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 March 31, 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 May 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	57
Item 4.	Controls and Procedures	61

PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	62
Item 1A.	Risk Factors	62
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	62
Item 3.	Defaults upon Senior Securities	62
Item 4.	Mine Safety Disclosures	62
Item 5.	Other Information	62
Item 6.	Exhibits	62

Signatures		63

PART I

Item 1. Financial Statements

MTGE INVESTMENT CORP.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)



	March 31, 2018			December 31, 2017
	(unaudited)
Assets:
Agency securities, at fair value (including pledged securities of $3,434,631 and $3,581,868, respectively)	$	3,660,403		$	3,758,181
Non-agency securities, at fair value (including pledged securities of $760,144 and $743,278, respectively)	833,681			872,084
U.S. Treasury securities, at fair value (including pledged securities of $24,903 and $0, respectively)	24,924			—
Land	17,201			16,641
Buildings, furniture, fixtures and equipment, net of accumulated depreciation	259,775			240,352
Cash and cash equivalents	123,396			123,762
Restricted cash and cash equivalents	40,857			46,324
Interest receivable	14,919			14,608
Derivative assets, at fair value	29,726			14,712
Receivable under reverse repurchase agreements	836,901			843,130
Other assets	16,025			23,242
Total assets	$	5,857,808		$	5,953,036
Liabilities:
Repurchase agreements	$	3,743,436		$	3,863,719
Notes payable, net of deferred financing costs	201,986			186,500
Payable for securities purchased	58,182			4,357
Derivative liabilities, at fair value	—			4,454
Dividend payable	24,016			24,016
Obligation to return securities borrowed under reverse repurchase agreements, at fair value	824,688			830,776
Accounts payable and other accrued liabilities	44,904			33,592
Total liabilities	4,897,212			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	1,122,797			1,122,729
Retained deficit	(216,497		)	(171,119		)
Total stockholders’ equity	959,797			1,005,107
Noncontrolling interests	799			515
Total equity	960,596			1,005,622
Total liabilities and equity	$	5,857,808		$	5,953,036

See accompanying notes to consolidated financial statements.

MTGE INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



	For the Three Months Ended March 31,
	2018			2017
Interest income:
Agency securities	$	27,511		$	17,901
Non-agency securities	11,994			15,696
Other	125			160
Interest expense	(17,053		)	(10,165		)
Net interest income	22,577			23,592

Healthcare real estate:
Healthcare real estate income	7,760			3,315
Healthcare real estate expense	(5,795		)	(2,653		)
Net healthcare investment income	1,965			662

Other gains (losses):
Realized loss on agency securities, net	(1,940		)	(212		)
Realized gain on non-agency securities, net	4,154			12,714
Realized gain (loss) on periodic settlements of interest rate swaps, net	358			(2,660		)
Realized gain on other derivatives and securities, net	2,736			2,167
Unrealized loss on agency securities, net	(76,170		)	(115		)
Unrealized gain (loss) on non-agency securities, net	(3,337		)	13,014
Unrealized gain (loss) on other derivatives and securities, net	33,457			(2,839		)
Servicing income	50			2,558
Servicing expense	(250		)	(4,985		)
Total other gains (losses), net	(40,942		)	19,642
Expenses:
Management fees	3,389			3,376
General and administrative expenses	1,578			1,719
Total expenses	4,967			5,095
Net income (loss)	(21,367		)	38,801
Dividend on preferred stock	(1,117		)	(1,117		)
Noncontrolling interest in net loss (income)	5			(2		)
Net income (loss) available to common stockholders	$	(22,479	)	$	37,682

Net income (loss) per common share — basic and diluted	$	(0.49	)	$	0.82

Weighted average common shares — basic	45,810			45,798
Weighted average common shares — diluted	45,822			45,806

Dividend declared per common share	$	0.50		$	0.45

See accompanying notes to consolidated financial statements.

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		Additional Paid-in Capital		Retained Earnings (Deficit)			Noncontrolling Interests			Total Equity
Balance, December 31, 2016	2,200	$	53,039	45,798	$	458	$	1,122,493	$	(243,260	)	$	315		$	933,045
Net income	—	—		—	—		—		38,799			2			38,801
Distribution to noncontrolling interest	—	—		—	—		—		—			(11		)	(11		)
Stock-based compensation	—	—					34		—			—			34
Preferred dividends declared							—		(1,117		)	—			(1,117		)
Common dividends declared	—	—		—	—		—		(20,609		)	—			(20,609		)
Balance, March 31, 2017	2,200	$	53,039	45,798	$	458	$	1,122,527	$	(226,187	)	$	306		$	950,143

Balance, December 31, 2017	2,200	$	53,039	45,798	$	458	$	1,122,729	$	(171,119	)	$	515		$	1,005,622
Net income	—	—		—	—		—		(21,362		)	(5		)	(21,367		)
Issuance of noncontrolling interest	—	—		—	—		—		—			293			293
Distribution to noncontrolling interest	—	—		—	—		—		—			(4		)	(4		)
Stock-based compensation	—	—		—	—		68		—			—			68
Preferred dividends declared	—	—		—	—		—		(1,117		)	—			(1,117		)
Common dividends declared	—	—		—	—		—		(22,899		)	—			(22,899		)
Balance, March 31, 2018	2,200	$	53,039	45,798	$	458	$	1,122,797	$	(216,497	)	$	799		$	960,596

See accompanying notes to consolidated financial statements.

MTGE INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



	For the Three Months Ended March 31,
	2018			2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	(21,367	)	$	38,801
Adjustments to reconcile net income to net cash flows from operating activities:
Amortization of net premium on agency securities	4,486			5,481
Accretion of net discount on non-agency securities	(3,768		)	(6,783		)
Depreciation and amortization on real estate investments	2,059			771
Realization of cash flows from MSR	—			1,089
Unrealized loss (gain) on securities, MSR and derivatives, net	46,050			(10,060		)
Realized loss (gain) on agency securities, net	1,940			212
Realized gain on non-agency securities, net	(4,154		)	(12,714		)
Realized loss (gain) on other derivatives and securities, net	(3,094		)	592
Stock-based compensation	68			34
Increase in interest receivable	(311		)	(826		)
Decrease in other assets	4,024			4,799
Increase (decrease) in operating accounts payable and other accrued liabilities	(38		)	5,511
Net cash flows from operating activities	25,895			26,907
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of agency securities	(284,077		)	(485,296		)
Purchases of non-agency securities	(65,690		)	(77,819		)
Purchases of healthcare real estate investments	(21,984		)	(26,634		)
Proceeds from sale of agency securities	220,435			208,457
Proceeds from sale of non-agency securities	89,902			260,473
Proceeds from sale of MSR	3,193			43,823
Principal collections on agency securities	107,745			85,136
Principal collections on non-agency securities	18,776			43,258
Net proceeds from (payments on) reverse repurchase agreements	6,229			(847,588		)
Purchases of U.S. Treasury securities	(141,912		)	(332,959		)
Proceeds from sale of U.S. Treasury securities	153,449			1,193,721
Payments for the termination of interest rate swaps	—			(3,841		)
Other investing cash flows, net	10,788			(12,098		)
Net cash flows from investing activities	96,854			48,633
CASH FLOWS USED IN FINANCING ACTIVITIES:
Dividends paid	(24,016		)	(19,436		)
Issuance of noncontrolling interest	293			—
Distributions to noncontrolling interest	(4		)	(11		)
Proceeds from repurchase agreements and Federal Home Loan Bank advances	5,503,995			5,987,161
Repayments on repurchase agreements and Federal Home Loan Bank advances	(5,624,278		)	(6,035,054		)
Proceeds from notes payable, net of deferred financing costs	15,938			19,774
Repayments of notes payable	(510		)	(93		)
Net cash flows used in financing activities	(128,582		)	(47,659		)
Net increase (decrease) in cash and cash equivalents and restricted cash	(5,833		)	27,881
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	$	164,253		$	164,526

See accompanying notes to consolidated financial statements.

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.

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.

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.

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

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.

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 March 31, 2018 and December 31, 2017 (dollars in thousands):



	March 31, 2018
	Fannie Mae			Freddie Mac			Total
Agency RMBS:
Par value	$	2,393,236		$	1,196,372		$	3,589,608
Unamortized premium	118,223			63,641			181,864
Amortized cost	2,511,459			1,260,013			3,771,472
Gross unrealized gains	688			281			969
Gross unrealized losses	(75,332		)	(36,706		)	(112,038		)
Agency RMBS, at fair value	$	2,436,815		$	1,223,588		$	3,660,403

Weighted average coupon as of March 31, 2018	3.61		%	3.73		%	3.65		%
Weighted average yield as of March 31, 2018	2.82		%	2.96		%	2.87		%
Weighted average yield for the three months ended March 31, 2018	2.94		%	3.12		%	3.00		%



	March 31, 2018
	Amortized Cost		Gross Unrealized Gain		Gross Unrealized Loss			Fair Value
Agency RMBS:
Fixed rate	$	3,698,545	$	718	$	(111,935	)	$	3,587,328
Adjustable rate	72,927		251		(103		)	73,075
Total Agency RMBS	$	3,771,472	$	969	$	(112,038	)	$	3,660,403



	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		%



	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 March 31, 2018 and December 31, 2017 according to their estimated weighted average life classification (dollars in thousands):



	March 31, 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	$	42,371	$	43,132	2.10	%	3.93	%	$	40,404	$	40,815	2.06	%	3.92	%
Greater than three years and less than or equal to five years	489,624		498,048		2.39	%	3.15	%	534,299		535,608		2.38	%	3.19	%
Greater than five years and less than or equal to 10 years	2,872,403		2,967,793		2.94	%	3.74	%	3,149,565		3,182,468		2.90	%	3.75	%
Greater than 10 years	256,005		262,499		3.15	%	3.55	%	33,913		34,189		2.98	%	3.50	%
Total	$	3,660,403	$	3,771,472	2.87	%	3.65	%	$	3,758,181	$	3,793,080	2.82	%	3.67	%

As of March 31, 2018 and December 31, 2017, the estimated weighted average life of our agency security portfolio was 8.0 years and 7.5 years, respectively, which incorporates anticipated future prepayment assumptions. As of March 31, 2018 and December 31, 2017, our weighted average expected constant prepayment rate (“CPR”) over the remaining life of our aggregate agency investment portfolio was 7.6% and 8.4%, respectively.

Realized Gains and Losses

The following table summarizes our net realized gains and losses from the sale of agency RMBS during three months ended March 31, 2018 and 2017 (dollars in thousands):



	For the Three Months Ended March 31,
	2018			2017
Proceeds from agency securities sold	$	220,435		$	208,457
Less agency securities sold, at cost	(222,375		)	(208,669		)
Realized loss on agency securities, net	$	(1,940	)	$	(212	)

Gross realized gains on sale of agency securities	$	14		$	1,270
Gross realized losses on sale of agency securities	(1,954		)	(1,482		)
Realized loss on agency securities, net	$	(1,940	)	$	(212	)

Pledged Assets

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



	March 31, 2018
	Fannie Mae		Freddie Mac		Total
Fair Value of Agency Securities Pledged Under:
Financing agreements	$	2,294,011	$	1,140,080	$	3,434,091
Derivative agreements	80		460		540
Total fair value	2,294,091		1,140,540		3,434,631
Accrued interest on pledged agency RMBS	6,800		3,476		10,276
Total Fair Value of Agency RMBS Pledged and Accrued Interest	$	2,300,891	$	1,144,016	$	3,444,907



	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 March 31, 2018 and December 31, 2017 (dollars in thousands):



	March 31, 2018						December 31, 2017
Remaining Maturity	Fair Value		Amortized Cost		Accrued Interest		Fair Value		Amortized Cost		Accrued Interest
30 days or less	$	1,102,225	$	1,136,865	$	3,262	$	940,788	$	949,282	$	2,765
31 - 59 days	985,955		1,015,732		2,974		1,298,331		1,311,882		3,818
60 - 90 days	359,108		370,094		1,096		261,823		262,908		785
Greater than 90 days	986,803		1,019,398		2,944		1,080,236		1,091,195		3,161
Total	$	3,434,091	$	3,542,089	$	10,276	$	3,581,178	$	3,615,267	$	10,529

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

Note 5. Non-Agency Securities

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



March 31, 2018
	Fair Value		Gross Unrealized					Amortized Cost		Premium (Discount)			Par/ Current Face		Weighted Average
Category	Fair Value		Gains		Losses			Amortized Cost		Premium (Discount)			Par/ Current Face		Coupon ⁽¹⁾		Yield
Prime	$	139,841	$	9,529	$	(77	)	$	130,389	$	(13,262	)	$	143,651	3.86	%	5.89	%
CRT	300,338		16,465		(81		)	283,954		13,258			270,696		5.50	%	5.68	%
Alt-A	277,083		50,162		(628		)	227,549		(109,122		)	336,671		2.94	%	9.21	%
Option-ARM	84,683		12,790		—			71,893		(20,305		)	92,198		2.11	%	6.79	%
Subprime	13,337		873		—			12,464		(664		)	13,128		5.20	%	5.92	%
CMBS	18,399		171		(85		)	18,313		(187		)	18,500		5.68	%	6.04	%
Total	$	833,681	$	89,990	$	(871	)	$	744,562	$	(130,282	)	$	874,844	3.91	%	6.92	%

————————


⁽¹⁾	Coupon rates are floating, except for $11.4 million, $5.6 million, $12.0 million, $13.3 million and $18.4 million fair value of fixed-rate prime, CRT, Alt-A, subprime and CMBS non-agency securities, respectively, as of March 31, 2018.



December 31, 2017
	Fair Value		Gross Unrealized					Amortized Cost		Premium (Discount)			Par/ Current Face		Weighted Average
Category	Fair Value		Gains		Losses			Amortized Cost		Premium (Discount)			Par/ Current Face		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 March 31, 2018 and December 31, 2017 (dollars in thousands):



	March 31, 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	$	285,566	$	244,884	3.33	%	8.44	%	$	302,797	$	258,501	3.11	%	8.31	%
> 5 to ≤ 7 years	258,753		226,721		4.17	%	7.05	%	398,712		361,649		4.33	%	5.97	%
> 7 years	289,362		272,957		4.35	%	5.43	%	170,575		159,479		3.61	%	5.18	%
Total	$	833,681	$	744,562	3.91	%	6.92	%	$	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 March 31, 2018, Prime non-agency securities also include $17.2 million in fair value of securities with underlying mortgage loans that were originated with more stringent underwriting standards beginning in 2010. As of March 31, 2018, our Prime securities have both fixed and floating rate coupons ranging from 2.5% to 6.5%, with weighted average coupons of underlying collateral ranging from 3.5% to 5.0%.

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 March 31, 2018, our CRT securities had fixed and floating rate coupons ranging from 1.3% to 8.8%, with weighted average coupons of underlying collateral ranging from 3.6% 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 March 31, 2018, our Alt-A securities had both fixed and floating rate coupons ranging from 2.0% to 6.5% with weighted average coupons of underlying collateral ranging from 3.6% to 5.8%.

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 March 31, 2018, our Option-ARM securities had coupons ranging from 2.0% to 2.6% and have underlying collateral with weighted average coupons between 3.5% and 4.5%. The loans underlying our Option-ARM securities were originated between 2004 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 March 31, 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 March 31, 2018, our CMBS securities had a fair market value of $18.4 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 87% of our non-agency RMBS are rated below investment grade or have not been rated by credit agencies as of March 31, 2018.

Realized Gains and Losses

The following table summarizes our net realized gains from the sale of non-agency securities during three months ended March 31, 2018 and 2017 (dollars in thousands):



	For the Three Months Ended March 31,
	2018			2017
Proceeds from non-agency securities sold	$	89,901		$	260,473
Increase in receivable for securities sold	—			5,748
Less: non-agency securities sold, at cost	(85,747		)	(253,507		)
Realized gain on non-agency securities, net	$	4,154		$	12,714

Gross realized gain on sale of non-agency securities	$	4,155		$	12,864
Gross realized loss on sale of non-agency securities	(1		)	(150		)
Realized gain on non-agency securities, net	$	4,154		$	12,714

Pledged Assets

Non-agency securities with a fair value of $0.8 billion and $0.7 billion were pledged as collateral under financing arrangements as of March 31, 2018 and December 31, 2017, respectively, none of which had original overnight maturities.

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 March 31, 2018 and December 31, 2017 (dollars in thousands):



	March 31, 2018						December 31, 2017
Remaining Maturity	Fair Value		Amortized Cost		Accrued Interest		Fair Value		Amortized Cost		Accrued Interest
30 days or less	$	686,521	$	614,635	$	1,052	$	585,943	$	517,750	$	815
31 - 59 days	60,500		50,754		75		97,537		82,105		145
60 - 90 days	13,123		10,311		17		59,798		58,651		135
Total	$	760,144	$	675,700	$	1,144	$	743,278	$	658,506	$	1,095

Note 6. Investments in Real Property

Investment Activity

During March 2018, CHI acquired a senior living facility located in Kansas for total consideration of $21.5 million through an existing joint venture structured in a manner intended to comply with the REIT Income Diversification and Empowerment Act (“RIDEA”). The total purchase price has been allocated to assets and liabilities based upon their respective fair values in accordance with our accounting policies. As a result of these purchase price allocations, $20.0 million was allocated to buildings, $0.9 million to furniture, fixtures and equipment and $0.6 million to land during the first quarter of 2018.

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



	March 31, 2018			December 31, 2017
Buildings and improvements	$	253,649		$	233,407
Furniture, fixtures and equipment	15,719			14,537
Less: accumulated depreciation	(9,593		)	(7,592		)
Buildings, furniture, fixtures and equipment, net of accumulated depreciation	259,775			240,352
Land	17,201			16,641
Goodwill	5,840			5,840
Net working capital ⁽¹⁾	16,369			18,994
Total real estate assets	$	299,185		$	281,827

————————


⁽¹⁾	Net working capital primarily includes $14.7 million and $16.1 million of cash and cash equivalents and $3.4 million and $2.8 million of rent receivable recorded in other assets on the consolidated balances sheets as of March 31, 2018 and December 31, 2017, respectively.

Notes Payable

CHI finances its real estate investments primarily through secured debt. As of March 31, 2018, CHI had fixed rate debt with a principal amount of $138.3 million, a weighted average maturity of 25.3 years and an interest rate of 3.81% and floating rate debt with a principal amount of $66.4 million, a weighted average maturity of 0.9 years and a weighted average interest rate of 4.63%. 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 three months ended March 31, 2018 and 2017 (dollars in thousands):



	For the Three Months Ended March 31,
	2018			2017
Beginning balance	$	186,500		$	66,527
Debt issued and assumed, net of deferred financing costs	15,938			19,581
Amortization of deferred financing costs	58			193
Principal repayments	(510		)	(93		)
Ending balance	$	201,986		$	86,208

Our notes payable of $204.7 million, excluding $2.7 million of deferred financing costs, had a fair value of approximately $198 million as of March 31, 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.

Income from Healthcare Real Estate Investments

The following table presents the components of net income from our real property investments during the three months ended March 31, 2018 and 2017 (dollars in thousands):



	For the Three Months Ended March 31,
	2018		2017
Lease income	$	5,706	$	2,253
Rental income	2,054		1,062
Healthcare real estate income	7,760		3,315

Interest expense	2,089		1,173
Depreciation	2,001		771
Tenant expenses	1,425		709
Other	280		—
Healthcare real estate expense	5,795		2,653
Net healthcare investment income	$	1,964	$	662

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 March 31, 2018, future minimum lease payments receivable related to our healthcare and senior living facilities are as follows (dollars in thousands):



	March 31, 2018
2018	$	15,301
2019	20,764
2020	21,191
2021	21,627
2022	22,073
Thereafter	193,233
Total	$	294,189

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 March 31, 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.

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



	March 31, 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	$	3,170,784	1.78	%	106	$	3,307,662	1.54	%	114
Non-agency securities	569,380		2.93	%	18	556,057		2.72	%	24
U.S. Treasury securities	3,272		1.65	%	1	—		N/A		N/A
Total repurchase agreements	$	3,743,436	1.96	%	92	$	3,863,719	1.71	%	101

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



	March 31, 2018					December 31, 2017
			Weighted Average					Weighted Average
	Borrowings Outstanding		Interest Rate		Days to Maturity	Borrowings Outstanding		Interest Rate		Days to Maturity
≤ 1 month	$	1,584,501	2.09	%	14	$	1,341,712	1.91	%	17
> 1 to ≤ 2 months	955,061		1.80	%	43	1,334,493		1.55	%	40
> 2 to ≤ 3 months	342,533		1.95	%	78	295,204		1.76	%	76
> 3 to ≤ 6 months	510,378		1.71	%	155	334,372		1.51	%	123
> 6 to ≤ 12 months	85,963		2.04	%	301	292,938		1.57	%	256
> 12 months	265,000		2.18	%	568	265,000		1.80	%	658
Total repurchase agreements	$	3,743,436	1.96	%	92	$	3,863,719	1.71	%	101

We had repurchase agreements with 36 financial institutions as of March 31, 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 17% of our stockholders' equity at risk as of March 31, 2018.

We had agency RMBS with fair values of $3.4 billion and $3.6 billion pledged as collateral against repurchase agreements as of March 31, 2018 and December 31, 2017, respectively. We had non-agency securities with fair values of $0.8 billion and $0.7 billion pledged as collateral against repurchase agreements as of March 31, 2018 and December 31, 2017, respectively.

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.

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



	March 31, 2018		December 31, 2017
Derivative assets:
Interest rate swaps	$	7,195	$	4,894
Interest rate swaptions	12,820		6,728
TBA securities	9,711		3,090
Derivative assets, at fair value	$	29,726	$	14,712

Derivative liabilities:
TBA securities	—		1,339
Credit default swaps	—		3,115
Derivative liabilities, at fair value	$	—	$	4,454

The following tables summarize the effect of our outstanding derivatives and other securities on our consolidated statements of operations during three months ended March 31, 2018 and 2017 (in thousands):



	For the Three Months Ended March 31,
	2018							2017
	Realized Gain on Periodic Settlements of Interest Rate Swaps, net		Realized Gain (Loss) 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 (Loss) on Other Derivatives and Securities, net			Unrealized Gain (Loss) on Other Derivatives and Securities, net
Interest rate swaps	$	358	$	47,929		$	2,120	$	(2,660	)	$	26,021		$	(21,830	)
Interest rate swaptions	—		—			5,322		—			—			(428		)
TBA securities	—		(43,145		)	7,959		—			(24,290		)	29,510
Short sales of U.S. Treasuries	—		(389		)	16,503		—			251			(9,641		)
Credit default swaps	—		(1,648		)	1,528		—			(43		)	(457		)
Other	—		(11		)	25		—			228			7
Total	$	358	$	2,736		$	33,457	$	(2,660	)	$	2,167		$	(2,839	)

The following tables summarize changes in notional amounts for our outstanding derivatives and other securities during three months ended March 31, 2018 and 2017 (in thousands):



	December 31, 2017 Notional Amount			Additions/ Long Positions	Expirations/ Terminations/ Short Positions		March 31, 2018 Notional Amount
Interest rate swaps	$	3,530,000		100,000	—		$	3,630,000
Interest rate swaptions	$	425,000		75,000	—		$	500,000
TBA securities	$	1,704,386		5,057,110	(5,174,652	)	$	1,586,844
U.S. Treasuries	$	—		119,500	(94,500	)	$	25,000
Short sales of U.S. Treasuries	$	(846,700	)	49,500	(60,500	)	$	(857,700	)
Credit default swaps	$	48,000		—	(48,000	)	$	—



	December 31, 2016 Notional Amount			Additions/ Long Positions	Expirations/ Terminations/ Short Positions		March 31, 2017 Notional Amount
Interest rate swaps	$	2,975,000		75,000	(75,000	)	$	2,975,000
Interest rate swaptions	$	150,000		—	—		$	150,000
TBA securities	$	886,042		7,928,617	(6,774,908	)	$	2,039,751
U.S. Treasuries	$	21,000		22,500	(43,500	)	$	—
Short sales of U.S. Treasuries	$	(511,000	)	318,500	(1,172,000	)	$	(1,364,500	)
Credit default swaps	$	49,000		—	(500	)	$	48,500

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 March 31, 2018 and December 31, 2017, we had interest rate swap agreements summarized in the table below (dollars in thousands).



	March 31, 2018							December 31, 2017
	Notional Amount		Weighted Average					Notional Amount		Weighted Average
Current Maturity Date ⁽¹⁾	Notional Amount		Fixed Pay Rate ⁽²⁾		Receive Rate ⁽³⁾		Maturity (Years)	Notional Amount		Fixed Pay Rate ⁽²⁾		Receive Rate ⁽³⁾		Maturity (Years)
≤ 3 years	$	1,600,000	1.31	%	1.90	%	1.2	$	1,500,000	1.26	%	1.46	%	1.3
> 3 to ≤ 5 years	935,000		1.77	%	1.94	%	3.9	985,000		1.79	%	1.47	%	4.0
> 5 to ≤ 7 years	400,000		1.98	%	1.79	%	5.4	350,000		1.78	%	1.40	%	5.7
> 7 years	695,000		2.26	%	1.96	%	9.6	695,000		2.26	%	1.47	%	9.9
Total	$	3,630,000	1.68	%	1.91	%	4.0	$	3,530,000	1.65	%	1.46	%	4.2

————————


⁽¹⁾	Includes swaps with an aggregate notional of $0.2 billion and $0.4 billion with deferred start dates averaging 0.0 years and 0.1 years from March 31, 2018 and December 31, 2017, respectively.


⁽²⁾	Excluding forward starting swaps, the weighted average pay rate was 1.64% and 1.58% as of March 31, 2018 and December 31, 2017, respectively.


⁽³⁾	Weighted average receive rate excludes impact of forward starting interest rate swaps.

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 March 31, 2018 and December 31, 2017 (dollars in thousands):



March 31, 2018
	Option					Underlying Swap
Current Option Expiration Date	Cost		Fair Value		Weighted Average Years to Expiration	Notional Amount		Pay Rate		Weighted Average Term (Years)
Current Option Expiration Date	Cost		Fair Value		Weighted Average Years to Expiration	Notional Amount		Pay Rate		Weighted Average Term (Years)
≤ 12 months	$	2,341	$	3,979	0.7	$	200,000	2.73	%	8.4
>12 to ≤ 24 months	2,623		3,077		1.2	125,000		2.86	%	8.4
> 24 months	7,951		5,764		3.2	175,000		2.87	%	8.7
Total / weighted average	$	12,915	$	12,820	1.7	$	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)
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

TBA Securities

As of March 31, 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):



	March 31, 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	$	1,586,844	$	9,711	$	1,386,416		$	3,089
Sale of TBA securities	—		—		(1,200		)	1
Total TBA assets	1,586,844		9,711		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	$	1,586,844	$	9,711	$	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 U.S. Treasury securities with a fair value of $24.9 million and a face amount of $25.0 million as of March 31, 2018, which are presented as U.S. Treasury securities, at fair value on the consolidated balance sheets. In addition, 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 $0.8 billion as of both March 31, 2018 and December 31, 2017. The borrowed securities were collateralized by cash payments of $0.8 billion as of both March 31, 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 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 March 31, 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 March 31, 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 March 31, 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
	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Consolidated Balance Sheets		Net Amounts Presented in the Consolidated Balance Sheets		Financial Instruments			Collateral Received ⁽¹⁾			Net Amount
March 31, 2018
Interest rate swaps and swaptions ⁽²⁾	$	20,015	$	—	$	20,015	$	—		$	(16,891	)	$	3,124
TBA	9,711		—		9,711		—			—			9,711
Receivable under reverse repurchase agreements	836,901		—		836,901		(666,306		)	(170,595		)	—
Total	$	866,627	$	—	$	866,627	$	(666,306	)	$	(187,486	)	$	12,835

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

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
	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Consolidated Balance Sheets		Net Amounts Presented in the Consolidated Balance Sheets		Financial Instruments			Collateral Pledged ⁽¹⁾			Net Amount
March 31, 2018
Repurchase agreements	$	3,743,436	$	—	$	3,743,436	$	(666,306	)	$	(3,077,130	)	$	—
Total	$	3,743,436	$	—	$	3,743,436	$	(666,306	)	$	(3,077,130	)	$	—

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 3 and 4 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.


•	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 March 31, 2018 and December 31, 2017, on the consolidated balance sheets by the valuation hierarchy, as described above (in thousands):



	March 31, 2018
	Level 1		Level 2		Level 3		Total
Assets
Agency securities	$	—	$	3,660,403	$	—	$	3,660,403
Non-agency securities	—		833,681		—		833,681
U.S. Treasury securities	24,924		—		—		24,924
Derivative assets	—		29,726		—		29,726
Total	$	24,924	$	4,523,810	$	—	$	4,548,734

Liabilities
Obligation to return securities borrowed under reverse repurchase agreements	824,688		—		—		824,688
Total	$	824,688	$	—	$	—	$	824,688



	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 March 31, 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

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 March 31, 2018 and December 31, 2017 (dollars in thousands):



	March 31, 2018		December 31, 2017
Servicing advances	$	—	$	324
Prepaid expenses	1,595		1,993
Accounts receivable	2,033		5,682
Goodwill	5,840		5,840
Other	6,557		9,403
Total other assets	$	16,025	$	23,242

Note 12. Accounts Payable and Other Accrued Liabilities

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



	March 31, 2018		December 31, 2017
Cash collateral held	$	16,992	$	5,642
Due to manager	1,473		1,451
Accrued interest	15,181		12,547
Other accounts payable and accrued expenses	11,258		13,952
Total accounts payable and other accrued liabilities	$	44,904	$	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.

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 March 31, 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 March 31, 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 Company intends to repurchase shares under the stock repurchase plan only when the repurchase price is less than its estimate of its then current net asset value per common share. The total amount of $100 million remains authorized and available for common stock repurchases as of March 31, 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 months ended March 31, 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 March 31, 2018, we have not issued any shares under this program.

Note 14. Subsequent Events

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.

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 three months ended March 31, 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

The key market dynamics from 2017, including low volatility, steadily increasing equity valuations, stable longer-term rates, and tighter credit spreads all reversed course dramatically during the first quarter of 2018. The yield on the 10-year U.S. Treasury note rose 33 basis points over the quarter 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 quarter, which included a decline of $0.99 per common share in our net book value and dividends declared during the quarter of $0.50 per common share.

Given improving underlying economic fundamentals and a reduction of quantitative easing measures by several key central banks during the second half of 2017, our core view was that interest rates were biased somewhat higher. As such, by the end of 2017, we reduced our exposure to higher rates by increasing our interest rate hedge position to 86% of our repurchase agreement and TBA position. During the first quarter, we increased our interest rate hedge position further to 93% of our repurchase agreement and TBA balance as of March 31, 2018. These actions minimized the impact of the increase in long-term rates during the first quarter on our net book value and should continue to limit 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 March 31, 2018, moderately higher than our net duration gap of 0.6 years as of December 31, 2017. As of March 31, 2018, our sensitivity to an instantaneous parallel increase in rates of 50 and 100 basis points, and assuming no portfolio rebalancing actions, was an estimated decline of (4.6)% and (10.4)%, respectively, of our net book value.

The continued favorable U.S. residential housing market fundamentals led to a slight net fair value gain on our non-agency securities during the first quarter. In response to the favorable market valuations and the corresponding reduced projected returns, we continued to sell a subset of our non-agency securities and re-allocated the capital to more attractive investment opportunities in the agency RMBS and healthcare real estate sectors.

The average cost of our repo funding increased by 25 basis points during the first quarter, consistent with the increase in the federal funds rate, as the Federal Reserve continued to gradually increase short-term interest rates. Over the same period, three-month LIBOR, which determines the receive leg of our pay fixed interest rate swaps, increased 62 basis points, and ended the quarter 35 bps higher than our average repo rate. Despite this favorable spread differential, our average total cost of funds for the first quarter, which includes repurchase agreements, the implied funding costs of our TBA securities and interest rate swaps, increased by 16 basis points to 1.72% for the quarter, as the receive legs of our interest rate swaps had not yet fully reset to the higher prevailing 3-month LIBOR rates. Our average net interest margin (including our TBA dollar roll funded assets

and interest rate swap hedges and excluding "catch-up" premium amortization cost due to changes in CPR forecasts) for the first quarter decreased to 1.64%, compared to 1.74% for the fourth quarter, largely due to higher funding costs.

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 $299.2 million as of March 31, 2018.

The table below summarizes interest rates and prices for generic agency RMBS as of the end of each respective quarter since March 31, 2017:

Interest Rate / Security ⁽¹⁾

March

31, 2018

December 31, 2017

September 30, 2017

June 30, 2017

March 31, 2017

LIBOR:

MTGE Investment Corp. 10-Q