face Value
 
Loan Balance(1)
 
Loan Age (in months)(1)
 
3 Month CPR(1)(2)
 
Duration(3)
December 31, 2017
 
 
 
 
 
 
 
 
 
 
15-Year Agency RMBS
 
 
 
 
 
 
 
 
 
 
   2.5%
 
$
210,098

 
$
209,878

 
$
102.35

 
$195
 
14
 
4.3%
 
4.15
  TBA 2.5%*
 
120,000

 
119,813

 
99.84

 
n/a
 
n/a
 
n/a
 
3.94
   3.0%
 
1,985,385

 
2,024,695

 
102.37

 
262
 
28
 
9.0
 
3.28
3.5%
 
568,160

 
587,577

 
102.56

 
202
 
67
 
13.0
 
2.74
4.0%
 
81,454

 
84,887

 
100.94

 
165
 
82
 
16.8
 
2.52
4.5%
 
10,300

 
10,775

 
102.01

 
246
 
95
 
15.7
 
1.96
Subtotal
 
2,975,397

 
3,037,625

 
102.26

 
242
 
37
 
9.7
 
3.24
20-Year Agency RMBS
 
 
 
 
 
 
 
 
 
 
4.5%
 
30,692

 
32,748

 
102.53

 
207
 
89
 
23.8
 
2.74
30-Year Agency RMBS
 
 
 
 
 
 
 
 
 
 
3.0%
 
1,534

 
1,557

 
104.39

 
132
 
55
 
0.6
 
5.32
3.5%
 
4,120,955

 
4,240,031

 
102.77

 
329
 
9
 
6.4
 
4.14
  TBA 3.5%*
 
848,000

 
870,663

 
102.58

 
n/a
 
n/a
 
n/a
 
3.80
4.0%
 
2,684,319

 
2,815,290

 
104.88

 
298
 
18
 
12.3
 
2.94
  TBA 4.0%*
 
432,000

 
451,756

 
104.86

 
n/a
 
n/a
 
n/a
 
2.71
4.5%
 
93,793

 
100,565

 
106.47

 
267
 
80
 
14.0
 
2.67
Subtotal
 
8,180,601

 
8,479,862

 
103.59

 
316
 
14
 
8.7
 
3.62
Hybrid ARMs
 
 
 
 
 
 
 
 
 
 
3.1%(4)
 
488,665

 
498,630

 
102.43

 
323
 
26
 
10.3
 
2.38
Subtotal Agency RMBS
 
11,675,355

 
12,048,865

 
103.20

 
295
 
21
 
9.2
 
3.47
U.S. Treasuries
 
 
 
 
 
 
 
 
 
 
1.9%
 
1,050,000

 
1,046,934

 
99.81

 
n/a
 
n/a
 
n/a
 
2.80
Total
 
$
12,725,355

 
$
13,095,799

 
$
102.92

 
$295
 
21
 
9.2%
 
3.41
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
 
15-Year Agency RMBS
 
 
 
 
 
 
 
 
 
 
   2.5%
 
$
1,046,887

 
$
1,049,504

 
$
102.78

 
$276
 
4
 
5.4%
 
3.94
  TBA 2.5%(5)*
 
(400,000
)
 
(400,633
)
 
99.73

 
n/a
 
n/a
 
n/a
 
3.75
   3.0%
 
2,540,786

 
2,610,678

 
102.68

 
263
 
27
 
13.0
 
3.03
  TBA 3.0%*
 
200,000

 
205,174

 
102.86

 
n/a
 
n/a
 
n/a
 
2.83
3.5%
 
813,323

 
849,549

 
102.98

 
215
 
52
 
14.6
 
2.52
4.0%
 
108,173

 
114,207

 
101.03

 
167
 
70
 
14.7
 
2.27
4.5%
 
14,439

 
15,256

 
102.23

 
240
 
83
 
19.3
 
1.79
Subtotal
 
4,323,608

 
4,443,735

 
103.00

 
255
 
27
 
12.4
 
3.05
20-Year Agency RMBS
 
 
 
 
 
 
 
 
 
 
4.5%
 
39,328

 
42,348

 
102.66

 
209
 
77
 
19.6
 
2.16
30-Year Agency RMBS
 
 
 
 
 
 
 
 
 
 
3.0%
 
1,776

 
1,802

 
104.51

 
130
 
43
 
0.2
 
4.69
3.5%
 
4,934,357

 
5,062,330

 
104.48

 
338
 
8
 
9.5
 
4.48

44


(dollars in thousands)
 
 
 
 
 
Weighted-Average
Coupon
 
Face Value
 
Fair Value
 
Amortized Cost Basis per Face Value
 
Loan Balance(1)
 
Loan Age (in months)(1)
 
3 Month CPR(1)(2)
 
Duration(3)
  TBA 3.5%*
 
383,000

 
392,293

 
102.58

 
n/a
 
n/a
 
n/a
 
4.10
4.0%
 
1,247,116

 
1,314,969

 
104.93

 
244
 
30
 
22.0
 
3.30
  TBA 4.0%*
 
500,000

 
524,869

 
104.50

 
n/a
 
n/a
 
n/a
 
2.95
4.5%
 
113,274

 
122,361

 
106.63

 
282
 
68
 
21.7
 
2.32
Subtotal
 
7,179,523

 
7,418,624

 
104.34

 
319
 
13
 
13.1
 
4.12
Hybrid ARMs
 
 
 
 
 
 
 
 
 
 
2.8%(4)
 
375,745

 
385,502

 
102.74

 
322
 
30
 
21.3
 
2.16
Subtotal Agency RMBS
 
11,918,204

 
12,290,209

 
103.80

 
293
 
20
 
13.1
 
3.66
U.S. Treasuries
 
 
 
 
 
 
 
 
 
 
0.6%
 
50,000

 
49,686

 
99.90

 
n/a
 
n/a
 
n/a
 
1.48
Total
 
$
11,968,204

 
$
12,339,895

 
$
103.78

 
$293
 
20
 
13.1%
 
3.66
__________________
(1)
TBAs are excluded from this calculation as they do not have a defined weighted-average loan balance or age until mortgages have been assigned to the pool.
(2)
The Constant Prepayment Rate ("CPR") represents the three-month CPR of the Company's Agency RMBS held at December 31, 2017 and December 31, 2016. The CPR experienced by the Company during the period may differ. Securities with no prepayment history are excluded from this calculation.
(3)
Duration measures the market price volatility of financial instruments as interest rates change, using Dollar Value of One Basis Point, or "DV01", methodology. We generally calculate duration using various third-party financial models and empirical data. Different models and methodologies can produce different estimates of duration for the same securities. Duration estimates in the table are calculated utilizing Yield Book® software and may reflect adjustments based on our judgment.
(4)
Coupon represents the weighted-average coupon of Hybrid ARMs.
(5)
Includes $400.6 million of forward settling transactions at December 31, 2016.
*
Includes TBA Derivatives with a fair value of $461.1 million and $(308.8) million at December 31, 2017 and 2016, respectively.

In January 2018, the monthly weighted-average experienced CPR of the Company's Debt Securities declined to 7.5% from 9.0% in December 2017.

Hedging Instruments
We seek to hedge interest rate risk to the extent it is determined to be in the best interests of our stockholders. Our policies do not contain specific requirements as to the percentages or amount of interest rate risk we are required to hedge. No assurance can be given that our hedging activities will have the desired impact on our results of operations or financial condition. None of the Company's derivatives have been designated as hedging instruments for accounting purposes.
Interest rate hedging may fail to have the desired effect or could adversely affect us because, among other things:
interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;
available interest rate hedging may not correspond directly with the interest rate risk we desire to hedge;
due to prepayments on assets and repayments of debt securing such assets, the duration of the hedge may not match the duration of the related liability or asset;
the credit quality of the hedging counterparty may be downgraded to such an extent that it may impair our ability to sell or assign our side of the hedging transaction; and
the hedging counterparty may default on its obligation to pay.
We engage in interest rate swaps, swaptions and caps as a means of managing our exposure to an increase in interest rates and our cost of financing for the term of the swap, underlying term of the swaption and cap contracts. An interest rate swap is a contractual agreement entered into by two counterparties under which each agrees to make periodic payments to the other for an agreed period of time based upon a notional amount of principal. Under the most common form of interest rate swap, commonly known as a fixed-floating interest rate swap, a series of fixed interest rate payments on a notional amount of

45


principal are exchanged for a series of floating interest rate payments on such notional amount. A swaption is an agreement that provides us, the buyer, with an option to enter into an interest rate swap agreement at a specified notional, term and pay rate on a specified future date. The swaption agreement will specify whether the buyer of the swaption will be a fixed-rate receiver or a fixed-rate payer. In a simple interest rate cap, one investor pays a premium for a notional principal amount based on a capped interest rate (the "cap rate"). When the floating rate exceeds the cap rate, the investor receives a payment from the cap counterparty equal to the difference between the floating rate and the cap rate on the same notional principal amount for a specified period of time. The fair value of interest rate swaps, swaptions and caps is heavily dependent on the current fixed-rate, the corresponding term structure of floating rates (known as the yield curve), and the expectation of changes in future floating rates. Below is a summary of our interest rate swaps and caps as of December 31, 2017 and 2016:
 
 
 
 
 
 
Weighted-Average