UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

Commission file number 001-35260

MTGE INVESTMENT CORP.

(Exact name of registrant as specified in its charter)

Maryland	45-0907772
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

2 Bethesda Metro Center

12th Floor

Bethesda, Maryland 20814

(Address of principal executive offices)

(301) 968-9220

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports 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 þ.        No ¨.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes þ.        No ¨.

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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	þ		Accelerated filer	o
Non-accelerated filer	o	(Do not check if a smaller reporting company)	Smaller Reporting Company	o
Emerging growth company	o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨    No þ

The number of shares of the issuer’s common stock outstanding as of August 1, 2018 was 45,797,687. 

MTGE INVESTMENT CORP.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements	2
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	58
Item 4.	Controls and Procedures	62
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	63
Item 1A.	Risk Factors	63
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	63
Item 3.	Defaults upon Senior Securities	63
Item 4.	Mine Safety Disclosures	63
Item 5.	Other Information	63
Item 6.	Exhibits	63
Signatures		65

1

PART I

Item 1. Financial Statements

MTGE INVESTMENT CORP.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

	June 30, 2018			December 31, 2017
	(unaudited)
Assets:
Agency securities, at fair value (including pledged securities of $3,313,818 and $3,581,868, respectively)	$	3,519,280		$	3,758,181
Non-agency securities, at fair value (including pledged securities of $659,954 and $743,278, respectively)	739,960			872,084
Land	17,538			16,641
Buildings, furniture, fixtures and equipment, net of accumulated depreciation	262,599			240,352
Cash and cash equivalents	124,007			123,762
Restricted cash and cash equivalents	42,235			46,324
Interest receivable	14,865			14,608
Derivative assets, at fair value	32,716			14,712
Receivable under reverse repurchase agreements	890,059			843,130
Other assets	15,897			23,242
Total assets	$	5,659,156		$	5,953,036
Liabilities:
Repurchase agreements	$	3,560,273		$	3,863,719
Notes payable, net of deferred financing costs	201,812			186,500
Payable for securities purchased	—			4,357
Derivative liabilities, at fair value	23			4,454
Dividend payable	24,016			24,016
Obligation to return securities borrowed under reverse repurchase agreements, at fair value	878,933			830,776
Accounts payable and other accrued liabilities	49,480			33,592
Total liabilities	4,714,537			4,947,414
Equity:
Preferred stock, $0.01 par value; 50,000 shares authorized:
8.125% Series A Cumulative Redeemable Preferred Stock; 2,200 shares issued and outstanding (aggregate liquidation preference of $55,000)	53,039			53,039
Common stock, $0.01 par value; 300,000 shares authorized, 45,798 issued and outstanding	458			458
Additional paid-in capital	1,122,885			1,122,729
Retained deficit	(232,552		)	(171,119		)
Total stockholders’ equity	943,830			1,005,107
Noncontrolling interests	789			515
Total equity	944,619			1,005,622
Total liabilities and equity	$	5,659,156		$	5,953,036

See accompanying notes to consolidated financial statements.

2

MTGE INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Interest income:
Agency securities	$	26,873		$	22,010		$	54,384		$	39,911
Non-agency securities	11,725			13,478			23,719			29,174
Other	21			245			146			405
Interest expense	(19,482		)	(12,344		)	(36,535		)	(22,509		)
Net interest income	19,137			23,389			41,714			46,981
Healthcare real estate:
Healthcare real estate income	8,411			5,754			16,171			9,069
Healthcare real estate expense	(6,571		)	(4,373		)	(12,366		)	(7,026		)
Net healthcare investment income	1,840			1,381			3,805			2,043
Other gains (losses):
Realized loss on agency securities, net	(466		)	(489		)	(2,406		)	(701		)
Realized gain on non-agency securities, net	5,543			14,481			9,697			27,195
Realized gain (loss) on periodic settlements of interest rate swaps, net	4,175			(2,281		)	4,533			(4,941		)
Realized gain on other derivatives and securities, net	6,844			4,745			9,580			6,912
Unrealized gain (loss) on agency securities, net	(21,341		)	9,146			(97,511		)	9,031
Unrealized gain (loss) on non-agency securities, net	(5,780		)	11,219			(9,117		)	24,233
Unrealized gain (loss) on other derivatives and securities, net	6,583			(11,718		)	40,040			(14,557		)
Servicing income	2			75			52			2,633
Servicing expense	(775		)	(1,915		)	(1,025		)	(6,900		)
Total other gains (losses), net	(5,215		)	23,263			(46,157		)	42,905
Expenses:
Management fees	3,585			3,488			6,974			6,864
General and administrative expenses	4,220			1,933			5,798			3,652
Total expenses	7,805			5,421			12,772			10,516
Net income (loss)	7,957			42,612			(13,410		)	81,413
Dividend on preferred stock	(1,117		)	(1,117		)	(2,234		)	(2,234		)
Noncontrolling interest in net loss (income)	4			7			9			5
Net income (loss) available to common stockholders	$	6,844		$	41,502		$	(15,635	)	$	79,184
Net income (loss) per common share — basic and diluted	$	0.15		$	0.91		$	(0.34	)	$	1.73
Weighted average common shares — basic	45,816			45,803			45,813			45,800
Weighted average common shares — diluted	45,818			45,804			45,815			45,802
Dividend declared per common share	$	0.50		$	0.45		$	1.00		$	0.90

See accompanying notes to consolidated financial statements.

3

MTGE INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF EQUITY

(in thousands)

(unaudited)

	Preferred Stock			Common Stock			Additional Paid-in Capital		Retained Earnings (Deficit)			Noncontrolling Interests			Total Equity
	Shares	Amount		Shares	Amount
Balance, December 31, 2016	2,200	$	53,039	45,798	$	458	$	1,122,493	$	(243,260	)	$	315		$	933,045
Net income	—	—		—	—		—		81,418			(5		)	81,413
Issuance of noncontrolling interest	—			—	—		—		—			245			245
Distribution to noncontrolling interest	—	—		—	—		—		—			(22		)	(22		)
Stock-based compensation	—	—		—	—		100		—			—			100
Preferred dividends declared							—		(2,234		)	—			(2,234		)
Common dividends declared	—	—		—	—		—		(41,218		)	—			(41,218		)
Balance, June 30, 2017	2,200	$	53,039	45,798	$	458	$	1,122,593	$	(205,294	)	$	533		$	971,329
Balance, December 31, 2017	2,200	$	53,039	45,798	$	458	$	1,122,729	$	(171,119	)	$	515		$	1,005,622
Net loss	—	—		—	—		—		(13,401		)	(9		)	(13,410		)
Issuance of noncontrolling interest	—	—		—	—		—		—			293			293
Distribution to noncontrolling interest	—	—		—	—		—		—			(10		)	(10		)
Stock-based compensation	—	—		—	—		156		—			—			156
Preferred dividends declared	—	—		—	—		—		(2,234		)	—			(2,234		)
Common dividends declared	—	—		—	—		—		(45,798		)	—			(45,798		)
Balance, June 30, 2018	2,200	$	53,039	45,798	$	458	$	1,122,885	$	(232,552	)	$	789		$	944,619

See accompanying notes to consolidated financial statements.

4

MTGE INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	For the Six Months Ended June 30,
	2018			2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	(13,410	)	$	81,413
Adjustments to reconcile net income to net cash flows from operating activities:
Amortization of net premium on agency securities	9,770			12,103
Accretion of net discount on non-agency securities	(7,390		)	(11,883		)
Depreciation and amortization on real estate investments	4,271			2,737
Realization of cash flows from MSR	—			1,089
Unrealized loss (gain) on securities, MSR and derivatives, net	66,588			(18,707		)
Realized loss on agency securities, net	2,406			701
Realized gain on non-agency securities, net	(9,697		)	(27,195		)
Realized gain on other derivatives and securities, net	(14,113		)	(1,842		)
Stock-based compensation	156			100
Increase in interest receivable	(257		)	(2,900		)
Decrease in other assets	3,219			12,559
Increase in operating accounts payable and other accrued liabilities	3,618			5,928
Net cash flows from operating activities	45,161			54,103
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Purchases of agency securities	(345,278		)	(1,303,488		)
Purchases of non-agency securities	(79,478		)	(221,717		)
Purchases of healthcare real estate investments	(27,302		)	(99,719		)
Proceeds from sale of agency securities	251,641			309,727
Proceeds from sale of non-agency securities	175,495			440,867
Proceeds from sale of MSR	4,126			43,823
Principal collections on agency securities	218,494			183,237
Principal collections on non-agency securities	44,077			88,525
Net proceeds from (payments on) reverse repurchase agreements	(46,929		)	(369,899		)
Purchases of U.S. Treasury securities	(208,343		)	(991,237		)
Proceeds from sale of U.S. Treasury securities	278,835			1,356,834
Payments for the termination of interest rate swaps	—			(3,841		)
Other investing cash flows, net	21,653			(3,712		)
Net cash flows from (used in) investing activities	286,991			(570,600		)
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Dividends paid	(48,032		)	(41,162		)
Issuance of noncontrolling interest	293			245
Distributions to noncontrolling interest	(10		)	(22		)
Proceeds from repurchase agreements and Federal Home Loan Bank advances	11,588,230			13,209,021
Repayments on repurchase agreements and Federal Home Loan Bank advances	(11,891,676		)	(12,636,270		)
Proceeds from notes payable, net of deferred financing costs	56,874			44,325
Repayments of notes payable	(41,675		)	(320		)
Net cash flows from (used in) financing activities	(335,996		)	575,817
Net increase (decrease) in cash and cash equivalents and restricted cash	(3,844		)	59,320
Cash and cash equivalents and restricted cash at beginning of the period	170,086			136,645
Cash and cash equivalents and restricted cash at end of period	$	166,242		$	195,965
Supplemental disclosure of non-cash information:
Assumption of notes payable	$	—		$	75,952

See accompanying notes to consolidated financial statements.

5

MTGE INVESTMENT CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Unaudited Interim Consolidated Financial Statements

The unaudited interim consolidated financial statements of MTGE Investment Corp. (referred to throughout this report as the “Company”, “we”, “us” and “our”) are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.

Our unaudited interim consolidated financial statements include the accounts of all of our subsidiaries. Significant intercompany accounts and transactions have been eliminated. In the opinion of management, all adjustments, consisting solely of normal recurring accruals, necessary for the fair presentation of financial statements for the interim period have been included. The current period’s results of operations are not necessarily indicative of results that ultimately may be achieved for the year.

Note 2. Organization

We were incorporated in Maryland and commenced operations in 2011 following the completion of our initial public offering (“IPO”). We are externally managed by MTGE Management, LLC (our “Manager”), an affiliate of AGNC Investment Corp. (“AGNC”). Our common stock is traded on the Nasdaq Global Select Market under the symbol “MTGE.”

We invest in, finance and manage a leveraged portfolio of real estate-related investments, which include agency residential mortgage-backed securities (“agency RMBS”), non-agency securities, other mortgage-related investments and other real estate investments. Agency RMBS include residential mortgage pass-through certificates and collateralized mortgage obligations (“CMOs”) structured from residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by a government-sponsored enterprise (“GSE”), such as Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”), or by a U.S. Government agency, such as Government National Mortgage Association (“Ginnie Mae”). Non-agency securities include securities backed by residential mortgages that are not guaranteed by a GSE or U.S. Government agency and credit risk transfer securities (“CRT”). Other mortgage-related investments may include mortgage servicing rights (“MSR”), commercial mortgage-backed securities (“CMBS”), prime and non-prime residential mortgage loans, commercial mortgage loans and mortgage-related derivatives. Other real estate investments include equity investments in healthcare and senior living facilities that are leased to or operated by third parties who conduct all business operations of the facilities.

Our objective is to provide attractive risk-adjusted returns to our stockholders through a combination of dividends and net asset value appreciation. In pursuing this objective, we rely on our Manager’s expertise to construct and manage a diversified investment portfolio by selecting assets that, when properly financed and hedged, are expected to produce attractive risk-adjusted returns across a variety of market conditions and economic cycles.

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). As such, we are required to distribute annually at least 90% of our taxable income. As a REIT, we will generally not be subject to U.S. Federal or state corporate taxes on our taxable income to the extent that we distribute all of our annual taxable income to our stockholders. It is our intention to distribute 100% of our taxable income, after application of available tax attributes, within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year.

6

Note 3. Summary of Significant Accounting Policies

Fair Value of Financial Assets

We have elected the option to account for all of our financial assets, including all mortgage-related investments, at estimated fair value, with changes in fair value reflected in income during the period in which they occur. In management's view, this election more appropriately reflects the results of our operations for a particular reporting period, as financial asset fair value changes are presented in a manner consistent with the presentation and timing of the fair value changes of hedging instruments. See Note 10 - Fair Value Measurements.

Interest Income

Interest income is accrued based on the outstanding principal amount of the securities and their contractual terms. Premiums or discounts associated with the purchase of agency RMBS and non-agency securities of high credit quality are amortized or accreted into interest income, respectively, over the projected lives of the securities, including contractual payments and estimated prepayments, using the effective interest method.

We estimate long-term prepayment speeds using a third-party service and market data. Actual and anticipated prepayment experience is reviewed at least quarterly and effective yields are recalculated when differences arise between the previously estimated future prepayments and the amounts received plus currently anticipated future prepayments. If the actual and anticipated future prepayment experience differs from our prior estimate of prepayments, we are required to record an adjustment in the current period to the amortization or accretion of premiums and discounts for the cumulative difference in the effective yield through the reporting date.

At the time we purchase non-agency securities that are not of high credit quality, we determine an effective yield based on our estimate of the timing and amount of future cash flows and our cost basis. Our initial cash flow estimates for these investments are based on our observations of current information and events and include assumptions related to interest rates, prepayment rates and the impact of default and severity rates on the timing and amount of credit losses. On at least a quarterly basis, we review the estimated cash flows and make appropriate adjustments, based on inputs and analysis received from external sources, internal models, and our judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Any resulting changes in effective yield are recognized prospectively based on the current amortized cost of the investment as adjusted for credit impairment, if any.

Real Property Owned

Tangible assets primarily consist of land, buildings and furniture, fixtures and equipment. Depreciable tangible assets are depreciated on a straight-line basis over their estimated useful lives, which can range from 3 years for furniture, fixtures and equipment to 40 years for buildings.

On January 1, 2017 the Company adopted Accounting Standards Update (“ASU”) No. 2017-01, Clarifying the Definition of a Business (“ASU 2017-01”) which provides a framework to determine whether a transaction involves an asset, or a group of assets, or a business. ASU 2017-01 states that when substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the transaction should not be considered a business combination. The ASU also clarifies the requirements for a set of activities to be considered a business and narrows the definition of outputs that would lead to business combination accounting treatment. As a result of these changes, the Company expects that a majority of its future real estate acquisitions and dispositions will be deemed asset transactions rather than business combinations. For asset acquisitions subsequent to January 1, 2017, the Company records identifiable assets acquired, liabilities assumed and any associated noncontrolling interests at cost on a relative fair value basis, with no goodwill recognized and third-party transaction costs capitalized.

The net book value of long-lived assets is reviewed quarterly on a property by property basis to determine if facts and circumstances suggest that the assets may be impaired or that depreciable lives may need to be changed. We consider external factors relating to each asset and the existence of a master lease that may link the cash flows of an individual asset to a larger portfolio of assets leased to the same tenant. If these factors and the projected undiscounted cash flows of the asset over the remaining depreciation period indicate that the asset will not be recoverable, the carrying value is reduced to the estimated fair market value. In addition, we are exposed to the risks inherent in investments in real estate and, in particular, the senior housing and healthcare industries. A downturn in these industries or in the real estate markets in which our properties are located could adversely affect the value of our properties and our ability to sell properties for a price or terms acceptable to us.

7

Intangible Assets

Intangible assets can include goodwill and identifiable intangible assets such as above or below market component of in-place leases and the value associated with the presence of in-place tenants or residents. Goodwill is calculated as the excess of consideration transferred over the estimated fair value of net assets recognized and represents the estimated future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. Goodwill and intangible assets are included in other assets on the consolidated balance sheets and tested for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired.

Healthcare Real Estate Income

Healthcare real estate income consists primarily of lease and rental income. For operating leases with minimum scheduled rent increases, the Company recognizes income on a straight line basis over the lease term when collectability is reasonably assured. Recognizing lease income on a straight line basis results in a difference in the timing of revenue amounts from what is contractually due. If the Company determines that collectability of straight line lease income is not reasonably assured, future revenue recognition is limited to amounts contractually owed and paid, and, when appropriate, an allowance for estimated losses is established.

Resident rental income is recorded when services are rendered and includes resident room and care charges, community fees and other resident charges. Residency agreements are generally for a term of 30 days to one year, with resident fees billed monthly. Revenue for certain care-related services is recognized as the services are provided.

Noncontrolling Interests

Arrangements with noncontrolling interest holders are reported as a component of equity separate from the Company’s stockholders' equity, recorded at the initial carrying amount, and increased or decreased for the noncontrolling interest’s share of net income or loss. Net income attributable to a noncontrolling interest is included in net income on the consolidated statements of operations.

Deferred Loan Expenses

We amortize deferred financing costs, which are reported within notes payable, net of deferred financing costs on our consolidated balance sheets, as a component of interest expense of the debt over the terms of the related borrowings using a method that approximates a level yield.

Repurchase Agreements

We finance the acquisition of agency RMBS and non-agency securities through repurchase transactions under master repurchase agreements. We account for repurchase transactions as collateralized financing transactions which are carried at their contractual amounts, including accrued interest, as specified in the respective transaction agreements. The contractual amounts approximate fair value due to their short-term maturities or floating rate coupons.

Reverse Repurchase Agreements and Obligation to Return Securities Borrowed under Reverse Repurchase Agreements

We borrow securities to cover short sales of U.S. Treasury securities through reverse repurchase transactions under our master repurchase agreements (see Derivatives below). We account for these as securities borrowing transactions and recognize an obligation to return the borrowed securities at fair value on the consolidated balance sheets based on the value of the underlying borrowed securities as of the reporting date. The fair value of our reverse repurchase agreements is assumed to equal cost as they generally mature daily or have interest rates that are reset daily.

Derivatives

We utilize a risk management strategy, under which we may use a variety of derivative instruments to mitigate our exposure to market risks, including interest rate risk, prepayment risk, extension risk and credit risk. The objective of our risk management strategy is to reduce fluctuations in net asset value over a range of market conditions. The principal instruments that we currently use are interest rate swaps and options to enter into interest rate swaps (“interest rate swaptions”). We also utilize forward contracts for the purchase or sale of agency RMBS, or to-be-announced forward (“TBA”) contracts, and short sales of U.S. Treasury securities and U.S. Treasury futures contracts. We may also purchase or sell options on TBA securities and utilize other types of derivative instruments.

8

We also enter into TBA contracts as a means of investing in and financing agency RMBS (thereby increasing our “at

risk” leverage) or as a means of disposing of or reducing our exposure to agency RMBS (thereby reducing our “at risk” leverage). Pursuant to TBA contracts, we agree 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. We may also choose, prior to settlement, to move the settlement of these securities out to a later date by entering into an offsetting short or long position (referred to as a “pair off”), net settling the paired off positions for cash, and simultaneously purchasing or selling a similar TBA contract for a later settlement date. This transaction is commonly referred to as a “dollar roll.” The agency RMBS purchased or sold for a forward settlement date are typically priced at a discount to agency RMBS for settlement in the current month. This difference (or discount) is referred to as the “price drop.” The price drop is the economic equivalent of net interest carry income on the underlying agency RMBS over the roll period (interest income less implied financing cost) and is commonly referred to as “dollar roll income (loss).” Consequently, forward purchases of agency RMBS and dollar roll transactions represent a form of off-balance sheet financing.

We present all derivative instruments as either assets or liabilities at fair value on our consolidated balance sheets and report all changes in fair value in earnings in our consolidated statements of operations in unrealized gain (loss) on other derivatives and securities, net during the period in which they occur. Derivatives in a gain position are reported as derivative assets at fair value and derivatives in a loss position are reported as derivative liabilities at fair value in our consolidated balance sheets. Cash receipts and payments related to derivative instruments are classified in our consolidated statements of cash flows according to the underlying nature or purpose of the derivative transaction, generally in the investing section.

Our derivative agreements generally contain provisions that allow for netting or setting off derivative assets and liabilities with each counterparty; however, we report related assets and liabilities on a gross basis in our consolidated balance sheets.

The use of derivative instruments creates exposure to credit risk relating to potential losses that could be recognized in the event counterparties to these instruments fail to perform their obligations under the contracts. Our derivative agreements require that we post or receive collateral based on daily market value changes. We also attempt to minimize our risk of loss by limiting our counterparties to major financial institutions with acceptable credit ratings, monitoring positions with individual counterparties and adjusting posted collateral as required.

Interest rate swap agreements

We use interest rate swaps to hedge the variable cash flows associated with short-term borrowings made under our repurchase agreement and other financing facilities. Under our interest rate swap agreements, we typically pay a fixed rate and receive a floating rate based on one, three or six-month LIBOR (“payer swaps”) with terms up to 15 years. The floating rate we receive under our swap agreements has the effect of offsetting the repricing characteristics of our repurchase agreements and cash flows on such liabilities. Our swap agreements are privately negotiated in the over-the-counter (“OTC”) market. Swap agreements entered into subsequent to May 2013 are centrally cleared through the Chicago Mercantile Exchange (“CME”), a registered commodities exchange.

We estimate the fair value of our centrally cleared interest rate swaps using the daily settlement price determined by the respective exchange. Centrally cleared swaps are valued by the exchange using a pricing model that references observable market inputs, including LIBOR, swap rates and the forward yield curve, to produce the daily settlement price.

Our centrally cleared swaps require that we post an “initial margin” to our counterparties for an amount determined by the CME, which is generally intended to be set at a level sufficient to protect the CME from the maximum estimated single-day price movement in that market participant’s contracts. We also exchange cash “variation margin” with our counterparties on our centrally cleared swaps based upon daily changes in the fair value as measured by the CME. Beginning in the first quarter of 2017, as a result of a CME amendment to its rule book governing central clearing activities, the daily exchange of variation margin associated with a CME centrally cleared derivative instrument is legally characterized as the daily settlement of the derivative instrument itself, as opposed to a pledge of collateral. Accordingly, beginning in 2017, we account for the daily receipt or payment of variation margin associated with our centrally cleared interest rate swaps as a direct reduction to the carrying value of the interest rate swap derivative asset or liability, respectively. Beginning in 2017, the carrying amount of centrally cleared interest rate swaps reflected in our consolidated balance sheets is equal to the unsettled fair value of such instruments.

We estimate the fair value of our “non-centrally cleared” interest rate swaps based on valuations obtained from third-party pricing services and the swap counterparty (collectively, “third-party valuations”). The third-party valuations are model-driven using observable inputs, including LIBOR, swap rates and the forward yield curve. We also consider the creditworthiness of both us and our counterparties and the impact of netting and credit enhancement provisions contained in each derivative

9

agreement, such as collateral postings. All of our “non-centrally cleared” interest rate swaps are subject to bilateral collateral arrangements. Consequently, no credit valuation adjustment was made in determining the fair value of such instruments.

The payment of periodic settlements of net interest on interest rate swaps is reported in realized loss on periodic settlements of interest rate swaps, net in our consolidated statements of operations. Cash payments received or paid for the early termination of an interest rate swap agreement are recorded as realized loss on other derivatives and securities, net in our consolidated statements of operations. Changes in fair value of our interest rate swap agreements are reported in unrealized gain (loss) on other derivatives and securities, net in our consolidated statements of operations.

Interest rate swaptions

We purchase interest rate swaptions to help mitigate the potential impact of larger, more rapid changes in interest rates

on the performance of our investment portfolio. The interest rate swaptions provide us the option to enter into an interest rate swap agreement for a predetermined notional amount, stated term and pay or receive interest rates in the future. The premium paid for interest rate swaptions is reported as a derivative asset in our consolidated balance sheets. We estimate the fair value of interest rate swaptions based on the fair value of the future interest rate swap that we have the option to enter into as well as the remaining length of time that we have to exercise the option. The difference between the premium and the fair value of the swaption is reported in unrealized gain (loss) on other derivatives and securities, net in our consolidated statements of operations. If a swaption expires unexercised, the realized loss on the swaption would be equal to the premium paid and reported in realized loss on other derivatives and securities, net in our consolidated statements of operations. If we exercise a swaption, the realized gain or loss on the swaption would be equal to the difference between the fair value of the underlying interest rate swap and the premium paid and reported in realized gain (loss) on other derivatives and securities, net in our consolidated statements of operations.

Interest rate swaption agreements are privately negotiated in the OTC market and are not subject to central clearing. We estimate the fair value of our interest rate swaption agreements based on model-driven valuations obtained from third-party

pricing services and the swaption counterparty. These estimates incorporate observable inputs and include the fair value of the future interest rate swaps that we have the option to enter into, as well as the remaining length of time that we have to exercise the options, adjusted for non-performance risk, if any.

TBA securities

TBA securities are forward contracts for the purchase (“long position”) or sale (“short position”) of agency RMBS at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date. The specific agency RMBS delivered into the contract upon the settlement date, published each month by the Securities Industry and Financial Markets Association, are not known at the time of the transaction. We may enter into TBA contracts as a means of hedging against short-term changes in interest rates. We may also enter into TBA dollar roll transactions to finance agency RMBS purchases.

We account for all TBA contracts as derivatives since we cannot assert that it is probable at the inception and throughout the term of the contract that it will not settle net and will result in physical delivery of an agency security when it is issued. A TBA dollar roll transaction is a series of derivative transactions. The net settlement of a TBA contract is reported as realized gain (loss) on other derivatives and securities, net and changes in the fair value of our TBA contracts are reported as unrealized gain (loss) on other derivatives and securities, net in our consolidated statements of operations.

We estimate the fair value of TBA securities based on similar methods used to value our agency RMBS.

U.S. Treasury securities

We purchase or sell short U.S. Treasury securities and U.S. Treasury futures contracts to help mitigate the potential impact of changes in interest rates on the performance of our portfolio. Realized gains and losses associated with purchases and short sales of U.S. Treasury securities and U.S. Treasury futures contracts are recognized in realized gain (loss) on other derivatives and securities, net, and unrealized gains and losses are recognized in unrealized gain (loss) on other derivatives and securities, net on our consolidated statements of operations.

10

Adoption of Accounting Standard Updates

As of January 1, 2018, we adopted Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), and ASU 2016-18, Statement of Cash Flows (Topic 230) - Restricted Cash. Net income was not impacted. The adoption of ASU 2016-18 resulted in the presentation of restricted cash with cash and cash equivalents on the consolidated statements of cash flows when reconciling the total beginning and ending amounts. Our prior period results have been revised to conform to the current presentation.

Note 4. Agency Securities

The following tables summarize our investments in agency RMBS as of June 30, 2018 and December 31, 2017 (dollars in thousands):

	June 30, 2018
	Fannie Mae			Freddie Mac			Total
Agency RMBS:
Par value	$	2,285,555		$	1,189,667		$	3,475,222
Unamortized premium	113,789			62,678			176,467
Amortized cost	2,399,344			1,252,345			3,651,689
Gross unrealized gains	139			60			199
Gross unrealized losses	(87,953		)	(44,655		)	(132,608		)
Agency RMBS, at fair value	$	2,311,530		$	1,207,750		$	3,519,280
Weighted average coupon as of June 30, 2018	3.61		%	3.73		%	3.66		%
Weighted average yield as of June 30, 2018	2.84		%	2.99		%	2.89		%
Weighted average yield for the three months ended June 30, 2018	2.87		%	2.99		%	2.91		%
Weighted average yield for the six months ended June 30, 2018	2.91		%	3.06		%	2.96		%

	June 30, 2018
	Amortized Cost		Gross Unrealized Gain		Gross Unrealized Loss			Fair Value
Agency RMBS:
Fixed rate	$	3,581,562	$	38	$	(132,483	)	$	3,449,117
Adjustable rate	70,127		161		(125		)	70,163
Total Agency RMBS	$	3,651,689	$	199	$	(132,608	)	$	3,519,280

	December 31, 2017
	Fannie Mae			Freddie Mac			Total
Agency RMBS:
Par value	$	2,485,055		$	1,117,551		$	3,602,606
Unamortized premium	127,008			63,466			190,474
Amortized cost	2,612,063			1,181,017			3,793,080
Gross unrealized gains	3,876			1,149			5,025
Gross unrealized losses	(28,364		)	(11,560		)	(39,924		)
Agency RMBS, at fair value	$	2,587,575		$	1,170,606		$	3,758,181
Weighted average coupon as of December 31, 2017	3.63		%	3.75		%	3.67		%
Weighted average yield as of December 31, 2017	2.78		%	2.89		%	2.82		%
Weighted average yield for the year ended December 31, 2017	2.67		%	2.69		%	2.68		%

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	December 31, 2017
	Amortized Cost		Gross Unrealized Gain		Gross Unrealized Loss			Fair Value
Agency RMBS:
Fixed rate	$	3,717,285	$	3,707	$	(39,924	)	$	3,681,068
Adjustable rate	75,795		1,318		—			77,113
Total Agency RMBS	$	3,793,080	$	5,025	$	(39,924	)	$	3,758,181

Actual maturities of agency RMBS are generally shorter than the stated contractual maturities. Actual maturities are affected by the contractual lives of the underlying mortgages, periodic principal payments and principal prepayments.

The following table summarizes our agency RMBS as of June 30, 2018 and December 31, 2017 according to their estimated weighted average life classification (dollars in thousands):

	June 30, 2018								December 31, 2017
					Weighted Average								Weighted Average
Estimated Weighted Average Life	Fair Value		Amortized Cost		Yield		Coupon		Fair Value		Amortized Cost		Yield		Coupon
Less than or equal to three years	$	55,745	$	57,037	2.16	%	3.93	%	$	40,404	$	40,815	2.06	%	3.92	%
Greater than three years and less than or equal to five years	417,277		426,694		2.39	%	3.10	%	534,299		535,608		2.38	%	3.19	%
Greater than five years and less than or equal to 10 years	2,577,463		2,683,748		2.93	%	3.74	%	3,149,565		3,182,468		2.90	%	3.75	%
Greater than 10 years	468,795		484,210		3.19	%	3.69	%	33,913		34,189		2.98	%	3.50	%
Total	$	3,519,280	$	3,651,689	2.89	%	3.66	%	$	3,758,181	$	3,793,080	2.82	%	3.67	%

As of June 30, 2018 and December 31, 2017, the estimated weighted average life of our agency security portfolio was 8.2 years and 7.5 years, respectively, which incorporates anticipated future prepayment assumptions. As of June 30, 2018 and December 31, 2017, our weighted average expected constant prepayment rate (“CPR”) over the remaining life of our aggregate agency investment portfolio was 7.2% and 8.4%, respectively.

Realized Gains and Losses

The following table summarizes our net realized losses from the sale of agency RMBS during the three and six months ended June 30, 2018 and 2017 (dollars in thousands):

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Proceeds from agency securities sold	$	31,206		$	101,270		$	251,641		$	309,727
Less agency securities sold, at cost	(31,672		)	(101,759		)	(254,047		)	(310,428		)
Realized loss on agency securities, net	$	(466	)	$	(489	)	$	(2,406	)	$	(701	)
Gross realized gains on sale of agency securities	$	—		$	494		$	14		$	1,764
Gross realized losses on sale of agency securities	(466		)	(983		)	(2,420		)	(2,465		)
Realized loss on agency securities, net	$	(466	)	$	(489	)	$	(2,406	)	$	(701	)

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Pledged Assets

The following tables summarize our agency RMBS pledged as collateral under financing and derivative agreements by type as of June 30, 2018 and December 31, 2017 (dollars in thousands):

	June 30, 2018
	Fannie Mae		Freddie Mac		Total
Fair Value of Agency Securities Pledged Under:
Financing agreements	$	2,197,052	$	1,116,237	$	3,313,289
Derivative agreements	77		452		529
Total fair value	2,197,129		1,116,689		3,313,818
Accrued interest on pledged agency RMBS	6,570		3,422		9,992
Total Fair Value of Agency RMBS Pledged and Accrued Interest	$	2,203,699	$	1,120,111	$	3,323,810

	December 31, 2017
	Fannie Mae		Freddie Mac		Total
Fair Value of Agency Securities Pledged Under:
Financing agreements	$	2,443,591	$	1,137,587	$	3,581,178
Derivative agreements	84		606		690
Total fair value	2,443,675		1,138,193		3,581,868
Accrued interest on pledged agency RMBS	7,132		3,399		10,531
Total Fair Value of Agency RMBS Pledged and Accrued Interest	$	2,450,807	$	1,141,592	$	3,592,399

The following table summarizes our agency RMBS pledged as collateral under financings agreements, by remaining maturity, including securities pledged related to sold but not yet settled securities, as of June 30, 2018 and December 31, 2017 (dollars in thousands):

	June 30, 2018						December 31, 2017
Remaining Maturity	Fair Value		Amortized Cost		Accrued Interest		Fair Value		Amortized Cost		Accrued Interest
30 days or less	$	1,059,318	$	1,096,281	$	3,203	$	940,788	$	949,282	$	2,765
31 - 59 days	981,288		1,021,998		2,958		1,298,331		1,311,882		3,818
60 - 90 days	814,914		844,346		2,473		261,823		262,908		785
Greater than 90 days	457,769		476,444		1,358		1,080,236		1,091,195		3,161
Total	$	3,313,289	$	3,439,069	$	9,992	$	3,581,178	$	3,615,267	$	10,529

As of June 30, 2018 and December 31, 2017, none of our repurchase agreement borrowings backed by agency RMBS had original overnight maturities.

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Note 5. Non-Agency Securities

The following tables summarize our non-agency securities as of June 30, 2018 and December 31, 2017 (dollars in thousands):

June 30, 2018
	Fair   Value		Gross Unrealized					Amortized Cost		Premium (Discount)			Par/ Current Face		Weighted Average
Category			Gains		Losses										Coupon (1)		Yield
Prime	$	117,059	$	8,487	$	(169	)	$	108,741	$	(11,683	)	$	120,424	3.94	%	6.07	%
CRT	267,402		15,137		(225		)	252,490		10,614			241,876		5.66	%	5.90	%
Alt-A	243,683		46,950		(578		)	197,311		(103,153		)	300,464		3.20	%	9.71	%
Option-ARM	82,061		12,810		—			69,251		(19,613		)	88,864		2.34	%	6.98	%
Subprime	13,309		826		—			12,483		(645		)	13,128		5.20	%	5.93	%
CMBS	16,446		141		(41		)	16,346		(139		)	16,485		5.68	%	6.09	%
Total	$	739,960	$	84,351	$	(1,013	)	$	656,622	$	(124,619	)	$	781,241	4.09	%	7.19	%

————————

⁽¹⁾ Coupon rates are floating, except for $11.0 million, $5.6 million, $11.8 million, $13.3 millionand$16.4 million fair value of fixed-rate prime, CRT, Alt-A, subprime and CMBS non-agency securities, respectively, as of June 30, 2018.

December 31, 2017
	Fair   Value		Gross Unrealized					Amortized Cost		Premium (Discount)			Par/ Current Face		Weighted Average
Category			Gains		Losses										Coupon (1)		Yield
Prime	$	143,329	$	9,342	$	(12	)	$	133,999	$	(13,893	)	$	147,892	3.77	%	5.66	%
CRT	322,819		18,346		—			304,473		16,011			288,462		5.34	%	5.23	%
Alt-A	286,953		51,123		(774		)	236,604		(112,305		)	348,909		2.69	%	8.93	%
Option-ARM	86,886		13,114		—			73,772		(21,044		)	94,816		1.79	%	6.58	%
Subprime	13,374		929		—			12,445		(683		)	13,128		5.20	%	5.97	%
CMBS	18,723		387		—			18,336		(164		)	18,500		5.68	%	6.03	%
Total	$	872,084	$	93,241	$	(786	)	$	779,629	$	(132,078	)	$	911,707	3.73	%	6.59	%

————————

⁽¹⁾ Coupon rates are floating, except for $11.8 million, $0.9 million,$12.2 million, $13.4 million and $18.7 million fair value of fixed-rate prime, CRT, Alt-A, subprime and CMBS non-agency securities, respectively, as of December 31, 2017.

The following table summarizes our non-agency securities at fair value, by their estimated weighted average life classifications as of June 30, 2018 and December 31, 2017 (dollars in thousands): 

	June 30, 2018								December 31, 2017
					Weighted Average								Weighted Average
Estimated Weighted Average Life	Fair Value		Amortized Cost		Coupon		Yield		Fair Value		Amortized Cost		Coupon		Yield
≤ 5 years	$	224,275	$	189,555	3.68	%	9.01	%	$	302,797	$	258,501	3.11	%	8.31	%
> 5 to ≤ 7 years	304,848		266,186		4.35	%	7.28	%	398,712		361,649		4.33	%	5.97	%
> 7 years	210,837		200,881		4.21	%	5.37	%	170,575		159,479		3.61	%	5.18	%
Total	$	739,960	$	656,622	4.09	%	7.19	%	$	872,084	$	779,629	3.73	%	6.59	%

Our Prime non-agency securities include investments in securitization trusts collateralized by prime mortgage loans, which were originated between 2002 and 2006, a period of generally weaker underwriting standards and elevated housing prices. As a result, there is still material credit risk embedded in these loan origination vintages. As of June 30, 2018, Prime non-agency securities also include $16.7 million in fair value of securities with underlying mortgage loans that were originated with more stringent underwriting standards beginning in 2010. As of June 30, 2018, our Prime securities have both fixed and floating rate coupons ranging from 2.7% to 6.5%, with weighted average coupons of underlying collateral ranging from 3.5% to 5.0%.

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Our CRT reference the performance of loans underlying agency RMBS issued by Fannie Mae or Freddie Mac, which were subject to their underwriting standards. As of June 30, 2018, our CRT securities had fixed and floating rate coupons ranging from 1.3% to 9.0%, with weighted average coupons of underlying collateral ranging from 3.7% to 4.3%. The loans underlying our CRT securities were originated between 2012 and 2018.

Our Alt-A non-agency RMBS are collateralized by Alt-A mortgage loans that were originated from 2002 to 2007. Alt-A, or alternative A-paper, mortgage loans are considered to have more credit risk than prime mortgage loans and less credit risk than sub-prime mortgage loans. Alt-A loans are typically characterized by borrowers with less than full documentation, lower credit scores, higher loan-to-value ratios and a higher percentage of investment properties. As of June 30, 2018, our Alt-A securities had both fixed and floating rate coupons ranging from 2.2% to 6.5% with weighted average coupons of underlying collateral ranging from 3.7% to 5.7%.

Our Option-ARM non-agency RMBS include senior tranches in securitization trusts that are collateralized by residential mortgages that have origination and underwriting characteristics similar to Alt-A mortgage loans, with the added feature of providing underlying mortgage borrowers the option, within certain constraints, to make lower payments than otherwise required by the stated interest rate for a number of years, leading to negative amortization and increased loan balances. This additional feature can increase the credit risk of these securities. As of June 30, 2018, our Option-ARM securities had coupons ranging from 2.2% to 2.8% and have underlying collateral with weighted average coupons between 3.6% and 4.6%. The loans underlying our Option-ARM securities were originated between 2001 and 2007.

Our Subprime non-agency RMBS include investments in securitization trusts collateralized by residential mortgages originated during or before 2005 that were originally considered to be of lower credit quality. As of June 30, 2018, our Subprime securities had a fair value of $13.3 million with fixed and floating rate coupons ranging from 5.0% to 5.5% and have underlying collateral with weighted-average coupons ranging from 5.5% to 5.7%.

Our CMBS are collateralized by a commercial mortgage loan originated in 2016 that is secured by first priority liens on 64 skilled nursing facilities. As of June 30, 2018, our CMBS securities had a fair market value of $16.4 million with fixed rate coupons ranging from 5.2% to 6.6% and underlying collateral with a weighted average coupon of 4.5%.

More than 85% of our non-agency RMBS are rated below investment grade or have not been rated by credit agencies as of June 30, 2018.

Realized Gains and Losses

The following table summarizes our net realized gains from the sale of non-agency securities during the three and six months ended June 30, 2018 and 2017 (dollars in thousands):

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Proceeds from non-agency securities sold	$	85,594		$	180,394		$	175,495		$	440,867
Increase in receivable for securities sold	—			(629		)	—			5,119
Less: non-agency securities sold, at cost	(80,051		)	(165,284		)	(165,798		)	(418,791		)
Realized gain on non-agency securities, net	$	5,543		$	14,481		$	9,697		$	27,195
Gross realized gain on sale of non-agency securities	$	5,543		$	14,489		$	9,698		$	27,353
Gross realized loss on sale of non-agency securities	—			(8		)	(1		)	(158		)
Realized gain on non-agency securities, net	$	5,543		$	14,481		$	9,697		$	27,195

Pledged Assets

Non-agency securities with a fair value of $0.7 billion were pledged as collateral under financing arrangements as of both June 30, 2018 and December 31, 2017, none of which had original overnight maturities.

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The following table summarizes our non-agency securities pledged as collateral under repurchase agreements, by remaining maturity, including securities pledged related to sold but not yet settled securities, as of June 30, 2018 and December 31, 2017 (dollars in thousands):

	June 30, 2018						December 31, 2017
Remaining Maturity	Fair Value		Amortized Cost		Accrued Interest		Fair Value		Amortized Cost		Accrued Interest
30 days or less	$	609,141	$	541,589	$	1,031	$	585,943	$	517,750	$	815
31 - 59 days	38,581		30,038		59		97,537		82,105		145
60 - 90 days	12,232		9,493		15		59,798		58,651		135
Total	$	659,954	$	581,120	$	1,105	$	743,278	$	658,506	$	1,095

Note 6. Investments in Real Property

Investment Activity

The following table summarizes our real estate investments net of accumulated depreciation as of June 30, 2018 and December 31, 2017 (dollars in thousands):

	June 30, 2018			December 31, 2017
Buildings and improvements	$	258,065		$	233,407
Furniture, fixtures and equipment	16,284			14,537
Less: accumulated depreciation	(11,750		)	(7,592		)
Buildings, furniture, fixtures and equipment, net of accumulated depreciation	262,599			240,352
Land	17,538			16,641
Goodwill	5,840			5,840

Notes Payable

Our wholly-owned subsidiary, Capital Healthcare Investments, LLC (“CHI”) finances its real estate investments primarily through secured debt. As of June 30, 2018, CHI had fixed rate debt with a principal amount of $179.9 million, a weighted average maturity of 27.4 years and an interest rate of 3.91% and floating rate debt with a principal amount of $25.8 million, a weighted average maturity of 1.3 years and a weighted average interest rate of 5.13%. As of December 31, 2017, CHI had floating rate debt with a principal amount of $50.3 million, a weighted average maturity of 0.8 years and a weighted average interest rate of 4.34% and fixed rate debt with a principal amount of $138.8 million, a weighted average maturity of 25.6 years and an interest rate of 3.80%.

The following is a summary of our notes payable activity for the six months ended June 30, 2018 and 2017 (dollars in thousands):

	For the Six Months Ended June 30,
	2018			2017
Beginning balance	$	186,500		$	66,527
Debt issued and assumed, net of deferred financing costs	56,874			120,277
Amortization of deferred financing costs	113			440
Principal repayments	(41,675		)	(320		)
Ending balance	$	201,812		$	186,924

Our notes payable of $205.7 million, excluding $3.9 million of deferred financing costs, had a fair value of approximately $196 million as of June 30, 2018. Our notes payable of $189.0 million, excluding $2.5 million of deferred financing costs, had a fair value of approximately $190 million as of December 31, 2017.

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Income from Healthcare Real Estate Investments

The following table presents the components of net income from our real property investments during the three and six months ended June 30, 2018 and 2017 (dollars in thousands):

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
	2018		2017		2018		2017
Lease income	$	5,707	$	4,615	$	11,413	$	6,868
Rental income	2,704		1,139		4,758		2,201
Healthcare real estate income	8,411		5,754		16,171		9,069
Interest expense	2,261		1,887		4,350		3,060
Depreciation	2,157		1,526		4,158		2,297
Tenant expenses	1,718		848		3,143		1,557
Other	435		112		715		112
Healthcare real estate expense	6,571		4,373		12,366		7,026
Net healthcare investment income	$	1,840	$	1,381	$	3,805	$	2,043

Healthcare lease income is derived from our real property investments subject to triple net lease arrangements, and rental income relates to investments made through RIDEA joint ventures. Under RIDEA, a REIT may lease “qualified healthcare properties” on an arm’s-length basis to a taxable REIT subsidiary (“TRS”) if the property is operated on behalf of such subsidiary by a person who qualifies as an “eligible independent contractor.” Generally, the rent received from the TRS will meet the related party rent exception and will be treated as “rents from real property.” Resident level rents and related operating expenses are subject to federal and state income taxes as the operations of such facilities are included in a TRS.

At June 30, 2018, future minimum lease payments receivable related to our healthcare facilities are as follows (dollars in thousands):

	June 30, 2018
2018	$	10,215
2019	20,764
2020	21,191
2021	21,627
2022	22,073
Thereafter	193,233
Total	$	289,103

Note 7. Repurchase Agreements

We pledge certain of our securities as collateral under repurchase and other financing arrangements with financial institutions and the terms and conditions are negotiated on a transaction-by-transaction basis. Interest rates on these borrowings are generally based on LIBOR plus or minus a margin and amounts available to be borrowed are dependent upon the fair value of the securities pledged as collateral, which fluctuates with changes in interest rates, type of security and liquidity conditions within the banking, mortgage finance and real estate industries. In response to declines in fair value of pledged securities, lenders may require us to post additional collateral or pay down borrowings to re-establish agreed upon collateral requirements, referred to as margin calls. As of June 30, 2018 and December 31, 2017, we have met all margin call requirements and had no agency or non-agency repurchase agreements with original overnight maturities. Repurchase agreements are carried at cost, which approximates fair value due to their short-term maturities or floating rate coupons.

17

As of June 30, 2018 and December 31, 2017, our borrowings under repurchase agreements had the following collateral characteristics (dollars in thousands):

	June 30, 2018					December 31, 2017
			Weighted Average					Weighted Average
Collateral Type	Borrowings Outstanding		Interest Rate		Days to Maturity	Borrowings Outstanding		Interest Rate		Days to Maturity
Agency securities	$	3,053,483	2.10	%	85	$	3,307,662	1.54	%	114
Non-agency securities	504,420		3.15	%	18	556,057		2.72	%	24
U.S. Treasury securities	2,370		2.10	%	2	—		N/A		N/A
Total repurchase agreements	$	3,560,273	2.25	%	75	$	3,863,719	1.71	%	101

The following table summarizes our borrowings under repurchase arrangements as of June 30, 2018 and December 31, 2017 (dollars in thousands):

	June 30, 2018					December 31, 2017
			Weighted Average					Weighted Average
	Borrowings Outstanding		Interest Rate		Days to Maturity	Borrowings Outstanding		Interest Rate		Days to Maturity
≤ 1 month	$	1,470,714	2.43	%	17	$	1,341,712	1.91	%	17
> 1 to ≤ 2 months	953,784		2.10	%	40	1,334,493		1.55	%	40
> 2 to ≤ 3 months	784,686		1.95	%	76	295,204		1.76	%	76
> 3 to ≤ 6 months	—		N/A		N/A	334,372		1.51	%	123
> 6 to ≤ 12 months	86,089		2.04	%	210	292,938		1.57	%	256
> 12 months	265,000		2.79	%	477	265,000		1.80	%	658
Total repurchase agreements	$	3,560,273	2.25	%	75	$	3,863,719	1.71	%	101

We had repurchase agreements with 36 financial institutions as of June 30, 2018. Less than 4% of stockholders' equity was at risk due to collateral pledged in excess of borrowings under repurchase agreements with any one counterparty, with the top five counterparties representing approximately 16% of our stockholders' equity at risk as of June 30, 2018.

We had agency RMBS with fair values of $3.3 billion and $3.6 billion pledged as collateral against repurchase agreements as of June 30, 2018 and December 31, 2017, respectively. We had non-agency securities with fair values of $0.7 billion pledged as collateral against repurchase agreements as of both June 30, 2018 and December 31, 2017.

Note 8. Derivatives and Other Securities

In connection with our risk management strategy, we mitigate our exposure to market risks, including interest rate risk, prepayment risk and credit risk, by entering into derivative and other hedging instrument contracts. We may enter into agreements for interest rate swaps, interest rate swaptions, interest rate cap or floor contracts and futures or forward contracts. We may also purchase or short TBA and U.S. Treasury securities, purchase or sell options on TBA securities or we may invest in other types of derivative securities, including synthetic total return swaps and credit default swaps. Our risk management strategy attempts to manage the overall risk of the portfolio and reduce fluctuations in net asset value. Derivatives have not been designated as hedging instruments. For additional information regarding our derivative instruments and our overall risk management strategy, please refer to the discussion of derivatives in Note 3.

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The table below presents the balance sheet location and fair value information for our derivatives outstanding as of June 30, 2018 and December 31, 2017 (in thousands):

	June 30, 2018		December 31, 2017
Derivative assets:
Interest rate swaps	$	8,854	$	4,894
Interest rate swaptions	14,039		6,728
TBA securities	9,823		3,090
Derivative assets, at fair value	$	32,716	$	14,712
Derivative liabilities:
Interest rate swaps	23		—
TBA securities	—		1,339
Credit default swaps	—		3,115
Derivative liabilities, at fair value	$	23	$	4,454

The following tables summarize the effect of our outstanding derivatives and other securities on our consolidated statements of operations during the three and six months ended June 30, 2018 and 2017 (in thousands):

	For the Three Months Ended June 30,
	2018								2017
	Realized Gain on Periodic Settlements of Interest Rate Swaps, net		Realized Gain on Other Derivatives and Securities, net			Unrealized Gain (Loss) on Other Derivatives and Securities, net			Realized Loss on Periodic Settlements of Interest Rate Swaps, net			Realized Gain on Other Derivatives and Securities, net			Unrealized Gain (Loss) on Other Derivatives and Securities, net
Interest rate swaps	$	4,175	$	11,303		$	1,407		$	(2,281	)	$	(11,570	)	$	2,081
Interest rate swaptions	—		—			1,219			—			—			(135		)
TBA securities	—		(4,109		)	113			—			31,177			(12,077		)
Short sales of U.S. Treasuries	—		(370		)	3,869			—			(14,425		)	(1,861		)
Credit default swaps	—		—			—			—			(470		)	274
Other	—		20			(25		)	—			33			—
Total	$	4,175	$	6,844		$	6,583		$	(2,281	)	$	4,745		$	(11,718	)

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	For the Six Months Ended June 30,
	2018							2017
	Realized Gain on Periodic Settlements of Interest Rate Swaps, net		Realized Gain on Other Derivatives and Securities, net			Unrealized Gain (Loss) on Other Derivatives and Securities, net		Realized Loss on Periodic Settlements of Interest Rate Swaps, net			Realized Gain on Other Derivatives and Securities, net			Unrealized Gain (Loss) on Other Derivatives and Securities, net
Interest rate swaps	$	4,533	$	59,232		$	3,527	$	(4,941	)	$	14,451		$	(19,749	)
Interest rate swaptions	—		—			6,541		—			—			(563		)
TBA securities	—		(47,254		)	8,072		—			6,887			17,433
Short sales of U.S. Treasuries	—		(759		)	20,372		—			(14,174		)	(11,502		)
Credit default swaps	—		(1,648		)	1,528		—			(513		)	(183		)
Other	—		9			—		—			261			7
Total	$	4,533	$	9,580		$	40,040	$	(4,941	)	$	6,912		$	(14,557	)

The following tables summarize changes in notional amounts for our outstanding derivatives and other securities during the three and six months ended June 30, 2018 and 2017 (in thousands):

	December 31, 2017 Notional Amount			Additions/ Long Positions	Expirations/ Terminations/ Short Positions		June 30, 2018 Notional Amount
Interest rate swaps	$	3,530,000		200,000	(200,000	)	$	3,530,000
Interest rate swaptions	$	425,000		75,000	—		$	500,000
TBA securities	$	1,704,386		10,721,305	(10,709,077	)	$	1,716,614
U.S. Treasuries	$	—		129,500	(129,500	)	$	—
Short sales of U.S. Treasuries	$	(846,700	)	82,000	(151,500	)	$	(916,200	)
Credit default swaps	$	48,000		—	(48,000	)	$	—

	December 31, 2016 Notional Amount			Additions/ Long Positions	Expirations/ Terminations/ Short Positions		June 30, 2017 Notional Amount
Interest rate swaps	$	2,975,000		595,000	(265,000	)	$	3,305,000
Interest rate swaptions	$	150,000		125,000	—		$	275,000
TBA securities	$	886,042		13,678,610	(12,953,692	)	$	1,610,960
U.S. Treasuries	$	21,000		22,500	(43,500	)	$	—
Short sales of U.S. Treasuries	$	(511,000	)	1,090,500	(1,434,500	)	$	(855,000	)
Credit default swaps	$	49,000		—	(500	)	$	48,500

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Interest Rate Swap Agreements

Our derivative portfolio includes interest rate swaps, which are used to manage our exposure to interest rate risk. Under our interest rate swaps, we typically pay a fixed rate and receive a floating rate based on LIBOR with terms usually ranging up to 15 years. As of June 30, 2018 and December 31, 2017, we had interest rate swap agreements summarized in the table below (dollars in thousands).

	June 30, 2018							December 31, 2017
	Notional Amount		Weighted Average					Notional Amount		Weighted Average
Current Maturity Date			Fixed Pay Rate		Receive  Rate		Maturity (Years)			Fixed Pay Rate		Receive  Rate		Maturity (Years)
≤ 3 years	$	1,475,000	1.37	%	2.34	%	1.2	$	1,500,000	1.26	%	1.46	%	1.3
> 3 to ≤ 5 years	1,010,000		1.90	%	2.33	%	3.9	985,000		1.79	%	1.47	%	4.0
> 5 to ≤ 7 years	250,000		1.71	%	2.35	%	5.4	350,000		1.78	%	1.40	%	5.7
> 7 years	795,000		2.35	%	2.34	%	9.1	695,000		2.26	%	1.47	%	9.9
Total	$	3,530,000	1.77	%	2.34	%	4.0	$	3,530,000	1.65	%	1.46	%	4.2

Interest Rate Swaption Agreements

Our interest rate swaption agreements provide us the option to enter into interest rate swap agreements in the future where we would pay a fixed rate and receive LIBOR. The following tables present certain information about our interest rate swaption agreements as of June 30, 2018 and December 31, 2017 (dollars in thousands):

June 30, 2018
	Option					Underlying Swap
Current Option Expiration Date	Cost		Fair Value		Weighted Average Years to Expiration	Notional Amount		Pay Rate		Weighted Average Term (Years)
≤ 12 months	$	3,302	$	5,935	0.5	$	250,000	2.75	%	8.4
>12 to ≤ 24 months	2,562		3,120		1.3	100,000		2.85	%	8.8
> 24 months	7,051		4,984		3.1	150,000		2.90	%	8.5
Total / weighted average	$	12,915	$	14,039	1.4	$	500,000	2.81	%	8.5

December 31, 2017
	Option					Underlying Swap
Current Option Expiration Date	Cost		Fair Value		Weighted Average Years to Expiration	Notional Amount		Pay Rate		Weighted Average Term (Years)
< 12 months	$	2,111	$	1,621	0.9	$	175,000	2.71	%	8.6
>12 to ≤ 24 months	2,083		1,400		1.5	75,000		2.73	%	10.0
> 24 months	7,951		3,707		3.4	175,000		2.87	%	8.9
Total / weighted average	$	12,145	$	6,728	2.0	$	425,000	2.78	%	8.9

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TBA Securities

As of June 30, 2018 and December 31, 2017, we had contracts to purchase (“long position”) and sell (“short position”) TBA securities on a forward basis, presented in the following table (in thousands):

	June 30, 2018				December 31, 2017
Purchase and Sale Contracts for TBA Securities	Notional  Amount (1)		Fair Value (2)		Notional  Amount (1)			Fair Value (2)
TBA assets:
Purchase of TBA securities	$	1,716,614	$	9,823	$	1,386,416		$	3,089
Sale of TBA securities	—		—		(1,200		)	1
Total TBA assets	1,716,614		9,823		1,385,216			3,090
TBA liabilities:
Purchase of TBA securities	—		—		319,170			(1,339		)
Sale of TBA securities	—		—		—			—
Total TBA liabilities	—		—		319,170			(1,339		)
Total net TBA	$	1,716,614	$	9,823	$	1,704,386		$	1,751

————————

⁽¹⁾  Notional amount represents the par value or principal balance of the underlying agency security.

⁽²⁾  Fair value represents the current market value of the agency RMBS underlying the TBA contract as of period end, less the forward price to be paid for the underlying agency RMBS.

U.S. Treasury Securities and Futures

We purchase or sell short U.S. Treasury securities and U.S. Treasury futures contracts to mitigate our exposure to changes in interest rates.

We had obligations to return U.S. Treasury securities borrowed under reverse repurchase agreements accounted for as securities borrowing transactions with a fair value of $0.9 billion and $0.8 billion as of June 30, 2018 and December 31, 2017, respectively. The borrowed securities were collateralized by cash payments of $0.9 billion and $0.8 billion as of June 30, 2018 and December 31, 2017, which are presented as receivable under reverse repurchase agreements on the consolidated balance sheets. All changes in fair value of long and short U.S. Treasury securities and futures are recorded in realized and unrealized gain (loss) on other derivatives and securities, net in our consolidated statements of operations.

Credit Risk-Related Contingent Features

The use of derivatives creates exposure to credit risk relating to potential losses that could be recognized in the event that the counterparties to these instruments fail to perform their obligations under the contracts. We minimize this risk by limiting our counterparties for instruments which are not centrally cleared on a registered exchange to major financial institutions with acceptable credit ratings and monitoring positions with individual counterparties. In addition, both we and our counterparties may be required to pledge collateral for our derivatives, based on the market value, notional amount and remaining term of the derivative contract. In the event of a default by a counterparty, we may not receive payments provided for under the terms of our derivative agreements and may have difficulty obtaining our assets pledged as collateral for our derivatives. The cash and cash equivalents pledged as collateral for our derivative instruments is included in restricted cash and cash equivalents on our consolidated balance sheets.

Each of our ISDA Master Agreements contains provisions pursuant to which we are required to fully collateralize our obligations under our interest rate swap agreements if at any point the fair value of the swap represents a liability greater than the minimum transfer amount contained within our ISDA Master Agreements. We are also required to post initial collateral upon execution of certain of our swap transactions. If we breach any of these provisions, we will be required to settle our obligations under the agreements at their termination values, which approximates fair value.

Further, each of our ISDA Master Agreements contain cross default provisions under which a default under certain of our other indebtedness in excess of a certain threshold causes an event of default under the agreement. Threshold amounts vary by lender. Following an event of default, we could be required to settle our obligations under the agreements at their termination values. Additionally, under certain of our ISDA Master Agreements, we could be required to settle our obligations under the

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agreements at their termination values if we fail to maintain either our REIT status or certain minimum equity thresholds, or comply with limits on our leverage above certain specified levels. As of June 30, 2018, the fair value of the additional collateral that could be required to be posted as a result of the credit-risk related contingent features being triggered was not material to our consolidated financial statements.

We did not have counterparty credit risk with any single counterparty in excess of 1% of our equity, as of June 30, 2018 under our non-centrally cleared interest rate swap and swaption agreements.

In the case of centrally cleared interest rate swap contracts, we could be exposed to credit risk if the central clearing agency or a clearing member defaults on its respective obligation to perform under the contract. The risk is considered minimal, however, due to initial and daily exchange of mark to market margin requirements, the clearinghouse guarantee fund and other resources that are available in the event of a clearing member default.

Note 9. Offsetting Assets and Liabilities

Certain of our repurchase agreements and derivative transactions are governed by underlying agreements that generally provide for a right of offset under master netting arrangements (or similar agreements), including in the event of default or in the event of bankruptcy of either party to the transactions.  We present our assets and liabilities subject to such arrangements on a gross basis in our consolidated balance sheets.  The following tables present information about our assets and liabilities that are subject to such agreements and can potentially be offset on our consolidated balance sheets as of June 30, 2018 and December 31, 2017 (in thousands):

Offsetting of Financial Assets and Derivative Assets:

	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Consolidated Balance Sheets		Net Amounts Presented in the Consolidated Balance Sheets		Gross Amounts Not Offset in the Consolidated Balance Sheets
							Financial Instruments			Collateral Received (1)			Net Amount
June 30, 2018
Interest rate swaps and swaptions (2)	$	22,893	$	—	$	22,893	$	(23	)	$	(17,912	)	$	4,958
TBA	9,823		—		9,823		—			—			9,823
Receivable under reverse repurchase agreements	890,059		—		890,059		(680,057		)	(210,002		)	—
Total	$	922,775	$	—	$	922,775	$	(680,080	)	$	(227,914	)	$	14,781
December 31, 2017
Interest rate swaps and swaptions (2)	$	11,622	$	—	$	11,622	$	—		$	(5,642	)	$	5,980
TBA	3,090		—		3,090		(1,339		)	—			1,751
Receivable under reverse repurchase agreements	843,130		—		843,130		(725,319		)	(117,811		)	—
Total	$	857,842	$	—	$	857,842	$	(726,658	)	$	(123,453	)	$	7,731

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Offsetting of Financial Liabilities and Derivative Liabilities:

	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Consolidated Balance Sheets		Net Amounts Presented in the Consolidated Balance Sheets		Gross Amounts Not Offset in the Consolidated Balance Sheets
							Financial Instruments			Collateral Pledged (1)			Net Amount
June 30, 2018
Repurchase agreements	$	3,560,273	$	—	$	3,560,273	$	(680,057	)	$	(2,880,216	)	$	—
Interest rate swaps (2)	23		—		23		(23		)	—			—
Total	$	3,560,296	$	—	$	3,560,296	$	(680,080	)	$	(2,880,216	)	$	—
December 31, 2017
TBA	$	1,339	$	—	$	1,339	$	(1,339	)	$	—		$	—
Repurchase agreements	3,863,719		—		3,863,719		(725,319		)	(3,138,400		)	—
Total	$	3,865,058	$	—	$	3,865,058	$	(726,658	)	$	(3,138,400	)	$	—

————————

⁽¹⁾ Includes cash and securities received / pledged as collateral, at fair value. Amounts presented are limited to collateral pledged sufficient to reduce the net amount to zero on a counterparty by counterparty basis, as applicable. Refer to Notes 4 and 5 for additional information regarding assets pledged.

⁽²⁾  Reported under derivative assets / liabilities, at fair value in the accompanying consolidated balance sheets. Refer to Note 8 for a reconciliation of derivative assets / liabilities, at fair value to their sub-components.

Note 10. Fair Value Measurements

We have elected the option to account for all of our financial assets at fair value, with changes in fair value reflected in income during the period in which they occur. We have determined that this presentation most appropriately represents our financial results and position. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, based on the assumptions market participants would use when pricing an asset or liability.

We determine the fair value of our agency and non-agency securities, including securities held as collateral, based upon fair value estimates obtained from multiple third-party pricing services and dealers. In determining fair value, third-party pricing sources use various valuation approaches, including market and income approaches. Factors used by third-party sources in estimating the fair value of an instrument may include observable inputs such as recent trading activity, credit data, volatility statistics, and other market data that are current as of the measurement date. The availability of observable inputs can vary by instrument and is affected by a wide variety of factors, including the type of instrument, whether the instrument is new and not yet established in the marketplace and other characteristics particular to the instrument. Third-party pricing sources may also use certain unobservable inputs, such as assumptions of future levels of prepayment, default and loss severity, especially when estimating fair values for securities with lower levels of recent trading activity. When possible, we make inquiries of third-party pricing sources to understand their use of significant inputs and assumptions.

We review the various third-party fair value estimates and perform procedures to validate their reasonableness, including an analysis of the range of third-party estimates for each position, comparison to recent trade activity for similar securities, and our Manager's review for consistency with market conditions observed as of the measurement date. While we do not adjust prices we obtain from third-party pricing sources, we will exclude third-party prices for securities from our determination of fair value if we determine (based on our validation procedures and our Manager's market knowledge and expertise) that the price is significantly different than observable market data would indicate and we cannot obtain a satisfactory understanding from the third party source as to the significant inputs used to determine the price.

We utilize a three-level valuation hierarchy for disclosure of fair value measurement. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument’s categorization within the hierarchy is based upon the lowest level of input that is significant to the fair value measurement. We use the results of the validation procedures described above as part of our determination of the appropriate fair value measurement hierarchy classification. The three levels of valuation hierarchy are defined as follows:

• Level 1 Inputs - Quoted prices (unadjusted) for identical unrestricted assets and liabilities in active markets that are accessible at the measurement date.

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

• Level 3 Inputs - Significant unobservable market inputs that are supported by little or no market activity. The unobservable inputs represent the assumptions that market participants would use to price the assets and liabilities.

The following tables present our financial instruments carried at fair value as of June 30, 2018 and December 31, 2017, on the consolidated balance sheets by the valuation hierarchy, as described above (in thousands):

	June 30, 2018
	Level 1		Level 2		Level 3		Total
Assets
Agency securities	$	—	$	3,519,280	$	—	$	3,519,280
Non-agency securities	—		739,960		—		739,960
Derivative assets	—		32,716		—		32,716
Total	$	—	$	4,291,956	$	—	$	4,291,956
Liabilities
Derivative liabilities	—		23		—		23
Obligation to return securities borrowed under reverse repurchase agreements	878,933		—		—		878,933
Total	$	878,933	$	23	$	—	$	878,956

	December 31, 2017
	Level 1		Level 2		Level 3		Total
Assets
Agency securities	$	—	$	3,758,181	$	—	$	3,758,181
Non-agency securities	—		872,084		—		872,084
Derivative assets	—		14,712		—		14,712
Total	$	—	$	4,644,977	$	—	$	4,644,977
Liabilities
Derivative liabilities	$	—	$	4,454	$	—	$	4,454
Obligation to return securities borrowed under reverse repurchase agreements	830,776		—		—		830,776
Total	$	830,776	$	4,454	$	—	$	835,230

Our agency and non-agency securities are valued using the various market data described above, which include inputs determined to be observable or whose significant value drivers are observable. Accordingly, our agency and non-agency securities are classified as Level 2 in the fair value hierarchy as of June 30, 2018.

For information regarding valuation of our derivative instruments, please refer to the discussion of derivative and other hedging instruments in Note 2. Our interest rate swaps and other derivatives are classified as Level 2 in the fair value hierarchy.

The fair value of our obligation to return securities borrowed under reverse repurchase agreements is based upon the value of the underlying borrowed U.S. Treasury securities as of the reporting date. Both U.S. Treasury securities and our

obligation to return borrowed U.S. Treasury securities are classified as Level 1 in the fair value hierarchy.

Excluded from the table above are financial instruments, including cash and cash equivalents, restricted cash and cash equivalents, receivables, payables, borrowings under repurchase agreements, and debt secured by healthcare real estate investments, which are presented in our consolidated financial statements at cost. The cost basis of financial instruments with initial terms of less than one year are determined to approximate fair value, primarily due to the short duration of these

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instruments.  The cost basis of floating rate borrowings with initial terms of greater than one year is determined to approximate fair value, primarily as such agreements have floating interest rates based on an index plus or minus a fixed spread and the fixed spread is generally consistent with those demanded in the market. The fair value of fixed rate secured debt is estimated by discounting the estimated future cash flows using the current rates at which similar loans would be made with similar credit ratings and for the same remaining maturities. We estimate the fair value of these instruments using Level 2 inputs.

In addition to items that are measured at fair value on a recurring basis, we also have assets and liabilities in our balance sheet that are measured at fair value on a nonrecurring basis, including those acquired in business combinations. We have determined that the fair value measurements included in each of these assets and liabilities rely primarily on company-specific inputs and our assumptions about the use of the assets and settlement of liabilities, and that each of these fair value measurements generally incorporate Level 3 inputs. We estimate the fair value of real estate and related intangibles using the income approach and unobservable data such as net operating income and estimated capitalization and discount rates. We also consider local and national industry market data including comparable sales, and commonly engage an external real estate appraiser to assist us in our estimation of fair value. We estimate the fair value of secured debt assumed in business combinations using current interest rates at which similar borrowings could be obtained on the transaction date.

Note 11. Other Assets

The following table summarizes our other assets as of June 30, 2018 and December 31, 2017 (dollars in thousands):

	June 30, 2018		December 31, 2017
Servicing advances	$	—	$	324
Prepaid expenses	1,779		1,993
Accounts receivable	1,072		5,682
Goodwill	5,840		5,840
Other	7,206		9,403
Total other assets	$	15,897	$	23,242

Note 12. Accounts Payable and Other Accrued Liabilities

The following table summarizes our accounts payable and other accrued liabilities as of June 30, 2018 and December 31, 2017 (dollars in thousands):

	June 30, 2018		December 31, 2017
Cash collateral held	$	17,912	$	5,642
Due to manager	1,567		1,451
Accrued interest	17,548		12,547
Other accounts payable and accrued expenses	12,453		13,952
Total accounts payable and other accrued liabilities	$	49,480	$	33,592

Risk Mitigation Activities

The Company’s previous investment in MSR exposes us to certain risks, including representation and warranty risk. Representation and warranty risk refers to the representations and warranties we made (or are deemed to have made) to the applicable investor (including, without limitation, the GSEs) regarding, among other things, the origination and servicing of mortgage loans with respect to which we had acquired MSR. We mitigated representation and warranty risk through our due diligence in connection with MSR acquisitions, including counterparty reviews and loan file reviews, as well as negotiated contractual protections from our MSR transaction counterparties with respect to prior origination and servicing. In connection with the sale of its servicing assets and remaining MSR in 2016 and 2017, Residential Credit Solutions, Inc. (“RCS”), the Company’s subsidiary that was previously engaged in mortgage servicing operations, retained certain risk exposure existing prior to the time of such sales, including representation and warranty risk.

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Note 13. Stockholders’ Equity

Redeemable Preferred Stock

Pursuant to our charter, we are authorized to designate and issue up to 50.0 million shares of preferred stock in one or more classes or series. Our Board of Directors has designated 2.3 million shares as 8.125% Series A Cumulative Redeemable Preferred Stock (“Series A Preferred Stock”). As of June 30, 2018, we had 47.8 million of authorized but unissued shares of preferred stock. Shares of our Series A Preferred Stock are redeemable at $25.00 per share plus accumulated and unpaid dividends (whether or not declared) exclusively at our option commencing on May 22, 2019, or earlier under certain circumstances intended to preserve our qualification as a REIT for Federal income tax purposes. Dividends are payable quarterly in arrears on the 15th day of each January, April, July and October. As of June 30, 2018, we had declared all required quarterly dividends on the Series A Preferred Stock.

Our Board of Directors may designate additional series of authorized preferred stock ranking junior to or in parity with the Series A Preferred Stock or designate additional shares of the Series A Preferred Stock and authorize the issuance of such shares. Our Series A Preferred Stock has no stated maturity and is not subject to any sinking fund or mandatory redemption.

Common Stock Repurchase Program

Our Board of Directors adopted a stock repurchase plan pursuant to which the Company is authorized to repurchase up to $100 million of its outstanding shares of common stock through December 31, 2018. The Company may repurchase shares in the open market or privately negotiated transactions or pursuant to a trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Act of 1934, as amended. The total amount of $100 million remains authorized and available for common stock repurchases as of June 30, 2018.

Shares of our common stock may be purchased in the open market, including through block purchases, or through privately negotiated transactions, or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The timing, manner, price and amount of any repurchases will be determined at our discretion and the program may be suspended, terminated or modified at any time for any reason.

Long-Term Incentive Plan

The Company sponsors the American Capital Mortgage Investment Corp. Amended and Restated Equity Incentive Plan (“Incentive Plan” or “plan”), as amended March 4, 2016, to provide for the issuance of equity-based awards, including stock options, restricted stock, restricted stock units (“RSU”) and unrestricted stock to our independent directors. We did not issue any shares of common stock related to the vesting of RSU awards during the three and six months ended June 30, 2018, as any awards vested during the period were deferred to future periods. We have made no awards under the plan to our officers or the officers or employees of our Manager, and we no longer intend to issue RSUs to RCS employees.

Net Income per Common Share

Basic net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share assumes the conversion, exercise or issuance of all potential common stock equivalents unless the effect is to reduce a loss or increase the income per share. Any shares subject to performance conditions that would not be issuable at period end, if that were the end of the contingency period, have been excluded from diluted net income per common share.

Net income used in the numerator to calculate both basic and diluted EPS is the same.  The number of shares used in the denominator of the calculation for basic and diluted EPS is different by an amount equal to the dilutive effect of stock awards issued to employees and directors.

At-the-Market Offering Program

During August 2017, we entered into agreements with sales agents to publicly offer and sell shares of our common stock in privately negotiated and/or at-the-market transactions from time-to-time up to an aggregate amount of $125 million of shares of our common stock. As of June 30, 2018, we have not issued any shares under this program.

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Note 14. Annaly Merger Agreement

On May 2, 2018, the Company, Annaly Capital Management, Inc., a Maryland corporation (“Annaly”), and Mountain Merger Sub Corporation, a Maryland corporation and a wholly owned subsidiary of Annaly (“Purchaser”), entered into an Agreement and Plan of Merger (the “Merger Agreement”). Pursuant to the Merger Agreement, and upon the terms and conditions thereof, Purchaser will commence an exchange offer (the “Offer”) to purchase all of the Company’s issued and outstanding shares of common stock, par value $0.01 per share (the “Company Common Stock”). In the Offer, holders of Company Common Stock will have the option to elect from among three forms of consideration for each share of Company Common Stock (subject to proration as described below):

• $9.82 in cash and 0.9519 shares of Annaly common stock (the “Mixed Consideration Option”);

• $19.65 in cash (the “Cash Consideration Option”); or

• 1.9037 shares of Annaly common stock (the “Stock Consideration Option”).

Holders of Company Common Stock who do not make a valid election will receive the Mixed Consideration Option for their shares of Company Common Stock. Holders who elect to receive the Cash Consideration Option or Stock Consideration Option will be subject to proration to ensure that approximately 50% of the aggregate consideration paid to holders of Company Common Stock in the Offer will be paid in the form of Annaly common stock and approximately 50% of the aggregate consideration paid to holders of Company Common Stock in the Offer will be paid in cash.

Closing of the Offer is subject to the condition that a minimum number of shares be validly tendered and not validly withdrawn. Completion of the Offer is also subject to satisfaction or waiver of a number of other customary closing conditions, including the registration of shares of Annaly common stock to be issued in the transactions and the receipt of certain regulatory approvals. The Company cannot provide any assurance that the proposed transaction will close in a timely manner or at all.

Immediately following the closing of the Offer, the Company will be merged with and into the Purchaser, with the Purchaser surviving the merger. In the merger, holders of Company Common Stock will have the right to receive, at their election, the Mixed Consideration Option, the Cash Consideration Option or the Stock Consideration Option, subject to proration as described above, and each share of the Company’s 8.125% Series A Cumulative Redeemable Preferred Stock, par value $0.01 per share (“Company Preferred Stock”), that is outstanding immediately prior to the merger will be converted into one share of a newly designated series of Annaly preferred stock, par value $0.01 per share, which will have rights, preferences and privileges and voting powers substantially the same as shares of the Company Preferred Stock.

In connection with the execution of the Merger Agreement, the Company and our Manager entered into an amendment (the “Management Agreement Amendment”) to the management agreement, dated July 1, 2016 (the “Management Agreement”).  The Management Agreement Amendment provides that one month following the completion of the transactions contemplated by the Merger Agreement, the Management Agreement will terminate, and as a result of the completion of the transactions contemplated by the Merger Agreement and the subsequent termination of the Management Agreement, the Company will reimburse the Manager for certain unpaid expenses, pay all accrued management fees then owed and pay the Manager a termination fee of approximately $41.7 million as and when specified in the Management Agreement Amendment.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) provides readers of our consolidated financial statements a narrative from the perspective of management and should be read in conjunction with the consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q for the six months ended June 30, 2018. Our MD&A is presented in the following sections:

•Executive Overview

• Financial Condition

• Results of Operations

• Liquidity and Capital Resources

• Off-Balance Sheet Arrangements

• Forward-Looking Statements

EXECUTIVE OVERVIEW

Our principal objective is to provide our stockholders with attractive risk-adjusted returns through a combination of monthly dividends and net asset value appreciation. We generate income from the interest earned on our investments, net of associated borrowing and hedging costs, and net realized gains and losses on our investment and hedging activities.

The size and composition of our investment portfolio depend on investment strategies implemented by our Manager, the accessibility of investment capital and overall market conditions, including the availability of attractively priced investments and suitable financing to leverage our investment portfolio appropriately. Market conditions are influenced by, among other things, current levels of and expectations for future levels of interest rates both domestically and globally, mortgage prepayments, market liquidity, housing prices, unemployment rates, general economic conditions, government participation in the mortgage market, and regulations or legal requirements that impact other real estate-related activities.

Trends and Recent Market Impacts

In the first quarter of 2018, the yield on the 10-year U.S. Treasury note rose 33 basis points, while shorter maturity Treasury and swap rates increased 40 to 50 basis points. Consistent with the increase in rates and wider credit spreads more broadly, spreads on agency RMBS relative to benchmarks widened close to 10 basis points and were the primary driver of our negative economic return of (2.4)% for the first quarter, which included a decline of $0.99 per common share in our net asset value and dividends declared during the quarter of $0.50 per common share.

After a somewhat turbulent first quarter, financial market volatility returned to more normal levels in the second quarter of 2018. During the second quarter, the 10-year U.S. Treasury rate increased 11 basis points to 2.85% as of June 30, 2018, and the yield curve continued its flattening trend. Agency RMBS and credit spreads were largely unchanged for the quarter. We earned a positive economic return for the second quarter of 0.8%, consisting of a $0.35 per common share decline in net asset value and $0.50 per common share dividend declared.

Given our view that interest rates were biased higher, we chose to operate with greater interest rate risk protection during the first half of 2018. During the first quarter, we increased our interest rate hedge position further to 93% of our repurchase agreements and TBA balance as of March 31, 2018, and we maintained that level as of June 30, 2018. These actions minimized the impact of the increase in long-term rates on our net asset value during the first half and should continue to mitigate, but not fully offset, our exposure to further rate increases. Our net "duration gap," which is a measure of the risk due to mismatches that can occur between the interest rate sensitivity of our assets and liabilities, inclusive of hedges, was 1.1 years as of both March 31, 2018 and June 30, 2018, moderately higher than our net duration gap of 0.6 years as of December 31, 2017.

In response to continued favorable market valuations and the correspondingly lower projected returns for non-agency assets, we continued to re-allocate proceeds from our non-agency portfolio to more attractive investment opportunities in the agency RMBS and healthcare real estate sectors.

Consistent with the Federal Reserve’s 50 basis point increase in the federal funds rate through the first half of 2018, our average repo funding cost increased by 54 basis points, from 1.71% as of December 31, 2017 to 2.25% as of June 30, 2018. Our average total cost of funds, which includes the cost of our repurchase agreements, the implied funding costs of our TBA securities and net periodic settlements on interest rate swap hedges, was 1.72% for the second quarter, consistent the first quarter. Our average total cost of funds benefited from the favorable spread differential between the rate that we paid on our repo funding and the three-month LIBOR rate that we received on our pay fixed interest rate swaps, which offset the increase in our average repo funding. Our average net interest margin (including our TBA dollar roll funded assets and interest rate swap

29

hedges and excluding "catch-up" premium amortization cost due to changes in CPR forecasts) for the second quarter was 1.64%, consistent with the first quarter.

Within the healthcare sector, skilled nursing and senior living facilities continue to benefit from favorable demographic trends, including the substantial growth in the U.S. population aged 75 and older. This growth in the elderly population, coupled with the already high utilization rates at these facilities, provides a strong foundation for this sector. In addition, investments in these facilities benefit from a stable supply of long term, fixed rate funding from GSEs and HUD. Our wholly-owned subsidiary, Capital Healthcare Investments, LLC (“CHI”) has completed healthcare real estate acquisitions with a combined asset value of $298 million and an aggregate equity investment of $93 million as of June 30, 2018.

The table below summarizes interest rates and prices for generic agency RMBS as of the end of each respective quarter since June 30, 2017:

Interest Rate / Security (1)	June 30, 2018			March 31, 2018			December 31, 2017			September 30, 2017			June 30, 2017
LIBOR:
1-Month	2.09		%	1.88		%	1.56		%	1.23		%	1.22		%
3-Month	2.34		%	2.31		%	1.69		%	1.33		%	1.30		%
U.S. Treasury Securities:
2-Year U.S. Treasury	2.53		%	2.27		%	1.89		%	1.48		%	1.38		%
5-Year U.S. Treasury	2.73		%	2.57		%	2.21		%	1.93		%	1.89		%
10-Year U.S. Treasury	2.85		%	2.74		%	2.41		%	2.33		%	2.30		%
Interest Rate Swap Rates:
2-Year Swap Rate	2.79		%	2.58		%	2.08		%	1.73		%	1.61		%
5-Year Swap Rate	2.88		%	2.71		%	2.24		%	2.00		%	1.95		%
10-Year Swap Rate	2.93		%	2.78		%	2.40		%	2.28		%	2.27		%
30-Year Fixed Rate Agency Price:
3.5%	$	99.52		$	100.20		$	102.70		$	103.09		$	102.70
4.0%	$	101.96		$	102.61		$	104.59		$	105.27		$	105.12
4.5%	$	104.13		$	104.70		$	106.40		$	107.33		$	107.27
15-Year Fixed Rate Agency Price:
2.5%	$	97.22		$	97.98		$	99.88		$	100.69		$	100.53
3.0%	$	99.41		$	99.88		$	101.88		$	102.75		$	102.64
3.5%	$	101.16		$	101.94		$	103.23		$	104.14		$	104.06

 ________________________

⁽¹⁾  Price information is for generic instruments only and is not reflective of our specific portfolio holdings. Price information can vary by source. Prices in the table above were obtained from a combination of Bloomberg and dealer indications. Interest rates were obtained from Bloomberg.

For the estimated impact of changes in interest rates and mortgage spreads on our net asset value please refer to “Quantitative and Qualitative Disclosures about Market Risk” under Item 3 of this Quarterly Report on Form 10-Q.

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The table below summarizes pay-ups on specified pools over the corresponding generic agency RMBS as of the end of each respective quarter for a select sample of specified securities. Price information provided in the table below is for illustrative purposes only and is not meant to be reflective of our specific portfolio holdings. Actual pay-ups are dependent on specific securities held in our portfolio and prices can vary depending on the source.

Specified Mortgage Pool Pay-ups over Generic TBA Price (1)(2)	June 30, 2018		March 31, 2018		December 31, 2017		September 30, 2017		June 30, 2017
30-Year Lower Loan Balance (3):
3.0%	$	0.38	$	0.41	$	0.41	$	0.45	$	0.41
3.5%	$	0.56	$	0.56	$	0.81	$	0.89	$	0.83
4.0%	$	0.86	$	1.03	$	1.69	$	1.69	$	1.47
30-Year HARP (4):
3.5%	$	—	$	—	$	0.03	$	0.16	$	0.16
4.0%	$	0.03	$	0.05	$	0.17	$	0.50	$	0.50

 ^{________________________} 

⁽¹⁾  Source: Bloomberg and dealer indications.

⁽²⁾  “Pay-ups” represent the value of the price premium of specified securities over generic TBA pools. The table above includes pay-ups for newly originated specified pools. Price information is provided for information only and is not meant to be reflective of our specific portfolio holdings. Prices can vary materially depending on the source.

⁽³⁾  Lower loan balance pay-ups for pools with original loan balances from $85,000 to $110,000.

⁽⁴⁾  HARP pay-ups for pools backed by 100% refinance loans with original loan-to-value ratios between 95% and 100%.

Share Repurchases

Under our stock repurchase plan, the Company is authorized to repurchase up to $100 million of its outstanding shares of common stock through December 31, 2018. The Company may repurchase shares in the open market or privately negotiated transactions or pursuant to a trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Act of 1934, as amended.

At-the-Market Offering Program

During August 2017, we entered into agreements with sales agents to publicly offer and sell shares of our common stock in privately negotiated and/or at-the-market transactions from time-to-time up to an aggregate amount of $125 million of shares of our common stock.

Pending Merger 

On May 3, 2018, the Company, Annaly Capital Management, Inc., a Maryland corporation (“Annaly”), and Mountain Merger Sub Corporation, a Maryland corporation and a wholly owned subsidiary of Annaly (“Purchaser”), entered into an Agreement and Plan of Merger (the “Merger Agreement”).  See Note 14 of the Notes to Consolidated Financial Statements included elsewhere in this report for a discussion of the Merger Agreement. The merger is expected to close by the end of the third quarter of 2018, although closing is subject to various conditions and regulatory approvals, including receipt of required consents from HUD, and therefore, we cannot provide any assurance that the conditions to the completion of the proposed transaction will be satisfied and if the proposed transaction is not completed, MTGE and its shareholders would not realize any of the expected benefits of the merger. 

Our ability to execute on our business plan could be adversely impacted by operating restrictions included in the Merger Agreement, including, without limitation, restrictions on our investments, financing and hedging activities, as well as share issuances and repurchases. We have incurred and will incur a variety of merger-related expenses, which, while not recurring in nature, will not be recoverable if the merger is not consummated.

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Summary of Critical Accounting Estimates

Our critical accounting estimates relate to the fair value of our investments and derivatives and the recognition of interest income. Certain of these items involve estimates that require management to make judgments that are subjective in nature. We rely on our Manager's experience and analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. Under different conditions, we could report materially different amounts based on such estimates. Our significant accounting policies are described in Note 3 to the consolidated financial statements included under Item 1 of this Quarterly Report on Form 10-Q.

We have not designated any derivatives as hedging instruments and therefore all changes in fair value are reflected in income during the period in which they occur. We also have elected the option to account for all of our financial assets at fair value, with changes in fair value reflected in income during the period in which they occur. In management's view, this election more appropriately reflects the results of our operations, as financial asset fair value changes are presented in a manner consistent with the presentation and timing of the fair value changes of economic hedging instruments.

FINANCIAL CONDITION

As of June 30, 2018, our investment portfolio with a notional fair value of $6.3 billion was comprised of $3.5 billion of agency RMBS, $1.7 billion of net long TBA securities, $0.7 billion of non-agency securities and $0.3 billion of healthcare real estate investments.

	June 30, 2018		December 31, 2017
Notional fair value of securities investments:
Agency RMBS, at fair value	$	3,519,280	$	3,758,181
Non-agency securities, at fair value	739,960		872,084
Subtotal	4,259,240		4,630,265
TBA notional fair value	1,706,854		1,733,152
Total securities investments notional fair value	$	5,966,094	$	6,363,417
Agency and non-agency securities funding	$	3,560,273	$	3,863,719
At risk securities leverage	6.2x		6.2x
Healthcare investments:
Real estate related assets, including net working capital	$	304,701	$	281,827
Notes payable, net of deferred financing costs	$	201,812	$	186,500
Healthcare leverage	2.0x		2.0x
Total assets	$	5,659,156	$	5,953,036
Total liabilities	$	4,714,537	$	4,947,414
Total stockholders' equity	$	943,830	$	1,005,107
Net asset value per common share	$	19.41	$	20.75

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The following tables summarize certain characteristics of our mortgage securities portfolio by issuer and investment category as of June 30, 2018 and December 31, 2017 (dollars in thousands):

	June 30, 2018
	Fair Value		Amortized Cost Basis		Par Value		Weighted Average
							Coupon		Yield (1)
Fannie Mae	$	2,311,530	$	2,399,344	$	2,285,555	3.61	%	2.84	%
Freddie Mac	1,207,750		1,252,345		1,189,667		3.73	%	2.99	%
Agency RMBS total	3,519,280		3,651,689		3,475,222		3.66	%	2.89	%
Non-agency securities	739,960		656,622		781,241		4.09	%	7.19	%
Total	$	4,259,240	$	4,308,311	$	4,256,463	3.73	%	3.55	%
	December 31, 2017
	Fair Value		Amortized Cost Basis		Par Value		Weighted Average
							Coupon		Yield (1)
Fannie Mae	$	2,587,575	$	2,612,063	$	2,485,055	3.63	%	2.78	%
Freddie Mac	1,170,606		1,181,017		1,117,551		3.75	%	2.89	%
Agency RMBS total	3,758,181		3,793,080		3,602,606		3.67	%	2.82	%
Non-agency securities	872,084		779,629		911,707		3.73	%	6.59	%
Total	$	4,630,265	$	4,572,709	$	4,514,313	3.67	%	3.44	%

————————

⁽¹⁾  The weighted average agency security yield incorporates an average future CPR assumption of 7.2% and 8.4% as of June 30, 2018 and December 31, 2017, respectively, based on forward rates. For non-agency securities, the weighted average yield is based on estimated cash flows that incorporate expected credit losses.

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Agency RMBS

The following table summarizes certain characteristics of our agency RMBS portfolio by term and coupon as of June 30, 2018 (dollars in thousands):

	June 30, 2018
	Fair Value		Amortized Cost Basis		Par Value		Weighted Average
							Yield		Projected CPR
Fixed rate
≤ 15-year
2.5%	$	24,108	$	24,649	$	24,648	2.44	%	8.6	%
3.0%	179,776		184,031		179,974		2.32	%	9.0	%
3.5%	77,434		80,007		76,318		2.18	%	9.4	%
4.0%	80,458		82,397		78,312		2.17	%	11.2	%
4.5%	6,634		6,758		6,404		2.56	%	10.5	%
≤ 15-year total	368,410		377,842		365,656		2.27	%	9.6	%
20-year
3.0%	49,678		51,577		50,175		2.34	%	10.5	%
3.5%	59,358		60,387		58,662		2.82	%	9.7	%
5.0%	558		584		526		2.04	%	13.7	%
20-year total	109,594		112,548		109,363		2.60	%	10.1	%
30-year
3.0%	10,594		10,820		10,921		3.12	%	6.5	%
3.5%	1,444,217		1,506,658		1,441,329		2.87	%	6.4	%
4.0%	1,420,410		1,474,004		1,382,924		3.09	%	6.8	%
4.5%	47,425		49,295		45,030		3.11	%	7.2	%
30-year total	2,922,646		3,040,777		2,880,204		2.98	%	6.6	%
Pass through agency RMBS	3,400,650		3,531,167		3,355,223		2.89	%	7.0	%
Agency CMO and other	48,467		50,395		49,022		2.81	%	1.8	%
Total fixed-rate agency RMBS	3,449,117		3,581,562		3,404,245		2.89	%	7.0	%
Adjustable rate agency RMBS	70,163		70,127		70,977		2.85	%	20.5	%
Total agency RMBS	$	3,519,280	$	3,651,689	$	3,475,222	2.89	%	7.2	%

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The following table summarizes certain characteristics of our agency RMBS portfolio by term and coupon as of December 31, 2017 (dollars in thousands):

	December 31, 2017
	Fair Value		Amortized Cost Basis		Par Value		Weighted Average
							Yield		Projected CPR
Fixed rate
≤ 15-year
2.5%	$	31,438	$	31,421	$	31,405	2.44	%	8.8	%
3.0%	169,991		171,384		166,572		2.17	%	9.4	%
3.5%	141,410		142,448		136,503		2.30	%	10.4	%
4.0%	93,679		94,528		89,635		2.17	%	11.4	%
4.5%	7,841		7,883		7,457		2.58	%	10.8	%
≤ 15-year total	444,359		447,664		431,572		2.24	%	10.1	%
20-year
3.0%	55,360		55,876		54,349		2.34	%	10.8	%
3.5%	67,410		66,699		64,799		2.82	%	10.2	%
5.0%	1,116		1,135		1,038		2.20	%	16.7	%
20-year total	123,886		123,710		120,186		2.60	%	10.5	%
30-year
3.0%	11,077		10,966		11,071		3.12	%	7.1	%
3.5%	1,396,687		1,417,768		1,350,308		2.78	%	7.2	%
4.0%	1,601,321		1,612,878		1,514,426		3.02	%	8.4	%
4.5%	52,203		52,637		48,208		3.07	%	8.2	%
30-year total	3,061,288		3,094,249		2,924,013		2.91	%	7.9	%
Pass through agency RMBS	3,629,533		3,665,623		3,475,771		2.82	%	8.2	%
Agency CMO and other	51,535		51,662		50,115		2.81	%	2.1	%
Total fixed-rate agency RMBS	3,681,068		3,717,285		3,525,886		2.82	%	8.1	%
Adjustable rate agency RMBS	77,113		75,795		76,720		2.86	%	20.6	%
Total agency RMBS	$	3,758,181	$	3,793,080	$	3,602,606	2.82	%	8.4	%

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The percentage of our fixed-rate agency RMBS portfolio allocated to HARP and lower loan balance securities was 82% (not including our net long TBA position) as of June 30, 2018 as detailed in the following table (dollars in thousands):

	June 30, 2018
	Fair Value		Amortized Cost Basis		Par Value		Weighted Average
							Coupon		Yield		Projected CPR
HARP (1)	$	527,256	$	548,773	$	523,244	3.56	%	2.82	%	6.9	%
Lower loan balance (2)	2,316,820		2,406,972		2,281,534		3.70	%	2.85	%	7.3	%
Other	556,574		575,422		550,445		3.75	%	3.14	%	5.9	%
Pass through agency RMBS	3,400,650		3,531,167		3,355,223		3.69	%	2.89	%	7.0	%
Agency CMO and other	48,467		50,395		49,022		3.01	%	2.81	%	1.8	%
Total fixed-rate agency RMBS	3,449,117		3,581,562		3,404,245		3.68	%	2.89	%	7.0	%
Adjustable rate agency RMBS	70,163		70,127		70,977		2.54	%	2.85	%	20.5	%
Total agency RMBS	$	3,519,280	$	3,651,689	$	3,475,222	3.66	%	2.89	%	7.2	%

————————

⁽¹⁾ HARP securities are defined as pools backed by 100% refinance loans with LTVs greater than or equal to 80%. Our HARP securities had a weighted average LTV of 124% and 128% for 15-year and 30-year securities, respectively, as of June 30, 2018. Includes $315.7 million of >105% LTV pools which are not deliverable into TBA securities.

⁽²⁾ Lower loan balance securities represent pools with maximum original loan balances less than or equal to $150,000. Our lower loan balance securities had a weighted average original loan balance of $100,645 and $106,926 for 15-year and 30-year securities, respectively, as of June 30, 2018.

The percentage of our fixed-rate agency RMBS portfolio allocated to HARP and lower loan balance securities was 79% (not including our net long TBA position) as of December 31, 2017, as detailed in the following table (dollars in thousands):

	December 31, 2017
	Fair Value		Amortized Cost Basis		Par Value		Weighted Average
							Coupon		Yield		Projected CPR
HARP (1)	$	588,217	$	594,839	$	568,348	3.56	%	2.81	%	8.0	%
Lower loan balance (2)	2,303,047		2,330,173		2,200,991		3.72	%	2.76	%	8.1	%
Other	738,269		740,611		706,432		3.79	%	2.99	%	8.9	%
Pass through agency RMBS	3,629,533		3,665,623		3,475,771		3.70	%	2.82	%	8.2	%
Agency CMO	51,535		51,662		50,115		3.01	%	2.81	%	2.1	%
Total fixed-rate agency RMBS	3,681,068		3,717,285		3,525,886		3.69	%	2.82	%	8.1	%
Adjustable rate agency RMBS	77,113		75,795		76,720		2.55	%	2.86	%	20.6	%
Total agency RMBS	$	3,758,181	$	3,793,080	$	3,602,606	3.67	%	2.82	%	8.4	%

————————

⁽¹⁾  Our HARP securities had a weighted average LTV of 123% and 128% for 15-year and 30-year securities, respectively, as of December 31, 2017. Includes $355.0 million of >105% LTV pools which are not deliverable into TBA securities.

⁽²⁾  Our lower loan balance securities had a weighted average original loan balance of $98,996 and $106,244 for 15-year and 30-year securities, respectively, as of December 31, 2017.

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TBA Investments

Our TBA positions are recorded as derivative instruments in our accompanying consolidated financial statements, with the TBA dollar roll transactions representing a form of off-balance sheet financing. As of June 30, 2018, our net long TBA position had a notional market value of $1.7 billion and a net carrying value of $9.8 million reported in derivative assets on our consolidated balance sheets.

The following tables summarize our net long and (short) TBA positions as of June 30, 2018 and December 31, 2017 (dollars in thousands):

	June 30, 2018
	Notional Amount (1)		Cost Basis (2)		Notional Market Value (3)		Net Carrying Value (4)
15- Year
2.5%	$	41,000	$	39,636	$	39,856	$	220
3.0%	168,723		166,486		167,488		1,002
3.5%	46,570		46,958		47,096		138
Subtotal	256,293		253,080		254,440		1,360
30-Year
3.0%	470,660		452,423		455,654		3,231
3.5%	513,906		508,042		511,064		3,022
4.0%	423,909		429,817		431,765		1,948
4.5%	51,846		53,669		53,931		262
Subtotal	1,460,321		1,443,951		1,452,414		8,463
Portfolio total	$	1,716,614	$	1,697,031	$	1,706,854	$	9,823

	December 31, 2017
	Notional Amount (1)			Cost Basis (2)			Notional Market Value (3)			Net Carrying Value (4)
15- Year
2.5%	$	152,500		$	152,342		$	152,135		$	(207	)
3.0%	164,329			167,678			167,266			(412		)
3.5%	(1,200		)	(1,240		)	(1,239		)	1
Subtotal	315,629			318,780			318,162			(618		)
30-Year
3.0%	525,660			523,815			525,057			1,242
3.5%	659,506			675,182			676,598			1,416
4.0%	181,745			190,334			190,093			(241		)
4.5%	21,846			23,290			23,242			(48		)
Subtotal	1,388,757			1,412,621			1,414,990			2,369
Portfolio total	$	1,704,386		$	1,731,401		$	1,733,152		$	1,751

————————

⁽¹⁾  Notional amount represents the par value or principal balance of the underlying agency RMBS.

⁽²⁾  Cost basis represents the forward price to be paid for the underlying agency RMBS.

⁽³⁾  Notional market value represents the current market value of the agency RMBS underlying the TBA contracts as of period end.

⁽⁴⁾  Net carrying value represents the difference between the market value of the TBA contract as of period end and the cost basis and is reported in derivative assets / (liabilities), at fair value in our consolidated balance sheets.

37

Non-Agency Investments

Non-agency security yields are based on our estimates of the timing and amount of future cash flows and our amortized cost basis. Our cash flow estimates for these investments are based on our observations of current information and events and include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses and other factors.

The following tables summarize our non-agency securities portfolio as of June 30, 2018 and December 31, 2017 (dollars in thousands):

June 30, 2018
	Fair   Value		Gross Unrealized					Amortized Cost		Premium (Discount)			Par/ Current Face		Weighted Average
Category			Gains		Losses										Coupon (1)		Yield
Prime	$	117,059	$	8,487	$	(169	)	$	108,741	$	(11,683	)	$	120,424	3.94	%	6.07	%
CRT	267,402		15,137		(225		)	252,490		10,614			241,876		5.66	%	5.90	%
Alt-A	243,683		46,950		(578		)	197,311		(103,153		)	300,464		3.20	%	9.71	%
Option-ARM	82,061		12,810		—			69,251		(19,613		)	88,864		2.34	%	6.98	%
Subprime	13,309		826		—			12,483		(645		)	13,128		5.20	%	5.93	%
CMBS	16,446		141		(41		)	16,346		(139		)	16,485		5.68	%	6.09	%
Total	$	739,960	$	84,351	$	(1,013	)	$	656,622	$	(124,619	)	$	781,241	4.09	%	7.19	%

————————

⁽¹⁾ Coupon rates are floating, except for $11.0 million, $5.6 million, $11.8 million, $13.3 million, $16.4 million fair value of fixed-rate prime, CRT, Alt-A, subprime and CMBS non-agency securities, respectively, as of June 30, 2018.

December 31, 2017
	Fair   Value		Gross Unrealized					Amortized Cost		Discount			Par/ Current Face		Weighted Average
Category			Gains		Losses										Coupon (1)		Yield
Prime	$	143,329	$	9,342	$	(12	)	$	133,999	$	(13,893	)	$	147,892	3.77	%	5.66	%
CRT	322,819		18,346		—			304,473		16,011			288,462		5.34	%	5.23	%
Alt-A	286,953		51,123		(774		)	236,604		(112,305		)	348,909		2.69	%	8.93	%
Option-ARM	86,886		13,114		—			73,772		(21,044		)	94,816		1.79	%	6.58	%
Subprime	13,374		929		—			12,445		(683		)	13,128		5.20	%	5.97	%
CMBS	18,723		387		—			18,336		(164		)	18,500		5.68	%	6.03	%
Total	$	872,084	$	93,241	$	(786	)	$	779,629	$	(132,078	)	$	911,707	3.73	%	6.59	%

————————

⁽¹⁾   Coupon rates are floating, except for $11.8 million, $0.9 million,$12.2 million, $13.4 million and $18.7 million fair value of fixed-rate prime, CRT, Alt-A, subprime and CMBS non-agency securities, respectively, as of December 31, 2017.

The following table summarizes our non-agency securities by their estimated weighted average life classifications as of June 30, 2018 and December 31, 2017 (dollars in thousands): 

	June 30, 2018								December 31, 2017
					Weighted Average								Weighted Average
Estimated Weighted Average Life	Fair Value		Amortized Cost		Coupon		Yield		Fair Value		Amortized Cost		Coupon		Yield
≤ 5 years	$	224,275	$	189,555	3.68	%	9.01	%	$	302,797	$	258,501	3.11	%	8.31	%
> 5 to ≤ 7 years	304,848		266,186		4.35	%	7.28	%	398,712		361,649		4.33	%	5.97	%
> 7 years	210,837		200,881		4.21	%	5.37	%	170,575		159,479		3.61	%	5.18	%
Total	$	739,960	$	656,622	4.09	%	7.19	%	$	872,084	$	779,629	3.73	%	6.59	%

38

Our non-agency securities are subject to risk of loss of principal and interest payments. As of June 30, 2018, our non-agency securities were generally either assigned below investment grade ratings by rating agencies or were not rated. The following table summarizes the credit ratings of our non-agency securities as of June 30, 2018 and December 31, 2017:

	June 30, 2018		December 31, 2017
Credit Rating (1)
AA	1	%	1	%
A	3	%	1	%
BBB	11	%	7	%
BB	17	%	14	%
B	12	%	17	%
Below B	24	%	30	%
Not Rated	32	%	30	%
Total	100	%	100	%

————————

⁽¹⁾ Represents the lowest of Standard and Poor's, Moody's and Fitch credit ratings, stated in terms of the S&P equivalent, as of each respective balance sheet date.

The following tables present the fair value and weighted average purchase price for each of our non-agency securities categories, together with certain of their respective underlying loan collateral attributes and current performance metrics as of June 30, 2018 and December 31, 2017 (fair value dollars in thousands):

June 30, 2018
	Fair   Value		Weighted Average Purchase Price		Weighted Average Collateral Attributes				Weighted Average Current Performance
Category					Loan Age (months)	Original LTV		Original FICO (1)	60+ Day Delinquent (2)		3-Month CPR (3)
Prime	$	117,059	$	84.80	140	71	%	738	7	%	21	%
CRT	267,402		100.39		29	78	%	751	—	%	9	%
Alt-A	243,683		64.19		150	76	%	707	12	%	18	%
Option-ARM	82,061		71.98		144	76	%	704	13	%	13	%
Subprime	13,309		93.28		159	77	%	603	15	%	11	%
CMBS	16,446		98.92		19	55	%	NA	—	%	—	%
Total	$	739,960	$	81.90	101	76	%	710	7	%	14	%

39

December 31, 2017
	Fair   Value		Weighted Average Purchase Price		Weighted Average Collateral Attributes				Weighted Average Current Performance
Category					Loan Age (months)	Original LTV		Original FICO (1)	60+ Day Delinquent (2)		3-Month CPR (3)
Prime	$	143,329	$	85.51	136	71	%	738	8	%	18	%
CRT	322,819		101.63		32	76	%	754	—	%	11	%
Alt-A	286,953		64.36		145	76	%	708	12	%	15	%
Option-ARM	86,886		71.96		139	76	%	704	15	%	11	%
Subprime	13,374		93.28		153	77	%	604	18	%	12	%
CMBS	18,723		98.92		14	55	%	NA	—	%	—	%
Total	$	872,084	$	83.06	98	75	%	713	7	%	13	%

————————

⁽¹⁾ FICO represents a mortgage industry accepted credit score of a borrower based on a scale of 300 to 850 with a score of 850 being the highest quality rating.

⁽²⁾  60+ day delinquent represents the percentage of mortgage loans underlying each category of non-agency securities that were delinquent for at least 60 days.

⁽³⁾  Three-month CPR is reflective of the prepayment and default rate on the underlying securitization; however, it does not necessarily indicate the proceeds received on our non-agency securities. Proceeds received for each security are dependent on the position of the individual security within the structure of each deal.    

The mortgage loans underlying our non-agency securities are located throughout the United States. The following table presents the six states with the largest geographic concentrations of underlying mortgages as of June 30, 2018 and December 31, 2017:

	June 30, 2018		December 31, 2017
California	33	%	34	%
Florida	7	%	7	%
New York	5	%	4	%
Virginia	4	%	5	%
Texas	4	%	3	%
Maryland	4	%	4	%
Total	57	%	57	%

Investments in Real Property

As of June 30, 2018, CHI had real estate investments net of accumulated depreciation of $304.7 million which are financed through secured debt. As of June 30, 2018, CHI had fixed rate debt with a principal amount of $179.9 million, a weighted average maturity of 27.4 years and a weighted average interest rate of 3.91% and floating rate debt with a principal amount of $25.8 million, a weighted average maturity of 1.3 years and a weighted average interest rate of 5.13%.

40

Securities Financing and Hedging

As of June 30, 2018 and December 31, 2017, our borrowings under repurchase agreements had the following characteristics (dollars in thousands):

	June 30, 2018					December 31, 2017
			Weighted Average					Weighted Average
Collateral Type	Borrowings Outstanding		Interest Rate		Days to Maturity	Borrowings Outstanding		Interest Rate		Days to Maturity
Agency securities	$	3,053,483	2.10	%	85	$	3,307,662	1.54	%	114
Non-agency securities	504,420		3.15	%	18	556,057		2.72	%	24
U.S. Treasury securities	2,370		2.10	%	2	—		N/A		N/A
Total repurchase agreements	$	3,560,273	2.25	%	75	$	3,863,719	1.71	%	101

The following table summarizes our borrowings under repurchase arrangements as of June 30, 2018 and December 31, 2017 (dollars in thousands):

	June 30, 2018					December 31, 2017
			Weighted Average					Weighted Average
	Borrowings Outstanding		Interest Rate		Days to Maturity	Borrowings Outstanding		Interest Rate		Days to Maturity
≤ 1 month	$	1,470,714	2.43	%	17	$	1,341,712	1.91	%	17
> 1 to ≤ 2 months	953,784		2.10	%	40	1,334,493		1.55	%	40
> 2 to ≤ 3 months	784,686		1.95	%	76	295,204		1.76	%	76
> 3 to ≤ 6 months	—		N/A		N/A	334,372		1.51	%	123
> 6 to ≤ 12 months	86,089		2.04	%	210	292,938		1.57	%	256
> 12 months	265,000		2.79	%	477	265,000		1.80	%	658
Total repurchase agreements	$	3,560,273	2.25	%	75	$	3,863,719	1.71	%	101

The following table summarizes our interest rate swap agreements outstanding as of June 30, 2018 and December 31, 2017, (dollars in thousands):

Current Maturity Date	June 30, 2018							December 31, 2017
	Notional Amount		Weighted Average					Notional Amount		Weighted Average
			Fixed Pay Rate		Receive  Rate		Maturity (Years)			Fixed Pay Rate		Receive  Rate		Maturity (Years)
≤ 3 years	$	1,475,000	1.37	%	2.34	%	1.2	$	1,500,000	1.26	%	1.46	%	1.3
> 3 to ≤ 5 years	1,010,000		1.90	%	2.33	%	3.9	985,000		1.79	%	1.47	%	4.0
> 5 to ≤ 7 years	250,000		1.71	%	2.35	%	5.4	350,000		1.78	%	1.40	%	5.7
> 7 years	795,000		2.35	%	2.34	%	9.1	695,000		2.26	%	1.47	%	9.9
Total	$	3,530,000	1.77	%	2.34	%	4.0	$	3,530,000	1.65	%	1.46	%	4.2

41

The following tables present certain information about our interest rate swaption agreements as of June 30, 2018 and December 31, 2017 (dollars in thousands):

June 30, 2018
	Option					Underlying Swap
Current Option Expiration Date	Cost		Fair Value		Weighted Average Years to Expiration	Notional Amount		Pay Rate		Weighted Average Term (Years)
≤ 12 months	$	3,302	$	5,935	0.5	$	250,000	2.75	%	8.4
>12 to ≤ 24 months	2,562		3,120		1.3	100,000		2.85	%	8.8
> 24 months	7,051		4,984		3.1	150,000		2.90	%	8.5
Total / weighted average	$	12,915	$	14,039	1.4	$	500,000	2.81	%	8.5

December 31, 2017
	Option					Underlying Swap
Current Option Expiration Date	Cost		Fair Value		Weighted Average Years to Expiration	Notional Amount		Pay Rate		Weighted Average Term (Years)
< 12 months	$	2,111	$	1,621	0.9	$	175,000	2.71	%	8.6
>12 to ≤ 24 months	2,083		1,400		1.5	75,000		2.73	%	10.0
> 24 months	7,951		3,707		3.4	175,000		2.87	%	8.9
Total / weighted average	$	12,145	$	6,728	2.0	$	425,000	2.78	%	8.9

42

RESULTS OF OPERATIONS

The table below presents our consolidated statements of operations during the three and six months ended June 30, 2018 and 2017 (dollars in thousands, except per share amounts):

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Interest income:
Agency securities	$	26,873		$	22,010		$	54,384		$	39,911
Non-agency securities	11,725			13,478			23,719			29,174
Other	21			245			146			405
Interest expense	(19,482		)	(12,344		)	(36,535		)	(22,509		)
Net interest income	19,137			23,389			41,714			46,981
Healthcare real estate:
Healthcare real estate income	8,411			5,754			16,171			9,069
Healthcare real estate expense	(6,571		)	(4,373		)	(12,366		)	(7,026		)
Net healthcare investment income	1,840			1,381			3,805			2,043
Other gains (losses):
Realized loss on agency securities, net	(466		)	(489		)	(2,406		)	(701		)
Realized gain on non-agency securities, net	5,543			14,481			9,697			27,195
Realized gain (loss) on periodic settlements of interest rate swaps, net	4,175			(2,281		)	4,533			(4,941		)
Realized gain on other derivatives and securities, net	6,844			4,745			9,580			6,912
Unrealized gain (loss) on agency securities, net	(21,341		)	9,146			(97,511		)	9,031
Unrealized gain (loss) on non-agency securities, net	(5,780		)	11,219			(9,117		)	24,233
Unrealized gain (loss) on other derivatives and securities, net	6,583			(11,718		)	40,040			(14,557		)
Servicing income	2			75			52			2,633
Servicing expense	(775		)	(1,915		)	(1,025		)	(6,900		)
Total other gains (losses), net	(5,215		)	23,263			(46,157		)	42,905
Expenses:
Management fees	3,585			3,488			6,974			6,864
General and administrative expenses	4,220			1,933			5,798			3,652
Total expenses	7,805			5,421			12,772			10,516
Net income (loss)	7,957			42,612			(13,410		)	81,413
Dividend on preferred stock	(1,117		)	(1,117		)	(2,234		)	(2,234		)
Noncontrolling interest in net loss (income)	4			7			9			5
Net income (loss) available to common stockholders	$	6,844		$	41,502		$	(15,635	)	$	79,184
Net income (loss) per common share — basic and diluted	$	0.15		$	0.91		$	(0.34	)	$	1.73
Weighted average common shares — basic	45,816			45,803			45,813			45,800
Weighted average common shares — diluted	45,818			45,804			45,815			45,802
Dividend declared per common share	$	0.50		$	0.45		$	1.00		$	0.90

43

Interest Income and Asset Yields

The tables below present the interest income and weighted average yield for our agency and non-agency securities during the three and six months ended June 30, 2018 and 2017 (dollars in thousands):

	For the Three Months Ended June 30,
	2018						2017
	Average Amortized Cost		Weighted Average Yield		Interest Income		Average Amortized Cost		Weighted Average Yield		Interest Income
Agency RMBS (1)	$	3,687,738	2.91	%	$	26,873	$	3,310,019	2.66	%	$	22,010
Non-agency securities	678,136		6.92	%	11,725		849,488		6.35	%	13,478
Total	$	4,365,874	3.54	%	$	38,598	$	4,159,507	3.40	%	$	35,488

	For the Six Months Ended June 30,
	2018						2017
	Average Amortized Cost		Weighted Average Yield		Interest Income		Average Amortized Cost		Weighted Average Yield		Interest Income
Agency RMBS (1)	$	3,678,746	2.96	%	$	54,384	$	3,036,759	2.63	%	$	39,911
Non-agency securities	709,269		6.69	%	23,719		929,983		6.27	%	29,174
Total	$	4,388,015	3.56	%	$	78,103	$	3,966,742	3.48	%	$	69,085

—————— 

⁽¹⁾   Does not include TBA dollar roll income reported in realized gain (loss) on other derivatives and securities, net in our consolidated statements of operations.

The following is a summary of the estimated impact of changes in the principal elements of interest income during the three and six months ended June 30, 2018 and 2017 (in thousands):

	For the Three Months Ended June 30, 2018 vs. 2017								For the Six Months Ended June 30, 2018 vs. 2017
	Increase / (Decrease)			Due to Change in Average (1)					Increase / (Decrease)			Due to Change in Average (1)
				Volume			Yield					Volume			Yield
Agency RMBS	$	4,863		$	2,667		$	2,196	$	14,473		$	9,082		$	5,391
Non-agency securities	(1,753		)	(3,159		)	1,406		(5,455		)	(7,600		)	2,145
Total	$	3,110		$	(492	)	$	3,602	$	9,018		$	1,482		$	7,536

—————— 

⁽¹⁾   Variances that are the combined effect of volume and yield, but cannot be separately identified, are allocated to the volume and yield variances based on their respective relative amounts.

Interest income on agency RMBS increased by $4.9 million during the three months ended June 30, 2018 compared to the three months ended June 30, 2017, due to a 25 basis point increase in average yields combined with a 11% increase in average balances. Interest income on agency RMBS increased by $14.5 million during the six months ended June 30, 2018 compared to the six months ended June 30, 2017, due to a 33 basis point increase in average yields combined with a 21% increase in average balances. Interest income on non-agency securities decreased by $(1.8) million during the three months ended June 30, 2018 compared to the three months ended June 30, 2017, due to a 20% decrease in average balances related to net sales activity, partially offset by a 57 basis point increase in average yields. Interest income on non-agency securities decreased by $(5.5) million during the six months ended June 30, 2018 compared to the six months ended June 30, 2017, due to a 24% decrease in average balances related to net sales activity, partially offset by a 42 basis point increase in average yields.

We amortize or accrete premiums and discounts associated with agency RMBS and non-agency securities of high credit quality into interest income over the life of such securities using the effective yield method. The effective yield (or asset yield) on these securities is based on actual CPRs realized for individual securities in our investment portfolio through the reporting

44

date and assumes a CPR over the remaining projected life of our aggregate investment portfolio. We estimate projected CPRs on these securities using a third-party service and market data. We update our estimates on at least a quarterly basis, and more frequently when economic or market conditions warrant. The effective yield on these securities is adjusted retrospectively for differences between actual and projected CPR estimates or for changes in our projected CPR estimates. Our projected CPR estimate for our agency RMBS was 7.2% and 8.4% as of June 30, 2018 and December 31, 2017, respectively. The actual CPR realized for individual agency RMBS in our investment portfolio was approximately 9.2% for both the three months ended June 30, 2018 and 2017 and 9.0% and 9.2% for the six months ended June 30, 2018 and 2017, respectively.

Interest income from our agency RMBS is net of premium amortization expense of $5.3 million and $6.6 million for the three months ended June 30, 2018 and 2017, respectively, and $9.8 million and $12.1 million for the six months ended June 30, 2018 and 2017, respectively. The change in our weighted average CPR estimates resulted in the recognition of “catch up” premium amortization benefit (expense) of approximately $0.7 million and $(0.7) million for the three months ended June 30, 2018 and 2017, respectively, and $2.3 million and $(1.4) million for the six months ended June 30, 2018 and 2017, respectively. The amortized cost basis of our agency RMBS portfolio was 105.1% and 105.3% of par value as of June 30, 2018 and December 31, 2017, respectively. The net unamortized premium balance of our aggregate agency RMBS portfolio was $176.5 million and $190.5 million as of June 30, 2018 and December 31, 2017, respectively.

At the time we purchase non-agency securities that are not of high credit quality, we determine an effective yield based on our estimate of the timing and amount of future cash flows and our cost basis. On at least a quarterly basis, we review the estimated cash flows and make appropriate adjustments with any changes in effective yield recognized prospectively based on the current amortized cost of the investment as adjusted for credit impairment, if any. Our estimates of future cash flows are based on input and analysis received from external sources, internal models and judgment about interest rates, prepayment rates, the timing and amount of credit losses and other factors. Interest income from our non-agency securities includes discount accretion of $3.6 million and $5.1 million for the three months ended June 30, 2018 and 2017, respectively, and $7.4 million and $11.9 million for the six months ended June 30, 2018 and 2017, respectively. The weighted average cost basis of the non-agency portfolio was 84.0% and 85.5% of par as of June 30, 2018 and December 31, 2017, respectively. The total net discount remaining was $124.6 million and $132.1 million, with $80.3 million and $85.1 million designated as credit reserves as of June 30, 2018 and December 31, 2017, respectively.

Leverage

Our leverage, when adjusted for the net payables and receivables for unsettled securities and our net TBA position, was 6.2x our stockholders' equity, excluding investments in RCS and real property as of both June 30, 2018 and December 31, 2017. Our leverage will vary from time to time based on various factors, including our Manager’s opinion of the level of risk of our assets and liabilities, our view of the attractiveness of the return environment, composition of our investment portfolio, our liquidity position, our level of unused borrowing capacity, over-collateralization levels required by lenders when we pledge securities to secure our borrowings and the current market value of our investment portfolio. In addition, certain of our master repurchase agreements and master swap agreements contain a restriction that prohibits our leverage from exceeding certain levels. We do not expect these restrictions to adversely impact our operations.

The table below presents our mortgage securities funding balances outstanding and average leverage ratios for the quarterly periods since June 30, 2016 (dollars in thousands):

	Repurchase Agreements and Advances (1)						Average Interest Rate as of Period End (1)		Average Leverage During the Period (2)	Leverage as of Period End (3)	Adjusted Leverage as of Period End (4)
Quarter Ended	Average Daily Amount Outstanding		Maximum Daily Amount Outstanding		Ending Amount Outstanding
June 30, 2018	$	3,651,320	$	3,816,636	$	3,560,273	2.25	%	4.3x	4.2x	6.2x
March 31, 2018	$	3,717,094	$	3,883,304	$	3,743,436	1.96	%	4.2x	4.4x	6.2x
December 31, 2017	$	3,784,846	$	3,873,054	$	3,863,719	1.71	%	4.2x	4.2x	6.2x
September 30, 2017	$	3,650,206	$	3,893,263	$	3,807,880	1.58	%	4.1x	4.2x	6.3x
June 30, 2017	$	3,538,006	$	3,836,940	$	3,805,778	1.47	%	4.0x	4.4x	6.3x
March 31, 2017	$	3,117,397	$	3,272,548	$	3,185,134	1.31	%	3.5x	3.6x	5.9x
December 31, 2016	$	3,677,854	$	3,554,251	$	3,244,516	1.26	%	3.8x	3.7x	4.8x
September 30, 2016	$	3,682,233	$	3,781,117	$	3,553,666	1.11	%	4.0x	3.7x	5.0x
June 30, 2016	$	3,692,354	$	4,306,868	$	3,555,883	1.04	%	4.2x	4.5x	4.9x

————————

⁽¹⁾  Excludes repurchase agreements collateralized by U.S. Treasury securities and borrowings related to our healthcare investments.

45

⁽²⁾  Average leverage during the period was calculated by dividing our daily weighted average agency and non-agency financing balance by our average month-end stockholders’ equity for the period, less investments in RCS and healthcare real estate.

⁽³⁾  Leverage as of period end was calculated by dividing the amount outstanding under our agency and non-agency financing agreements and net payables and receivables for unsettled agency and non-agency securities by our total stockholders' equity at period end, less our investments in RCS and healthcare real estate.

⁽⁴⁾  Adjusted leverage as of period end was calculated by dividing the sum of the amounts outstanding under our agency and non-agency financing agreements, the cost basis (or contract price) of our net TBA position, and net payables and receivables for unsettled agency and non-agency securities by our total stockholders’ equity at period end, less our investments in RCS and healthcare real estate.

Adjusted leverage presented in the table above includes the impact of TBA positions, which have the effect of increasing or decreasing our “at risk” leverage. A net long position increases our at risk leverage, while a net short position reduces our at risk leverage. As of June 30, 2018, we had a net long TBA position with a notional market value and underlying costs basis of $1.7 billion.

Interest Expense and Cost of Funds

Interest expense on our mortgage securities portfolio of $19.5 million and $12.3 million for the three months ended June 30, 2018 and 2017, respectively, and $36.5 million and $22.5 million for the six months ended June 30, 2018 and 2017, respectively was comprised primarily of interest expense on our repurchase agreements. We recognized a benefit from net periodic interest settlements related to our interest rate swaps of $4.2 million and $4.5 million for the three and six months ended June 30, 2018, respectively, and an expense of $2.3 million and $4.9 million for the three and six months ended June 30, 2017, respectively, which is included in realized gain (loss) on periodic settlements of interest rate swaps, net, on our consolidated statements of operations.

The tables below present our adjusted cost of funds on our mortgage securities portfolio during the three and six months ended June 30, 2018 and 2017 (dollars in thousands):

	For the Three Months Ended June 30,
	2018						2017
	Average Balance / Effective Notional		Rate	Adjusted Cost of Funds (1)			Average Balance / Effective Notional		Rate	Adjusted Cost of Funds (1)
Repurchase agreements	$	3,651,320	2.14%	$	19,482		$	3,538,006	1.40%	$	12,344
Interest rate swaps	3,492,500		(0.48)%	(4,175		)	3,148,750		0.29%	2,281
Total adjusted cost of funds			1.68%	$	15,307				1.65%	$	14,625

	For the Six Months Ended June 30,
	2018						2017
	Average Balance / Effective Notional		Rate	Adjusted Cost of Funds (1)			Average Balance / Effective Notional		Rate	Adjusted Cost of Funds (1)
Repurchase agreements	$	3,684,025	2.00%	$	36,535		$	3,328,863	1.36%	$	22,509
Interest rate swaps	3,420,000		(0.27)%	(4,533		)	3,024,286		0.33%	4,941
Total adjusted cost of funds			1.75%	$	32,002				1.66%	$	27,450

————————

⁽¹⁾  Our adjusted cost of funds excludes any impacts from other supplemental hedges such as U.S. Treasury securities and swaptions, and the implied financing cost or benefit of our net TBA dollar roll position reported in gain (loss) on other derivatives and securities, net in our consolidated statements of operations.

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The following is a summary of the impact of changes in the principal elements of our adjusted cost of funds during the three and six months ended June 30, 2018 and 2017 (in thousands):

	For the Three Months Ended June 30, 2018 vs. 2017									For the Six Months Ended June 30, 2018 vs. 2017
	Increase / (Decrease)			Due to Change in Average (1)						Increase / (Decrease)			Due to Change in Average (1)
				Volume			Rate						Volume			Rate
Repurchase agreements	$	7,138		$	408		$	6,730		$	14,026		$	2,593		$	11,433
Interest rate swaps	(6,456		)	(3,066		)	(3,390		)	(9,474		)	(1,658		)	(7,816		)
Total adjusted cost of funds	$	682		$	(2,658	)	$	3,340		$	4,552		$	935		$	3,617

—————— 

⁽¹⁾   Variances that are the combined effect of volume and yield, but cannot be separately identified, are allocated to the volume and yield variances based on their respective relative amounts.

The increase in our adjusted cost of funds on our mortgage securities portfolio of $0.7 million for the three months ended June 30, 2018 compared to 2017 and $4.6 million for the six months ended June 30, 2018 compared to 2017, respectively, was primarily attributable to higher average rates on our repurchase agreements, largely offset by improved average net pay/receive rates on our interest rate swaps.

Healthcare Real Estate Income and Expense

The following table presents the components of net income and expense from our healthcare real estate investments for the three and six months ended June 30, 2018 and 2017 (dollars in thousands):

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
	2018		2017		2018		2017
Lease income	$	5,707	$	4,615	$	11,413	$	6,868
Rental income	2,704		1,139		4,758		2,201
Healthcare real estate income	8,411		5,754		16,171		9,069
Interest expense	2,261		1,887		4,350		3,060
Depreciation	2,157		1,526		4,158		2,297
Tenant expenses	1,718		848		3,143		1,557
Other	435		112		715		112
Healthcare real estate expense	6,571		4,373		12,366		7,026
Net healthcare investment income	$	1,840	$	1,381	$	3,805	$	2,043

The increase in healthcare real estate income and expense amounts during 2018 compared to 2017 result from investment activity beginning in the second quarter of 2017.

47

Realized and Unrealized Gain (Loss) on Securities, Net

Sales of securities for the six months ended June 30, 2018 and 2017 were largely driven by rebalancing of our agency and non-agency securities portfolios. The changes in portfolio composition were based upon our Manager's expectations concerning interest rates, Federal government actions, general economic conditions and other factors.

The following table is a summary of our net realized losses on agency RMBS during the three and six months ended June 30, 2018 and 2017 (dollars in thousands):

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Proceeds from agency securities sold	$	31,206		$	101,270		$	251,641		$	309,727
Less agency securities sold, at cost	(31,672		)	(101,759		)	(254,047		)	(310,428		)
Realized loss on agency securities, net	$	(466	)	$	(489	)	$	(2,406	)	$	(701	)
Gross realized gains on sale of agency securities	$	—		$	494		$	14		$	1,764
Gross realized losses on sale of agency securities	(466		)	(983		)	(2,420		)	(2,465		)
Realized loss on agency securities, net	$	(466	)	$	(489	)	$	(2,406	)	$	(701	)

The following table summarizes our net realized gains on non-agency securities incurred during the three and six months ended June 30, 2018 and 2017 (dollars in thousands):

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Proceeds from non-agency securities sold	$	85,594		$	180,394		$	175,495		$	440,867
Increase in receivable for securities sold	—			(629		)	—			5,119
Less: non-agency securities sold, at cost	(80,051		)	(165,284		)	(165,798		)	(418,791		)
Realized gain on non-agency securities, net	$	5,543		$	14,481		$	9,697		$	27,195
Gross realized gain on sale of non-agency securities	$	5,543		$	14,489		$	9,698		$	27,353
Gross realized loss on sale of non-agency securities	—			(8		)	(1		)	(158		)
Realized gain on non-agency securities, net	$	5,543		$	14,481		$	9,697		$	27,195

Unrealized net losses of $(21.3) million and $(97.5) million on agency RMBS for the three and six months ended June 30, 2018, respectively, were attributable mainly to the increase in interest rates described above in Trends and Recent Market Impacts, as well as the impact of realized gains and losses on sales of securities.

48

Gain (Loss) on Other Derivatives and Securities, Net

The following table is a summary of our realized and unrealized gain (loss) on other derivatives and securities, net, during the three and six months ended June 30, 2018 and 2017 (dollars in thousands): 

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Realized gain (loss) on periodic settlements of interest rate swaps, net	$	4,175		$	(2,281	)	$	4,533		$	(4,941	)
Realized gain on other derivatives and securities:
Interest rate swaps	$	11,303		$	(11,570	)	$	59,232		$	14,451
TBA securities	(4,109		)	31,177			(47,254		)	6,887
Short sales of U.S. Treasury securities	(370		)	(14,425		)	(759		)	(14,174		)
Credit default swaps	—			(470		)	(1,648		)	(513		)
Other, net	20			33			9			261
Total realized gain on other derivatives and securities, net	$	6,844		$	4,745		$	9,580		$	6,912
Unrealized gain (loss) on other derivatives and securities:
Interest rate swaps	$	1,407		$	2,081		$	3,527		$	(19,749	)
Interest rate swaptions	1,219			(135		)	6,541			(563		)
TBA securities	113			(12,077		)	8,072			17,433
Short sales of U.S. Treasury securities	3,869			(1,861		)	20,372			(11,502		)
Credit default swaps	—			274			1,528			(183		)
Other, net	(25		)	—			—			7
Total unrealized gain (loss) on other derivatives and securities, net	$	6,583		$	(11,718	)	$	40,040		$	(14,557	)

Net gains on pay-fixed interest rate swaps, swaptions and short positions in U.S. Treasury securities during the three and six months ended June 30, 2018 were due primarily to increases in interest rates.

Net losses on TBA securities during the three and six months ended June 30, 2018 were due primarily due to increases in interest rates.  

For further details regarding our derivatives and related hedging activity please refer to Notes 3 and 8 to our consolidated financial statements in this Quarterly Report on Form 10-Q.

Management Fees and General and Administrative Expenses

We pay our Manager a management fee payable monthly in arrears in an amount equal to one twelfth of 1.50% of our month-end GAAP stockholders’ equity, adjusted to exclude the effect of any unrealized gains or losses included in retained earnings as computed in accordance with GAAP. There is no incentive compensation payable to our Manager pursuant to the management agreement. We incurred management fees of $3.6 million and $3.5 million for the three months ended June 30, 2018 and 2017, respectively, and $7.0 million and $6.9 million for the six months ended June 30, 2018 and 2017, respectively.

General and administrative expenses, primarily consisting of prime brokerage fees, information technology costs, research and data service fees, audit fees, Board of Directors fees and insurance expenses, were $4.2 million and $1.9 million for the three months ended June 30, 2018 and 2017, respectively, and $5.8 million and $3.7 million during the six months ended June 30, 2018 and 2017, respectively. General and administrative expenses during the three months ended June 30, 2018 include $2.6 million of merger transaction costs, primarily legal and investment banking fees.

Our management fees and general and administrative expenses as a percentage of our average stockholders’ equity on an annualized basis were 3.3% and 2.2% for the three months ended June 30, 2018 and 2017, respectively, and 2.6% and 2.2% for the six months ended June 30, 2018 and 2017, respectively.

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Dividends and Income Taxes

We had estimated taxable income available to common shareholders of $13.0 million and $6.3 million (or $0.28 and $0.14 per common share) for the three months ended June 30, 2018 and 2017, respectively, and $21.6 million and $11.6 million (or $0.47 and $0.25 per common share) for the six months ended June 30, 2018 and 2017, respectively.

The following is a reconciliation of our GAAP net income to our estimated taxable income during the three and six months ended June 30, 2018 and 2017 (dollars in thousands, except per share amounts).

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Net income (loss)	$	7,957		$	42,612		$	(13,410	)	$	81,413
Book to tax differences:
Unrealized (gains) and losses, net
Agency RMBS	21,341			(9,146		)	97,511			(9,031		)
Non-agency securities	5,780			(11,219		)	9,117			(24,233		)
Derivatives, MSR and other securities	(6,583		)	11,718			(40,040		)	14,557
Amortization / accretion	1,480			62			386			(1,112		)
Capital losses (gains) (1)	(2,743		)	(40,978		)	38,116			(27,262		)
Realized losses (gains), net (1)	(13,881		)	12,536			(68,833		)	(24,788		)
Taxable REIT subsidiary loss and other	773			1,840			973			4,267
Total book to tax difference	6,167			(35,187		)	37,230			(67,602		)
Estimated taxable income	14,124			7,425			23,820			13,811
Dividend on preferred stock	(1,117		)	(1,117		)	(2,234		)	(2,234		)
Estimated taxable income available to common stockholders	$	13,007		$	6,308		$	21,586		$	11,577
Weighted average common shares — basic	45,816			45,803			45,813			45,800
Weighted average common shares — diluted	45,818			45,804			45,815			45,802
Estimated taxable income per common share - basic and diluted	$	0.28		$	0.14		$	0.47		$	0.25
Ending cumulative (overdistribution) of estimated taxable income per common share	$	(2.14	)	$	(1.13	)	$	(2.14	)	$	(1.13	)
Beginning cumulative non-deductible capital losses	$	114,111		$	132,063		$	73,252		$	118,347
Current period net capital loss (gain)	(2,743		)	(40,978		)	38,116			(27,262		)
Ending cumulative non-deductible capital losses	$	111,368		$	91,085		$	111,368		$	91,085
Ending cumulative non-deductible capital losses per common share	$	2.43		$	1.99		$	2.43		$	1.99

—————— 

⁽¹⁾   Estimated taxable income excludes estimated net capital gain (losses) of 0.06 and $(0.83) per common share for the three and six months ended June 30, 2018, respectively, which decrease/increase our net capital loss carryforwards from prior periods.

We believe that providing investors with estimated taxable income and certain financial metrics derived from such non-GAAP financial information, in addition to the related GAAP measures, gives investors greater transparency to the information used by management in its financial and operational decision-making. In the case of estimated taxable income, we believe it is meaningful information as it is directly related to the amount of dividends we are required to distribute in order to maintain our REIT qualification status. However, because estimated taxable income is an incomplete measure of our financial performance and involves differences from net income computed in accordance with GAAP, this non-GAAP financial information should be considered supplementary to, and not a substitute for, our net income computed in accordance with GAAP as a measure of our financial performance. In addition, because not all companies use identical calculations, our presentation of estimated taxable income may not be comparable to other similarly-titled measures of other companies. Furthermore, estimated taxable income

50

can include certain information that is subject to potential adjustments up to the time of filing our income tax returns, which occurs after the end of our fiscal year.

We declared dividends of $0.50 and $0.45 for the three months ended June 30, 2018 and 2017, respectively, and $1.00 and $0.90 per common share for the six months ended June 30, 2018 and 2017, respectively. As of June 30, 2018, we have distributed all of our 2017 taxable income within the allowable time frame, including the available spill-back provision, so that we will not be subject to Federal or state corporate income tax for 2017.

RCS is taxable as a corporation under Subchapter C of the Internal Revenue Code, with which we filed a joint TRS election. As of June 30, 2018, RCS had Federal net operating loss (“NOL”) carryforwards of approximately $119 million. The utilization of approximately $50 million of the NOL is subject to limitations imposed by the Internal Revenue Code. RCS sold its MSR holdings during the first quarter of 2017 and incurred approximately $14 million of capital loss, which can be carried forward until December 31, 2022.

RCS’s gross deferred tax assets associated with the NOL and temporary differences, as reevaluated based on the new corporate tax rate and estimated state effective rate, were approximately $31 million, with respect to which RCS has provided a full valuation allowance.

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Key Statistics

The table below presents key statistics for the three and six months ended June 30, 2018 and 2017 (dollars in thousands, except per share amounts):

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Ending agency securities, at fair value	$	3,519,280		$	3,657,947		$	3,519,280		$	3,657,947
Ending agency securities, at cost	$	3,651,689		$	3,682,313		$	3,651,689		$	3,682,313
Ending agency securities, at par	$	3,475,222		$	3,508,139		$	3,475,222		$	3,508,139
Average agency securities, at cost	$	3,687,738		$	3,310,019		$	3,678,746		$	3,036,759
Average agency securities, at par	$	3,510,579		$	3,151,220		$	3,501,070		$	2,891,855
Ending non-agency securities, at fair value	$	739,960		$	884,986		$	739,960		$	884,986
Ending non-agency securities, at cost	$	656,622		$	805,648		$	656,622		$	805,648
Ending non-agency securities, at par	$	781,241		$	951,656		$	781,241		$	951,656
Average non-agency securities, at cost	$	678,136		$	849,488		$	709,269		$	929,983
Average non-agency securities, at par	$	805,169		$	989,287		$	837,727		$	1,080,241
Net TBA portfolio - as of period end, at fair value	$	1,706,854		$	1,646,019		$	1,706,854		$	1,646,019
Net TBA portfolio - as of period end, at cost	$	1,697,031		$	1,647,075		$	1,697,031		$	1,647,075
Average net TBA portfolio, at cost	$	1,643,365		$	1,743,154		$	1,717,258		$	1,556,024
Average total assets, at fair value	$	5,684,905		$	5,549,988		$	5,728,228		$	5,298,784
Average agency and non-agency repurchase agreements and advances	$	3,651,320		$	3,538,006		$	3,684,025		$	3,328,863
Average stockholders' equity	$	958,163		$	969,718		$	973,316		$	959,114
Average coupon	3.73		%	3.58		%	3.71		%	3.49		%
Average asset yield	3.54		%	3.40		%	3.56		%	3.48		%
Average asset yield excluding “catch-up” premium amortization	3.47		%	3.48		%	3.46		%	3.55		%
Average cost of funds (1)	1.68		%	1.65		%	1.75		%	1.66		%
Average net interest rate spread	1.86		%	1.75		%	1.81		%	1.82		%
Average net interest rate spread, excluding “catch-up” premium amortization	1.79		%	1.83		%	1.71		%	1.89		%
Average net interest rate spread, including TBA dollar roll, excluding “catch-up” premium amortization	1.73		%	1.96		%	1.68		%	2.00		%
Average coupon as of period end	3.73		%	3.57		%	3.73		%	3.57		%
Average asset yield as of period end	3.55		%	3.45		%	3.55		%	3.45		%
Average repurchase agreement/ FHLB funding rate as of period end	2.25		%	1.47		%	2.25		%	1.47		%
Effective swap net receive (pay) rate as of period end	0.61		%	(0.25		)%	0.61		%	(0.25		)%

52

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Average actual CPR for agency securities held during the period	9.2		%	9.2		%	9.0		%	9.2		%
Average projected life CPR for agency securities as of period end	7.2		%	8.8		%	7.2		%	8.8		%
Leverage - average during the period (2)	4.3x			4.0x			4.2x			3.8x
Leverage - average during the period, including net TBA position	6.2x			6.0x			6.2x			5.6x
Leverage - as of period end (3)	4.2x			4.4x			4.2x			4.4x
Leverage - as of period end, including net TBA position	6.2x			6.3x			6.2x			6.3x
Expenses % of average total assets - annualized	0.6		%	0.4		%	0.4		%	0.4		%
Expenses % of average stockholders' equity - annualized	3.3		%	2.2		%	2.6		%	2.2		%
Net asset value per common share as of period end	$	19.41		$	20.00		$	19.41		$	20.00
Dividends declared per common share	$	0.50		$	0.45		$	1.00		$	0.90
Economic return (loss) on common equity - annualized	3.1		%	18.4		%	(3.3		)%	18.1		%

————————

⁽¹⁾  Average cost of funds includes periodic settlements of interest rate swaps and excludes U.S. Treasury repurchase agreements and healthcare real estate financing.

⁽²⁾  Leverage during the period was calculated by dividing the Company's daily weighted average agency and non-agency financing agreements for the period by the Company's average month-ended stockholders' equity for the period less investments in RCS and healthcare real estate. Leverage excludes U.S. Treasury repurchase agreements.

⁽³⁾  Leverage at period end was calculated by dividing the sum of the amount outstanding under the Company's agency and non-agency financing agreements, and the net receivable/payable for unsettled securities at period end by the Company's stockholders' equity at period end less investments in RCS and healthcare real estate. Leverage excludes U.S. Treasury repurchase agreements.

Non-GAAP Financial Measures

In addition to the results presented in accordance with GAAP, the Company presents certain non-GAAP financial information, including the total notional fair value of its investment portfolio, “net spread and dollar roll income,” “net spread and dollar roll income, excluding ‘catch-up’ premium amortization,” “estimated taxable income” and the related per common share measures and certain financial metrics derived from such non-GAAP information, such as “cost of funds” and “net interest rate spread.”

“Net spread and dollar roll income” is measured as (i) net interest income (GAAP measure) adjusted to include other interest rate swap periodic costs and TBA dollar roll income, less (ii) total operating expenses (GAAP measure), adjusted to exclude non-recurring transaction costs. “Net spread and dollar roll income, excluding “catch-up” premium amortization,” further excludes retrospective “catch-up” adjustments to premium amortization cost or benefit due to changes in projected CPR estimates.

By providing users of the Company's financial information with such measures in addition to the related GAAP measures, the Company believes users will have greater transparency into the information used by the Company's management in its financial and operational decision-making. The Company also believes it is important for users of its financial information to consider information related to its current financial performance without the effects of certain measures that are not necessarily indicative of its current or expected investment portfolio performance and operations.

While TBAs are economically equivalent to holding and financing generic agency MBS using short-term repurchase agreements, they are accounted for under GAAP as derivative instruments with gains and losses recognized in other gain (loss) in the Company’s statements of operations. As such, the Company includes TBAs in the total notional fair value of its investment portfolio and TBA dollar roll income in “net spread and dollar roll income.” Similarly, the Company believes that the inclusion of periodic settlements on interest rate swaps, which are recognized under GAAP in other gain (loss), is meaningful as interest rate swaps are the primary instrument used to economically hedge against fluctuations in the Company’s borrowing costs. As such, the inclusion of periodic interest rate swap settlement costs is more indicative of the Company’s total cost of funds than interest expense alone. In the case of “net spread and dollar roll income, excluding ‘catch-up’ premium

53

amortization,” the Company believes the exclusion of “catch-up” adjustments to premium amortization cost or benefit is meaningful as it excludes the cumulative effect from prior reporting periods due to current changes in future prepayment expectations and, therefore, exclusion of such cost or benefit is more indicative of the current and expected earnings potential of the Company’s investment portfolio. In the case of estimated taxable income, the Company believes it is meaningful information as it is directly related to the amount of dividends the Company is required to distribute in order to maintain its REIT qualification status.

However, because such measures are incomplete measures of the Company's financial performance and involve differences from results computed in accordance with GAAP, they should be considered as supplementary to, and not as a substitute for, results computed in accordance with GAAP. In addition, because not all companies use identical calculations, the Company's presentation of such non-GAAP measures may not be comparable to similarly-titled measures of other companies. Furthermore, estimated taxable income can include certain information that is subject to potential adjustments up to the time of filing the Company's income tax returns, which occurs after the end of its fiscal year.

Net Spread and Dollar Roll Income

The table below presents a reconciliation from GAAP net interest income to net spread and dollar roll income, excluding “catch-up” premium amortization, available to common stockholders during the three and six months ended June 30, 2018 and 2017 (dollars in thousands, except per share amounts):

	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
Interest income:
Agency securities	$	26,873		$	22,010		$	54,384		$	39,911
Non-agency securities and other	11,746			13,723			23,865			29,579
Interest expense	(19,482		)	(12,344		)	(36,535		)	(22,509		)
Net interest income	19,137			23,389			41,714			46,981
Realized gain (loss) on periodic settlements of interest rate swaps, net	4,175			(2,281		)	4,533			(4,941		)
Dollar roll income	6,540			9,567			14,005			16,838
Adjusted net interest and dollar roll income	29,852			30,675			60,252			58,878
Operating expenses	(7,805		)	(5,421		)	(12,772		)	(10,516		)
Less: merger transaction costs	2,640			—			2,640			—
Net spread and dollar roll income	24,687			25,254			50,120			48,362
Dividend on preferred stock	(1,117		)	(1,117		)	(2,234		)	(2,234		)
Net spread and dollar roll income available to common stockholders	23,570			24,137			47,886			46,128
Estimated “catch-up” premium amortization cost due to change in CPR forecast	(703		)	736			(2,266		)	1,381
Net spread and dollar roll income, excluding “catch-up” premium amortization, available to common stockholders	$	22,867		$	24,873		$	45,620		$	47,509
Weighted average common shares — basic	45,816			45,803			45,813			45,800
Weighted average common shares — diluted	45,818			45,804			45,815			45,802
Net spread and dollar roll income per common share- basic and diluted	$	0.51		$	0.53		$	1.05		$	1.01
Net spread and dollar roll income, excluding “catch up” amortization per common share - basic and diluted	$	0.50		$	0.54		$	1.00		$	1.04

LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of funds are borrowings under master repurchase agreements, equity offerings, asset sales and monthly principal and interest payments on our investment portfolio. Because the level of our borrowings can be adjusted on a daily basis, the level of cash and cash equivalents carried on our balance sheets is significantly less important than the potential

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liquidity available under our borrowing arrangements. We currently believe that we have sufficient liquidity and capital resources available for the acquisition of additional investments, repayments on borrowings, maintenance of any margin requirements and the payment of cash dividends as required for our continued qualification as a REIT. To qualify as a REIT, we must distribute annually at least 90% of our taxable income. To the extent that we annually distribute all of our taxable income in a timely manner, we will generally not be subject to Federal and state income taxes. We currently expect to distribute all of our taxable income in a timely manner so that we are not subject to Federal and state income taxes. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital from operations.

Equity Capital

Common Stock Repurchase Program

Our Board of Directors adopted a stock repurchase plan under which, the Company is authorized to repurchase up to $100 million of its outstanding shares of common stock through December 31, 2018. The Company may repurchase shares in the open market or privately negotiated transactions or pursuant to a trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Act of 1934, as amended. As of June 30, 2018, the total remaining amount authorized by our Board of Directors for repurchases of our common stock was $100 million.

Shares of our common stock may be purchased in the open market, including through block purchases, or through privately negotiated transactions, or pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended. The timing, manner, price and amount of any repurchases will be determined at our discretion and the program may be suspended, terminated or modified at any time for any reason.

At-the-Market Offering Program

During August 2017, we entered into agreements with sales agents to publicly offer and sell shares of our common stock in privately negotiated and/or at-the-market transactions from time-to-time up to an aggregate amount of $125 million of shares of our common stock. As of June 30, 2018, we have not issued any shares under this program.

Debt Capital

Repurchase Agreements

As part of our investment strategy, we borrow against our agency and non-agency securities pursuant to master repurchase agreements. We expect that our borrowings pursuant to repurchase transactions under such master repurchase agreements generally will have maturities of less than one year. When adjusted for net payables and receivables for unsettled agency and non-agency securities, our leverage ratio was 4.2x the amount of our stockholders’ equity less our investments in RCS and real property as of both June 30, 2018 and December 31, 2017, respectively.

To limit our exposure to counterparty credit risk, we diversify our funding across multiple counterparties and by counterparty region. We had repurchase agreements with 36 financial institutions as of June 30, 2018, located throughout North America, Europe and Asia. In addition, less than 4% of our equity was at risk with any one repurchase agreement counterparty, with the top five counterparties representing approximately 16% of our equity at risk as of June 30, 2018.

As of June 30, 2018, borrowings under repurchase agreements of $3.1 billion and $0.5 billion, with weighted average remaining days to maturity of 85 days and 18 days, were secured by agency and non-agency securities, respectively.

The table below includes a summary of our repurchase agreement funding and number of counterparties by region as of June 30, 2018. Please refer to Note 7 to our consolidated financial statements in this Quarterly Report on Form 10-Q for further details regarding our borrowings under repurchase agreements and weighted average interest rates as of June 30, 2018.

	June 30, 2018
Counterparty Region	Number of Counterparties	Percentage of Repurchase Agreement Funding
North America	20	69%
Asia	5	9%
Europe	11	22%
Total	36	100%

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Amounts available to be borrowed under our repurchase agreements are dependent upon lender collateral requirements and the lender's determination of the fair value of the securities pledged as collateral, based on recognized pricing sources agreed to by both parties to the agreement. Collateral fair value can fluctuate with changes in interest rates, credit quality and liquidity conditions within the investment banking, mortgage finance and real estate industries. Our counterparties also apply a “haircut” to the fair value of our pledged collateral, which reflects the underlying risk of the specific collateral and protects our counterparties against a decrease in collateral value, but conversely subjects us to counterparty risk and limits the amount we can borrow against our investment securities. Our master repurchase agreements do not specify the haircut, rather haircuts are determined on an individual repurchase transaction basis. Haircuts on our pledged collateral remain stable and, as of June 30, 2018, our weighted average haircut on agency and non-agency securities held as collateral were approximately 5% and 24%, respectively.

We may be required to pledge additional assets to repurchase agreement counterparties in the event the estimated fair value of the existing pledged collateral under such agreements declines and such counterparties demand additional collateral (a margin call), which may take the form of additional securities or cash. Specifically, margin calls would result from a decline in the value of our securities securing our repurchase agreements and prepayments on the mortgages securing such securities. Similarly, if the estimated fair value of our investment securities increases due to changes in interest rates or other factors, counterparties may release collateral back to us. Our repurchase agreements generally provide that the valuations for the securities securing our repurchase agreements are to be obtained from a generally recognized source agreed to by the parties. However, in certain circumstances our lenders have the sole discretion to determine the value of the securities securing our repurchase agreements. In such instances, our lenders are required to act in good faith in making determinations of value. Our repurchase agreements generally provide that in the event of a margin call we must provide additional securities or cash on the same business day that a margin call is made if the lender provides us notice prior to the margin notice deadline on such day.

As of June 30, 2018, we had met all margin requirements and had unrestricted cash and cash equivalents of $124.0 million and unpledged securities of approximately $285.5 million available to meet margin calls on our repurchase agreements and derivative instruments as of June 30, 2018.

Although we believe that we will have adequate sources of liquidity available to us through repurchase agreement financing to execute our business strategy, there can be no assurances that repurchase agreement financing will be available to us upon the maturity of our current repurchase agreements to allow us to renew or replace our repurchase agreement financing on favorable terms or at all. If our repurchase agreement lenders default on their obligations to resell the underlying securities back to us at the end of the term, we could incur a loss equal to the difference between the value of the securities and the cash we originally received.

We maintain an interest rate risk management strategy under which we use derivative financial instruments to help manage the adverse impact of interest rate changes on the value of our investment portfolio as well as our cash flows. In particular, we attempt to mitigate the risk of the cost of our short-term variable rate liabilities increasing at a faster rate than the earnings of our long-term assets during a period of rising interest rates. The principal derivative instruments that we use are interest rate swaps, swaptions and short Treasury positions. We may also supplement our hedge portfolio with the use of TBA positions and other instruments.

See Notes 3 and 8 to our consolidated financial statements in this Quarterly Report on Form 10-Q for further details regarding our outstanding interest rate swaps as of June 30, 2018 and the related activity for the six months ended June 30, 2018.

Our derivative agreements typically require that we pledge/receive collateral on such agreements to/from our counterparties in a similar manner as we are required to under our repurchase agreements. Our counterparties, or the clearing exchange in the case of our centrally cleared interest rate swaps, typically have the sole discretion to determine the value of the derivative instruments and the value of the collateral securing such instruments. In the event of a margin call, we must generally provide additional collateral on the same business day.

Similar to repurchase agreements, our use of derivatives exposes us to counterparty credit risk relating to potential losses that could be recognized in the event that the counterparties to these instruments fail to perform their obligations under the contracts. We minimize this risk by limiting our counterparties to major financial institutions with acceptable credit ratings, by maintaining collateral sufficient to cover the change in market value, and by monitoring positions with individual counterparties.

We did not have an amount at risk with any counterparty related to our non-centrally cleared interest rate swap and swaption agreements greater than 1% of our stockholders’ equity as of both June 30, 2018 and December 31, 2017.

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In the case of centrally cleared interest rate swap contracts, we could be exposed to credit risk if the central clearing agency or a clearing member defaults on its respective obligation to perform under the contract; however, the risk is considered minimal due to initial and daily exchange of mark to market margin requirements and the clearinghouse guarantee fund and other resources that are available in the event of a clearing member default.

Notes Payable

CHI finances its acquisition of healthcare related real estate investments primarily through the use of secured mortgage debt.

TBA Dollar Roll Transactions

We enter into TBA dollar roll transactions as a means of acquiring (long TBAs) or selling (short TBAs) agency RMBS in

our investment portfolio. TBA dollar roll transactions represent a form of off-balance sheet financing and are accounted for as derivative instruments in our accompanying consolidated financial statements in this Quarterly Report on Form 10-Q. Inclusive of our net TBA position as of June 30, 2018, our total “at risk” leverage, net of unsettled securities, was 6.2x our stockholders' equity.

Under certain market conditions, it may be uneconomical for us to roll our TBA contracts to future months and we may take physical delivery of the underlying securities. If we take physical delivery of a long TBA contract, we would have to fund the total purchase commitment with cash or other financing sources and our liquidity position could be negatively impacted. As of June 30, 2018, we had a net long TBA position with a cost basis and fair value of the underlying securities of $1.7 billion.

Our TBA dollar roll contracts are also subject to margin requirements governed by the Mortgage-Backed Securities Division (“MBSD”) of the Fixed Income Clearing Corporation and by our prime brokerage agreements, which may establish margin levels in excess of the MBSD. Such provisions require that we establish an initial margin based on the notional value of the TBA contract, which is subject to increase if the estimated fair value of our TBA contract or the estimated fair value of our pledged collateral declines. The MBSD has the sole discretion to determine the value of our TBA contracts and of the collateral pledged securing such contracts. In the event of a margin call, we must generally provide additional collateral on the same business day.

Settlement of our net long TBA obligations by taking delivery of the underlying securities as well as satisfying margin requirements could negatively impact our liquidity position. However, since we do not use TBA dollar roll transactions as our primary source of financing, we believe that we will have adequate sources of liquidity to meet such obligations.

Asset Sales and TBA Eligible Securities

We maintain a portfolio of highly liquid agency RMBS. We may sell our agency RMBS through the TBA market by delivering securities into TBA contracts for the sale of securities, subject to “good delivery” provisions promulgated by the Securities Industry and Financial Markets Association (“SIFMA”). We may also sell agency RMBS that have more unique attributes on a specified basis when such securities trade at a premium over generic TBA securities or if the securities are not otherwise eligible for TBA delivery. Since the agency TBA market is the second most liquid market (second to the U.S. Treasury market), maintaining a significant level of agency RMBS eligible for TBA delivery enhances our liquidity profile and provides price support for our TBA eligible securities in a rising interest rate scenario at or above generic TBA prices. As of June 30, 2018, approximately 90% of our agency RMBS portfolio was eligible for TBA delivery.

OFF-BALANCE SHEET ARRANGEMENTS

As of June 30, 2018, we did not maintain any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, or special purpose or variable interest entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Furthermore, as of June 30, 2018, we had not guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities.

FORWARD-LOOKING STATEMENTS

This document contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward looking statements are based on estimates, projections, beliefs and assumptions of our management as of the date of this Quarterly Report on Form 10-Q and involve risks and uncertainties in predicting future results and

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conditions. Our actual performance could differ materially from those projected or anticipated in any forward looking statements due to a variety of factors, including, without limitation, changes in interest rates, the yield curve or prepayment rates; the availability and terms of financing; changes in the market value of our assets; the effectiveness of our risk mitigation strategies; conditions in the market for mortgage securities and other real estate-related investments; or legislative or regulatory changes that affect our status as a REIT or our exemption from the Investment Company Act of 1940 or that affect the markets in which we participate. A discussion of risks and uncertainties that could cause actual results to differ from any of our forward looking statements is included in this document under Item 1A. Risk Factors. We caution readers not to place undue reliance on our forward looking statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the exposure to loss resulting from changes in market factors such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risks that we are exposed to are interest rate risk, prepayment risk, spread risk, liquidity risk, extension risk, credit risk and risks related to our healthcare and other senior living real estate investments.

Interest Rate Risk

Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.

Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities, by affecting the spread between our interest-earning assets and interest-bearing liabilities. Changes in the level of interest rates can also affect the rate of prepayments of our securities and the value of the RMBS that constitute our investment portfolio, which affects our net income and ability to realize gains from the sale of these assets and impacts our ability and the amount that we can borrow against these securities.

We may utilize a variety of financial instruments to limit the effects of changes in interest rates on our operations. The principal instruments that we use are interest rate swaps and options to enter into interest rate swaps. We also utilize forward contracts for the purchase or sale of agency RMBS on a generic pool, or a TBA contract basis and on a non-generic, specified pool basis, and we utilize U.S. Treasury securities and U.S. Treasury futures contracts, primarily through short sales. We may also purchase or write put or call options on TBA securities and we may invest in other types of mortgage derivatives, such as interest and principal-only securities, and synthetic total return swaps. Derivative instruments may expose us to certain risks, including the risk that losses on a hedge position will reduce the funds available for payments to holders of our common stock and that the losses may exceed the amount we invested in the instruments.

Our profitability and the value of our investment portfolio (including derivatives used for hedging purposes) may be adversely affected during any period as a result of changing interest rates including changes in forward yield curves. Primary measures of an instrument's price sensitivity to interest rate fluctuations are its duration and convexity. The duration of our investment portfolio changes with interest rates and tends to increase when interest rates rise and decrease when interest rates fall. The “negative convexity” generally increases the interest rate exposure of our investment portfolio by more than what is measured by duration alone.

We estimate the duration and convexity of our portfolio using both a third-party risk management system and market data. We review the duration estimates from the third-party model and may make adjustments based on our Manager's judgment. These adjustments are intended to, in our Manager's opinion, better reflect the unique characteristics and market trading conventions associated with certain types of securities, such as HARP and lower loan balance securities. These adjustments generally result in shorter durations than what the unadjusted third party model would otherwise produce. Without these adjustments, in rising rate scenarios, the longer unadjusted durations may underestimate price projections on certain securities with slower prepayment characteristics, such as HARP and lower loan balance securities, to a level below those of generic or TBA securities. However, in our Manager's judgment, because these securities are typically deliverable into TBA contracts, the price of these securities is unlikely to drop below the generic or TBA price in rising rate scenarios. The accuracy of the estimated duration of our portfolio and projected agency security prices depends on our Manager's assumptions and judgments. Our Manager may discontinue making these duration adjustments in the future or may choose to make different adjustments. Other models could produce materially different results.

The table below quantifies the estimated changes in net interest income (including periodic interest costs on our interest rate swaps) and the estimated changes in the fair value of our investment portfolio (including derivatives and other securities used for hedging purposes) and in our net asset value should interest rates go up or down by 50 and 100 basis points, assuming instantaneous parallel shifts in the yield curve, and including the impact of both duration and convexity.

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All changes in income and value are measured as percentage changes from the projected net interest income, investment portfolio value and net asset value at the base interest rate scenario. The base interest rate scenario assumes interest rates and prepayment projections as of June 30, 2018 and December 31, 2017. We apply a floor of 0% for the down rate scenarios on our interest bearing liabilities and the variable leg of our interest rate swaps, such that any hypothetical interest rate decrease would have a limited positive impact on our funding costs beyond a certain level.

Actual results could differ materially from estimates, especially in the current market environment. To the extent that these estimates or other assumptions do not hold true, which is likely in a period of high price volatility, actual results will likely differ materially from projections and could be larger or smaller than the estimates in the table below. Moreover, if different models were employed in the analysis, materially different projections could result. Lastly, while the table below reflects the estimated impact of interest rate increases and decreases on a static portfolio, we may from time to time sell any of our agency or non-agency securities as a part of our overall management of our investment portfolio.

Interest Rate Sensitivity (1)
	Percentage Change in Projected
Change in Interest Rate	Net Interest Income (2)		Portfolio Value (3) (4)		Net Asset Value (3) (5)
June 30, 2018
+100 basis points	5.8	%	(1.6	)%	(10.7	)%
+50 basis points	3.0	%	(0.7	)%	(4.7	)%
-50 basis points	(3.5	)%	0.5	%	3.0	%
-100 basis points	(8.5	)%	0.6	%	3.7	%
December 31, 2017
+100 basis points	6.8	%	(1.2	)%	(8.2	)%
+50 basis points	3.9	%	(0.5	)%	(3.1	)%
-50 basis points	(5.4	)%	0.1	%	0.3	%
-100 basis points	(14.0	)%	(0.4	)%	(2.8	)%

————————

⁽¹⁾  Interest rate sensitivity is derived from models that are dependent on inputs and assumptions provided by third parties as well as by our Manager, assumes there are no changes in mortgage spreads and assumes a static portfolio. Actual results could differ materially from these estimates.

⁽²⁾  Represents the estimated dollar change in net interest income expressed as a percentage of net interest income based on asset yields and cost of funds as of such date. It includes the effect of periodic interest costs on our interest rate swaps, but excludes TBA dollar roll income and costs associated with other supplemental hedges, such as swaptions and U.S. Treasury securities or TBA positions. Estimated dollar change in net interest income does not include the one time impact of retroactive “catch-up” premium amortization benefit/cost due to an increase/decrease in the projected CPR.

⁽³⁾     Includes the effect of derivatives and other securities used for hedging purposes.

⁽⁴⁾    Estimated change in portfolio value expressed as a percentage of the total fair value of our investment portfolio.

⁽⁵⁾  Estimated change in net asset value expressed as a percentage of stockholders' equity.

Prepayment Risk

Because residential borrowers generally have the option to prepay their mortgage loans at par at any time, we face the risk that we will experience a return of principal on our investments faster than anticipated. Various factors affect the rate at which mortgage prepayments occur, including changes in the level of and directional trends in housing prices, interest rates, general economic conditions, loan age and size, loan-to-value ratio, the location of the property and social and demographic conditions. Additionally, changes to GSE underwriting practices or other governmental programs could also significantly impact prepayment rates or expectations. Also, the pace at which the loans underlying our securities become seriously delinquent or are modified and the timing of GSE repurchases of such loans from our securities can materially impact the rate of prepayments. Generally, prepayments on agency RMBS increase during periods of falling mortgage interest rates and decrease during periods of rising mortgage interest rates. However, this may not always be the case.

We may reinvest principal repayments at yields that are lower or higher than the yield on the repaid investment, thus affecting our net interest income by altering the average yield on our assets. Premiums or discounts associated with the purchase of agency RMBS and non-agency securities of higher credit quality are amortized or accreted into interest income over the projected lives of the securities, including contractual payments and estimated prepayments using the effective interest method. Our policy for estimating prepayment speeds for calculating the effective yield is to evaluate published prepayment data for similar securities, market consensus and current market conditions. If the actual prepayment experienced differs from

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our estimate of prepayments, we will be required to make an adjustment to the amortization or accretion of premiums and discounts that would have an impact on future income.

Spread Risk

When the spread between the market yield on our securities and benchmark interest rates widens, our net asset value could decline if the value of our securities falls by more than the offsetting fair value increases on our hedging instruments, creating what we refer to as “spread risk” or “basis risk.” The spread risk associated with our agency and non-agency securities and the resulting fluctuations in fair value of these securities can occur independent of changes in benchmark interest rates and may relate to other factors impacting the mortgage and fixed income markets, such as actual or anticipated monetary policy actions by the Fed, market liquidity, or changes in required rates of return on different assets. Consequently, while we use interest rate swaps and other supplemental hedges to attempt to protect against moves in interest rates, such instruments typically will not protect our net asset value against spread risk.

The table below quantifies the estimated changes in the fair value of our investment portfolio (including derivatives and other securities used for hedging purposes) and in our net asset value should spreads between our mortgage assets and benchmark interest rates go up or down by 10 and 25 basis points for agency securities and 25 and 50 basis points for non-agency securities. These estimated impacts of spread changes are in addition to our sensitivity to interest rate shocks included in the above interest rate sensitivity table. The table below assumes a spread duration of 6.0 years and 5.5 years for agency RMBS and 4.8 years and 4.7 years for non-agency securities based on interest rates and securities prices as of June 30, 2018 and December 31, 2017, respectively. However, our portfolio's sensitivity of spread changes will vary with changes in interest rates and in the size and composition of our investment portfolio. Therefore, actual results could differ materially from our estimates.

Agency RMBS Spread Sensitivity (1)
	Percentage Change in Projected
Change in Spread	Portfolio Market Value (2) (3)		Net Asset Value (2) (4)
June 30, 2018
-25 basis points	1.3	%	8.8	%
-10 basis points	0.5	%	3.5	%
+10 basis points	(0.5	)%	(3.5	)%
+25 basis points	(1.3	)%	(8.8	)%
December 31, 2017
-25 basis points	1.2	%	7.9	%
-10 basis points	0.5	%	3.2	%
+10 basis points	(0.5	)%	(3.2	)%
+25 basis points	(1.2	)%	(7.9	)%

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Non-Agency Securities Spread Sensitivity (1)
	Percentage Change in Projected
Change in Spread	Portfolio Market Value (2) (3)		Net Asset Value (2) (4)
June 30, 2018
-50 basis points	0.3	%	2.0	%
-25 basis points	0.1	%	1.0	%
+25 basis points	(0.1	)%	(1.0	)%
+50 basis points	(0.3	)%	(2.0	)%
December 31, 2017
-50 basis points	0.3	%	2.2	%
-25 basis points	0.2	%	1.1	%
+25 basis points	(0.2	)%	(1.1	)%
+50 basis points	(0.3	)%	(2.2	)%

————————

⁽¹⁾  Spread sensitivity is derived from models that are dependent on inputs and assumptions provided by third parties as well as by our Manager, and assumes there are no changes in interest rates and a static portfolio. Actual results could differ materially from these estimates.

⁽²⁾Includes the effect of derivatives and other instruments used for hedging purposes.

⁽³⁾Estimated dollar change in portfolio market value expressed as a percentage of the total fair value of our investment portfolio as of such date.

⁽⁴⁾  Estimated dollar change in net asset value expressed as a percentage of stockholders' equity as of such date.

Liquidity Risk

Our primary liquidity risk arises from financing long-term assets with shorter-term borrowings. Our assets that are pledged to secure repurchase agreements are agency and non-agency securities and cash. As of June 30, 2018, we had unrestricted cash and cash equivalents of $124.0 million and unpledged securities of approximately $285.5 million, excluding unsettled purchases of securities, available to meet margin calls on our repurchase agreements, derivative instruments and for other corporate purposes. However, should the value of our securities pledged as collateral or the value of our derivative instruments suddenly decrease, margin calls could increase, causing an adverse change in our liquidity position. Further, there is no assurance that we will always be able to renew (or roll) our repurchase agreements. In addition, our counterparties have the option to increase our haircuts (margin requirements) on the assets we pledge, thereby reducing the amount that can be borrowed against an asset even if they agree to renew or roll the repurchase agreement. Significantly higher haircuts can reduce our ability to leverage our portfolio or even force us to sell assets, especially if correlated with asset price declines or faster prepayment rates on our assets.

In addition, we may utilize TBA dollar roll transactions as a means of acquiring and financing purchases of agency RMBS. Under certain economic conditions we may be unable to roll our TBA dollar roll transactions prior to the settlement date and we may have to take physical delivery of the underlying securities and settle our obligations for cash, which could negatively impact our liquidity position, result in defaults or force us to sell assets under adverse conditions.

Extension Risk

The projected weighted-average life and estimated duration (or interest rate sensitivity) of our investments is based on our Manager’s assumptions regarding the rates at which borrowers will prepay or default on the underlying mortgage loans. In general, we use interest rate swaps to help manage our funding cost on our investments in the event that interest rates rise. These swaps allow us to reduce our funding exposure on the notional amount of the swap for a specified period of time by establishing a fixed rate to pay in exchange for receiving a floating rate that generally tracks our financing costs under our repurchase agreements.

However, if prepayment rates decrease in a rising interest rate environment, the average life or duration of our fixed-rate assets generally extends. This could have a negative impact on our results from operations, as our interest rate swap maturities are fixed and will, therefore, cover a smaller percentage of our funding exposure on our mortgage assets to the extent that their average lives increase due to slower prepayments. This situation may also cause the market value of our securities collateralized by fixed rate mortgages to decline by more than otherwise would be the case while most of our hedging instruments (with the exception of short TBA mortgage positions, interest-only securities and certain other supplemental

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hedging instruments) would not receive any incremental offsetting gains. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur realized losses.

Credit Risk

We are exposed to credit risk related to our non-agency investments, certain derivative transactions, and our collateral held by funding and derivative counterparties. We accept credit exposure at levels we deem prudent as an integral part of our diversified investment strategy. Therefore, we may retain all or a portion of the credit risk on our investments. We seek to manage this risk through prudent asset selection, pre-acquisition due diligence, post-acquisition performance monitoring, sale of assets where we have identified negative credit trends and the use of various types of credit enhancements. We may also use non-recourse financing, which limits our exposure to credit losses to the specific pool of mortgages subject to the non-recourse financing. Our overall management of credit exposure may also include the use of credit default swaps or other financial derivatives that we believe are appropriate. Additionally, we intend to vary the percentage mix of our investments in an effort to actively adjust our credit exposure and to improve the risk/return profile of our investment portfolio. Our credit risk related to certain derivative transactions is largely mitigated through daily adjustments to collateral pledged based on changes in market value and we limit our counterparties to major financial institutions with acceptable credit ratings. There is no guarantee that our efforts to manage credit risk will be successful and we could suffer significant losses if credit performance is worse than our expectations or if economic conditions worsen.

Risks Related to Healthcare and Other Senior Living Investments.

Our healthcare and other senior living real estate investments are exposed to counterparty risk, including, for our equity investments, the ongoing ability of the facility operator to satisfy its lease obligations, or, for potential debt investments, the ability of the borrower to make principal and interest payments. As such, our real estate investments are heavily dependent upon the successful operation of the facilities by our counterparties. These operations may be impacted by factors specific to the healthcare space, including, but not limited to, regulatory changes, government reimbursement reductions and revisions to licensure or certification requirements. Additionally, real estate investments are relatively illiquid, generally cannot be sold quickly, and may be subject to impairment charges based on factors such as market conditions and operator performance. We seek to manage these risks through detailed pre-transaction due diligence of target properties and associated operators, prudent asset selection, and active post-acquisition monitoring.

Item 4.Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act of 1934, as amended (the “Exchange Act”) reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” as promulgated under the Exchange Act and the rules and regulations thereunder. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

We, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2018. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There have been no changes in our “internal control over financial reporting” (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during our fiscal quarter ended June 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.  

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PART II

Item 1. Legal Proceedings

Subsequent to the public announcement of the proposed acquisition of the Company by Annaly, four civil actions were filed challenging the adequacy of the disclosures disseminated in connection with the proposed transaction. On May 25, 2018, Jeroen Van Poeck, a purported stockholder of the Company, commenced an action in the United States District Court for the District of Maryland against the Company, certain of our current directors, Annaly and Purchaser. On May 25, 2018, Giampaolo Dell’Acqua, a purported stockholder of the Company, commenced a putative class action in the United States District Court for the District of Maryland against MTGE, certain of our current and former directors named therein, Annaly and Purchaser. On May 30, 2018, Anthony Franchi, a purported stockholder of MTGE, commenced a putative class action in the United States District Court for the District of Maryland against the Company, certain of our current directors named therein, Annaly and Purchaser. On May 31, 2018, Gary Meyer, a purported stockholder of the Company, commenced a putative class action in the United States District Court for the District of Maryland against MTGE and certain of our current and former directors named therein. The complaints assert claims under Sections 14(d), 14(e) and 20(a) of the Securities Exchange Act of 1934 challenging the adequacy of the public disclosures made concerning the proposed transaction. The plaintiffs seek, among other things, an injunction preventing consummation of the proposed transaction, rescission of the proposed transaction or rescissory damages in the event it is consummated, an accounting by defendants for all damages caused to the plaintiff and, where applicable, the putative class, and the award of attorneys’ fees and expenses. Although the outcomes of these cases cannot be predicted with certainty, we do not believe that these cases have merit or will result in a material liability, and, as of June 30, 2018, we did not accrue a loss contingency related to these matters.

Item 1A.Risk Factors

There have been no material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5.Other Information

None.

Item 6. Exhibits and Financial Statement Schedules

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Exhibit No.	Description
*2	Agreement and Plan of Merger dated May 2, 2018 by and among Annaly Capital Management, Inc., Mountain Merger Sub Corporation and MTGE Investment Corp., incorporated herein by reference to Exhibit 2.1 of Form 8-K (File No. 001-35260), filed May 3, 2018.
*3.1	MTGE Investment Corp. Articles of Amendment and Restatement, effective September 30, 2016, incorporated herein by reference to Exhibit 3.1 of Form 10-Q (File No. 001-35260), filed November 8, 2016.
*3.2	MTGE Investment Corp. Amended and Restated Bylaws, effective May 2, 2018, incorporated herein by reference to Exhibit 3.2 of Form 10-Q (File No. 001-35260), filed May 10, 2018.
*3.3	Articles Supplementary of 8.125% Series A Cumulative Redeemable Preferred Stock, incorporated herein by reference to Exhibit 3.3 of Form 8-A (File No. 001-35260), filed May 16, 2014.
*4.1	Form of Certificate for Common Stock, incorporated herein by reference to Exhibit 4.1 of Form 10-Q (File No. 001-35260), filed November 8, 2016.
*4.2	Instruments defining the rights of holders of securities: See Article VI of our Articles of Amendment and Restatement, incorporated herein by reference to Exhibit 3.1 of Form 10-Q (File No. 001-35260), filed November 8, 2016.
*4.3	Instruments defining the rights of holders of securities: See Article VII of our Amended and Restated Bylaws, incorporated herein by reference to Exhibit 3.1 of Form 8-K (File No. 001-35260), filed March 17, 2017.
*4.4	Form of certificate representing the 8.125% Series A Cumulative Redeemable Preferred Stock, incorporated herein by reference to Exhibit 4.1 of Form 8-A (File No. 001-35260), filed May 16, 2014.
*10	Amendment to the Amended and Restated Management Agreement by and among MTGE Investment Corp., MTGE TRS, LLC and MTGE Management, LLC dated May 2, 2018 incorporated herein by reference to Exhibit 10.1 of Form 8-K (File No. 001-35260), filed May 3, 2018
31.1	Certification of CEO Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
31.2	Certification of CFO Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
32	Certification of CEO and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS**	XBRL Instance Document
101.SCH**	XBRL Taxonomy Extension Schema Document
101.CAL**	XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB**	XBRL Taxonomy Extension Labels Linkbase Document
101.PRE**	XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF**	XBRL Taxonomy Extension Definition Linkbase Document

————————

*    Previously filed

**     This exhibit is being furnished rather than filed, and shall not be deemed incorporated by reference into any filing, in accordance with Item 601 of Regulation S-K

†    Management contract or compensatory plan or arrangement

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

MTGE Investment Corp.

By:	/s/    SEAN P. REID
	SEAN P. REID
	Chief Executive Officer (Principal Executive Officer)

Date: August 3, 2018

By:	/s/    DONALD W. HOLLEY
	DONALD W. HOLLEY
	Chief Financial Officer and Senior Vice President (Principal Financial Officer)

Date: August 3, 2018

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