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Such termination fee will be equal to the amount of three times the sum of (i) the average annual Quarterly Base Management Fee Amounts paid or payable with respect to the two 12-month periods ending on the last day of the latest fiscal quarter completed on or prior to the date of the notice of termination or non-renewal and (ii) the average annual Quarterly Incentive Fee Amounts paid or payable with respect to the two 12-month periods ending on the last day of the latest fiscal quarter completed on or prior to the date of the notice of termination or non-renewal. 75.236.957.00.200000.2000010000000029796601386479430.35270.00930.0701P0Y2M23DP4M2DP3M11D2019-03-152019-04-252019-02-142019-03-112019-03-012019-03-290.5100.077The Manager is entitled to receive a quarterly incentive fee equal to the positive excess, if any, of (i) the product of (A) 25% and (B) the excess of (1) Adjusted Net Income (described below) for the Incentive Calculation Period (which means such fiscal quarter and the immediately preceding three fiscal quarters) over (2) the sum of the Hurdle Amounts (described below) for the Incentive Calculation Period, over (ii) the sum of the incentive fees already paid or payable for each fiscal quarter in the Incentive Calculation Period preceding such fiscal quarter. For purposes of calculating the incentive fee, "Adjusted Net Income" for the Incentive Calculation Period means the net increase in equity from operations of the Operating Partnership, after all base management fees but before any incentive fees for such period, and excluding any non-cash equity compensation expenses for such period, as reduced by any Loss Carryforward (as described below) as of the end of the fiscal quarter preceding the Incentive Calculation Period. For purposes of calculating the incentive fee, the "Loss Carryforward" as of the end of any fiscal quarter is calculated by determining the excess, if any, of (1) the Loss Carryforward as of the end of the immediately preceding fiscal quarter over (2) the Company's net increase in equity from operations (expressed as a positive number) or net decrease in equity from operations (expressed as a negative number) of the Operating Partnership for such fiscal quarter. As of December 31, 2018, there was a Loss Carryforward of $2.1 million. For purposes of calculating the incentive fee, the "Hurdle Amount" means, with respect to any fiscal quarter, the product of (i) one-fourth of the greater of (A) 9% and (B) 3% plus the 10-year U.S. Treasury rate for such fiscal quarter, (ii) the sum of (A) the weighted average gross proceeds per share of all common share and OP Unit issuances since inception of the Company and up to the end of such fiscal quarter, with each issuance weighted by both the number of shares and OP Units issued in such issuance and the number of days that such issued shares and OP Units were outstanding during such fiscal quarter, using a first-in first-out basis of accounting (i.e. attributing any share and OP Unit repurchases to the earliest issuances first) and (B) the result obtained by dividing (I) retained earnings attributable to common shares and OP Units at the beginning of such fiscal quarter by (II) the average number of common shares and OP Units outstanding for each day during such fiscal quarter, (iii) the sum of (x) the average number of common shares and LTIP Units outstanding for each day during such fiscal quarter, and (y) the average number of OP Units and OP LTIP Units outstanding for each day during such fiscal quarter. For purposes of determining the Hurdle Amount, issuances of common shares, OP LTIP Units, and OP Units (a) as equity incentive awards, (b) to the Manager as part of its base management fee or incentive fee and (c) to the Manager or any of its affiliates in privately negotiated transactions, are excluded from the calculation. The payment of the incentive fee will be in a combination of common shares and cash, provided that at least 10% of any quarterly payment will be made in common 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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to         
Commission file number 001-34569
Ellington Financial Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware

26-0489289
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
53 Forest Avenue
Old Greenwich, Connecticut, 06870
(Address of Principal Executive Offices) (Zip Code)
(203) 698-1200
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Trading Symbol(s)
 
Name of Each Exchange on Which Registered
Common Stock, $0.001 par value per share
 
EFC
 
The New York Stock Exchange
6.750% Series A Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock
 
EFC PR A
 
The New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes      No  
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes      No 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
Accelerated Filer
Non-Accelerated Filer
Smaller Reporting Company
 
 
Emerging Growth Company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes    No  x
As of June 28, 2019, the last business day of the Registrant's most recently completed second fiscal quarter, the aggregate market value of the Registrant's common shares held by non-affiliates was $477,738,614 based on the closing price as reported by the New York Stock Exchange on that date.
Number of shares of the Registrant's common stock outstanding as of March 6, 2020: 44,068,096
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement with respect to its 2020 Annual Meeting of Stockholders to be filed not later than 120 days after the end of the Registrant's fiscal year are incorporated by reference into Part III hereof as noted therein.


Table of Contents

ELLINGTON FINANCIAL INC.
INDEX
Item No.
 
Form 10-K Report Page
 
PART I
 
1.
3
1A.
14
1B.
52
2.
53
3.
53
4.
53
 
PART II
 
5.
53
6.
53
7.
53
7A.
85
8.
88
9.
205
9A.
205
 
PART III
 
10.
206
11.
206
12.
206
13.
206
14.
206
 
PART IV
 
15.
207
16.
208


Table of Contents

PART I
Item 1. Business
Except where the context suggests otherwise, references in this Annual Report on Form 10-K to "EFC," "we," "us," and "our" refer to (i) Ellington Financial Inc. and its consolidated subsidiaries, including Ellington Financial Operating Partnership LLC, our operating partnership subsidiary, which we refer to as our "Operating Partnership," following our conversion to a corporation effective March 1, 2019 (our "corporate conversion"), and (ii) Ellington Financial LLC and its consolidated subsidiaries, including our Operating Partnership, before our corporate conversion. References in this Annual Report on Form 10-K to (1) "common shares" refer to (i) our common shares representing limited liability company interests, previously outstanding prior to our corporate conversion, and (ii) shares of our common stock outstanding after our corporate conversion and (2) "common shareholders" refer to (i) holders of our common shares representing limited liability company interests prior to our corporate conversion, and (ii) holders of shares of our common stock after our corporate conversion. We conduct all of our operations and business activities through our Operating Partnership. Our "Manager" refers to Ellington Financial Management LLC, our external manager, "Ellington" refers to Ellington Management Group, L.L.C. and its affiliated investment advisory firms, including our Manager, and "Manager Group" refers collectively to officers and directors of EFC, and partners and affiliates of Ellington (including families and family trusts of the foregoing). In certain instances, references to our Manager and services to be provided to us by our Manager may also include services provided by Ellington and its other affiliates from time to time.
Special Note Regarding Forward-Looking Statements
When used in this Annual Report on Form 10-K, in future filings with the Securities and Exchange Commission, or the "SEC," or in press releases or other written or oral communications, statements which are not historical in nature, including those containing words such as "believe," "expect," "anticipate," "estimate," "project," "plan," "continue," "intend," "should," "would," "could," "goal," "objective," "will," "may," "seek," or similar expressions, are intended to identify "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, or the "Securities Act," and Section 21E of the Securities Exchange Act of 1934, as amended, or the "Exchange Act," and, as such, may involve known and unknown risks, uncertainties, and assumptions.
Forward-looking statements are based on our beliefs, assumptions, and expectations of our future operations, business strategies, performance, financial condition, liquidity and prospects, taking into account information currently available to us. These beliefs, assumptions, and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity, results of operations and strategies may vary materially from those expressed or implied in our forward-looking statements. The following factors are examples of those that could cause actual results to vary from our forward-looking statements: changes in interest rates and the market value of our securities; market volatility; changes in the prepayment rates on the mortgage loans underlying the securities owned by us for which the principal and interest payments are guaranteed by a U.S. government agency or a U.S. government-sponsored entity; increased rates of default and/or decreased recovery rates on our assets; our ability to borrow to finance our assets; changes in government regulations affecting our business; our ability to maintain our exclusion from registration under the Investment Company Act of 1940, as amended, or the "Investment Company Act"; our ability to qualify and maintain our qualification as a real estate investment trust, or "REIT"; and risks associated with investing in real estate assets, including changes in business conditions and the general economy. These and other risks, uncertainties and factors, including the risk factors described under Item 1A of this Annual Report on Form 10-K, could cause our actual results to differ materially from those projected or implied in any forward-looking statements we make. All forward-looking statements speak only as of the date on which they are made. New risks and uncertainties arise over time, and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Our Company
We were originally formed as a Delaware limited liability company in July 2007 and commenced operations in August 2007. Through December 31, 2018, we believe that we were organized and had operated so that we qualified to be treated for U.S. federal income tax purposes as a partnership and not as an association or a publicly traded partnership taxable as a corporation. In February 2019, we elected to be taxed as a corporation for U.S. federal income tax purposes effective as of January 1, 2019, and we will elect to be treated as a REIT for U.S. federal income tax purposes upon the filing of our tax return for the taxable year ended December 31, 2019. We believe that, commencing on January 1, 2019, we were organized in conformity with the requirements for qualification and taxation as a REIT under the U.S. federal income tax laws and that our manner of operation enables us to meet the requirements for qualification and taxation as a REIT. Effective March 1, 2019, we converted to a Delaware corporation and changed our name to Ellington Financial Inc. We acquire and manage mortgage-related, consumer-related, corporate-related, and other financial assets. Our primary objective is to generate attractive, risk-


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adjusted total returns for our stockholders by making investments that we believe compensate us appropriately for the risks associated with them. We seek to attain this objective by utilizing an opportunistic strategy. Our targeted asset classes currently include investments in the U.S. and Europe (as applicable) in the categories listed below. Subject to maintaining our qualification as a REIT, we expect to continue to invest in these targeted asset classes.
residential mortgage-backed securities, or "RMBS," for which the principal and interest payments are guaranteed by a U.S. government agency or a U.S. government-sponsored entity, or "Agency RMBS";
residential mortgage loans, including (i) mortgage loans that are not deemed "qualified mortgage," or "QM," loans under the rules of the Consumer Financial Protection Bureau, or "non-QM loans," (ii) non-performing and re-performing residential mortgage loans, or "residential NPLs," including "legacy" (i.e. issued before the 2008 financial crisis) NPLs, and (iii) residential transition loans;
RMBS backed by U.S. residential mortgage loans for which the principal and interest payments are not guaranteed by a U.S. government agency or a U.S. government-sponsored entity, or "non-Agency RMBS"; and RMBS backed by European residential mortgage loans, or "European RMBS";
commercial mortgage-backed securities, or "CMBS," commercial mortgage loans, and other commercial real estate debt;
consumer loans and asset-backed securities, or "ABS," including ABS backed by consumer loans;
collateralized loan obligations, or "CLOs";
mortgage-related and non-mortgage-related derivatives; and
other investments, including corporate debt and equity securities and corporate loans, and strategic investments in companies from which we purchase, or may in the future purchase, targeted assets.
Subject to qualifying and maintaining our qualification as a REIT, we opportunistically utilize derivatives and other hedging instruments to hedge our interest rate, credit, and foreign currency risk.
Our investments in residential and commercial mortgage loans may consist of performing, non-performing, or sub-performing loans. In addition, we may from time to time acquire real property. We also have made, and may in the future make, investments in the debt and/or equity of other entities engaged in loan-related businesses, such as loan originators and mortgage-related entities. In connection with investments in loan originators, we may also enter into flow agreements that will allow us to purchase new loans from the loan originators in which we invest in accordance with the parameters set forth in the applicable flow agreement. We also opportunistically engage in relative value trading strategies, whereby we seek to identify and capitalize on short-term pricing disparities in various equity and/or fixed-income markets. We have and may in the future also opportunistically acquire and manage other types of mortgage-related and financial assets not listed above, such as mortgage servicing rights, or "MSRs," and credit risk transfer securities, or "CRTs."
Our "credit portfolio," which includes all of our assets other than Agency RMBS, has historically been the primary driver of our risk and return, and we expect that this will continue in the near to medium term. We also maintain a highly leveraged portfolio of Agency RMBS to take advantage of opportunities in that market sector, to help maintain our exclusion from registration as an investment company under the Investment Company Act, and to help qualify and maintain our qualification as a REIT. Unless we acquire very substantial amounts of whole mortgage loans or there are changes to the rules and regulations applicable to us under the Investment Company Act and/or to our qualification as a REIT, we expect that we will continue to maintain some amount of Agency RMBS. For more information on our targeted assets, see "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Our Targeted Asset Classes."
Our Manager and Ellington
We are externally managed and advised by our Manager, an affiliate of Ellington, pursuant to a management agreement. Our Manager was formed solely to serve as our manager and does not have any other clients. In addition, our Manager currently does not have any employees and instead relies on the employees of Ellington to perform its obligations to us. Ellington is an investment management firm and registered investment advisor with a 25-year history of investing in a broad spectrum of mortgage-backed securities, or "MBS," and related derivatives.
The members of our management team include Michael Vranos, founder and Chief Executive Officer of Ellington, who serves as our Co-Chief Investment Officer; Laurence Penn, Vice Chairman and Chief Operating Officer of Ellington, who serves as our Chief Executive Officer and President and a member of our Board of Directors; Mark Tecotzky, a Managing Director of Ellington, who serves as our Co-Chief Investment Officer; JR Herlihy, a Director of Ellington, who serves as our Chief Financial Officer; Christopher Smernoff, who serves as our Chief Accounting Officer; Daniel Margolis, General Counsel of Ellington, who serves as our General Counsel; Vincent Ambrico, who serves as our Controller; and Jason Frank, Associate


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General Counsel of Ellington, who serves as our Deputy General Counsel and Secretary. Each of these individuals is an officer of our Manager.
Our Manager is responsible for administering our business activities and day-to-day operations and, pursuant to a services agreement between our Manager and Ellington, relies on the resources of Ellington to support our operations. Ellington has well-established portfolio management resources for each of our targeted asset classes and an established infrastructure supporting those resources. Through our relationship with our Manager, we benefit from Ellington's highly analytical investment processes, broad-based deal flow, extensive relationships in the financial community, financial and capital structuring skills, investment surveillance database, and operational expertise. For example, Ellington's analytic approach to the investment process involves collection of substantial amounts of data regarding historical performance of MBS collateral and MBS market transactions. Ellington analyzes this data to identify possible relationships and trends and develops financial models used to support our investment and risk management process. In addition, throughout Ellington's 25-year investing history, it has developed strong relationships with a wide range of dealers and other market participants that provide Ellington access to a broad range of trading opportunities and market information. As a result, Ellington provides us with access to a wide variety of asset acquisition and disposition opportunities and information that assist us in making asset management decisions across our targeted asset classes, which we believe provides us with a significant competitive advantage. We also benefit from Ellington's finance, accounting, operational, legal, compliance, and administrative functions.
As of December 31, 2019, Ellington had over 150 employees and had assets under management of approximately $9.8 billion, of which approximately $7.0 billion consisted of our company and Ellington Residential Mortgage REIT, a REIT listed on the New York Stock Exchange, or the "NYSE," under the ticker "EARN," that focuses its investment strategy primarily on Agency RMBS, and various hedge funds and other alternative investment vehicles that employ financial leverage, and approximately $2.8 billion consisted of accounts that do not employ financial leverage. The $9.8 billion and $7.0 billion in assets under management include approximately $1.4 billion in Ellington-managed CLOs. For these purposes, the Ellington-managed CLO figure represents the aggregate outstanding balance of CLO notes and market value of CLO equity, excluding any notes and equity held by other Ellington-managed funds and accounts.
Our Strategy
We utilize an opportunistic strategy to seek to generate attractive, risk-adjusted returns. We pursue value across various types of mortgage-related, consumer-related, corporate-related, and other financial assets, through investments primarily in securities and loans.
Our strategy is adaptable to changing market environments, subject to qualifying and maintaining our qualification as a REIT for U.S. federal income tax purposes and maintaining our exclusion from registration as an investment company under the Investment Company Act. As a result, although we focus on the targeted assets described in the section captioned "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Our Targeted Asset Classes," our acquisition and management decisions depend on prevailing market conditions and our targeted asset classes may vary over time in response to market conditions. We may engage in a high degree of trading volume as we implement our strategy. Our Manager is authorized to follow very broad investment guidelines and, as a result, we cannot predict our portfolio composition. We expect to hold certain of our targeted assets through one or more domestic taxable REIT subsidiaries, or "TRSs." As a result, a portion of the income from such assets will be subject to U.S. federal and state corporate income tax. We may change our strategy and policies without a vote of our stockholders. Moreover, although our independent directors may periodically review our investment guidelines and our portfolio, they generally do not review our proposed asset acquisitions or asset management decisions.
We believe that Ellington's capabilities allow our Manager to identify attractive assets, value these assets, monitor and forecast the performance of these assets, and opportunistically hedge our risk with respect to these assets. Ellington's continued emphasis on and development of proprietary credit, interest rate, and prepayment models, as well as other proprietary research and analytics, underscores the importance it places on a disciplined and analytical approach to fixed income investing. We leverage these skills and resources to seek to meet our investment objectives.
With respect to structured products including MBS, Ellington seeks investments across a wide range of sectors without any restriction as to ratings, structure, or position in the capital structure. Over time and through market cycles, opportunities will present themselves in varying sectors and in varying forms. By rotating between and allocating among various sectors of the structured product markets and adjusting the extent to which it hedges, Ellington believes that it is able to capitalize on the disparities between these sectors as well as on overall trends in the marketplace, and therefore provide better and more consistent returns for its investors. Disparities between sectors vary from time to time and are driven by a combination of factors. For example, as various structured product sectors fall in and out of favor, the relative yields that the market demands for those sectors may vary. In addition, Ellington's performance projections for certain sectors may differ from those of other


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market participants and such disparities will naturally cause us, from time to time, to gravitate towards certain sectors and away from others. Disparities between structured product sectors and individual securities within such sectors may also be driven by differences in collateral performance (for example, loans originated during certain periods of time when underwriting standards were generally stricter may on average perform better than loans originated during other times) and in the structure of particular investments (for example, in the timing of cash flows or the level of credit enhancement), and our Manager may believe that other market participants are overestimating or underestimating the value of these differences. Furthermore, we believe that risk management, including opportunistic portfolio hedging and prudent financing and liquidity management, is essential for consistent generation of attractive, risk-adjusted total returns across market cycles.
With respect to loans, we have tended to focus on underserved, niche market segments where inefficiencies exist, and where the segment's size or complexity could present a barrier to entry. Since the financial crisis, capital requirements and other regulations in the banking industry have curtailed bank origination and ownership of certain types of loans, and as a result, capital availability for certain loan products is lower than it was historically, thus creating better opportunities for Ellington to invest in these loan products. Ellington uses its deep network of industry relationships to source new loan investments. These relationships have generated a regular flow of investment opportunities from diversified sources, including flow agreements with certain loan origination partners. By investing opportunistically in both loans and securities, we believe that we are able to achieve attractive diversification and can take advantage of relative value across investment classes.
We believe that our Manager is uniquely qualified to implement our strategy. Our strategy is consistent with Ellington's investment approach, which is based on its distinctive strengths in sourcing, analyzing, trading, and hedging complex structured products. Furthermore, we believe that Ellington's extensive experience in buying, selling, analyzing, and structuring fixed income securities, coupled with its broad access to market information and trading flows, provides us with a steady flow of opportunities to acquire assets with favorable trade executions.
In executing our strategies, subject to qualifying and maintaining our qualification as a REIT, we employ a wide variety of hedging instruments and derivative contracts. See "—Risk Management" below.
Investment Process
Our investment process benefits from the resources and professionals of our Manager and Ellington. The process is managed by an investment and risk management committee, which includes, among others, the following three officers of our Manager: Messrs. Vranos, Penn, and Tecotzky. These officers of our Manager also serve as our Co-Chief Investment Officer, Chief Executive Officer, and Co-Chief Investment Officer, respectively. The investment and risk management committee operates under investment guidelines and meets periodically to develop a set of preferences for the composition of our portfolio. The primary focus of the investment and risk management committee, as it relates to us, is to review and approve our investment policies and our portfolio holdings and related compliance with our investment policies and guidelines, and to give guidance and oversight to the various investment teams that make our day-to-day investment decisions. The investment and risk management committee has authority delegated by our Board of Directors to authorize transactions consistent with our investment guidelines.
Ellington has focused investment teams for many of our targeted asset classes. Our asset acquisition process includes sourcing and screening of asset acquisition opportunities, credit analysis, due diligence, structuring, financing, and hedging, each as appropriate, to seek attractive total returns commensurate with our risk tolerance. Our asset acquisition process is also informed by our objective to maintain our exclusion from registration as an investment company under the Investment Company Act, and to qualify and maintain our qualification as a REIT for U.S. federal income tax purposes.
Valuation of Assets
Our Manager's valuation process is subject to the oversight of our Manager's valuation committee as well as the oversight of the independent members of our Board of Directors. See Note 2 of the notes to consolidated financial statements included in this report for a complete discussion of our valuation process.
Risk Management
Risk management is a cornerstone of Ellington's portfolio management process. Ellington's risk management infrastructure system includes "ELLiN," a proprietary portfolio management system used by all departments at Ellington, including trading, research, risk management, finance, operations, accounting, and compliance. We benefit from Ellington's comprehensive risk management infrastructure and ongoing assessment of both portfolio and operational risks. In addition, we utilize derivatives and other hedging instruments to opportunistically hedge our credit, interest rate, and foreign currency risk.


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Interest Rate Hedging
We opportunistically hedge our interest rate risk by using various hedging strategies to mitigate such risks, subject to qualifying and maintaining our qualification as a REIT and maintaining our exclusion from registration as an investment company under the Investment Company Act. The interest rate hedging instruments that we use and may use in the future include, without limitation:
To-Be-Announced mortgage pass-through certificates, or "TBAs";
interest rate swaps (including floating-to-fixed, fixed-to-floating, or more complex swaps such as floating-to-inverse floating, callable or non-callable);
collateralized mortgage obligations, or "CMOs";
U.S. Treasury securities;
swaptions, caps, floors, and other derivatives on interest rates;
futures and forward contracts; and
options on any of the foregoing.
In particular, from time to time we enter into short positions in interest rate swaps to offset the potential adverse effects that changes in interest rates would have on the value of certain of our assets and our financing costs. An interest rate swap is an agreement to exchange interest rate cash flows, calculated on a notional principal amount, at specified payment dates during the life of the agreement. Typically, one party pays a fixed interest rate and receives a floating interest rate and the other party pays a floating interest rate and receives a fixed interest rate. Each party's payment obligation is computed using a different interest rate. In an interest rate swap, the notional principal is generally not exchanged.
Credit Risk Hedging
Subject to qualifying and maintaining our qualification as a REIT, we enter into credit-hedging positions in order to protect against adverse credit events with respect to certain of our credit assets. Our credit hedging portfolio can vary significantly from period to period, and can encompass a wide variety of financial instruments, including corporate debt or equity-related instruments, RMBS or CMBS-related instruments, or instruments involving other markets. Our hedging instruments can include both "single-name" instruments (i.e., instruments referencing one underlying entity or security) and hedging instruments referencing indices. We also often opportunistically overlay our credit hedges with certain relative value long/short positions involving the same or similar instruments.
Foreign Currency Hedging
To the extent we hold instruments denominated in currencies other than U.S. dollars, we may enter into transactions to offset the potential adverse effects of changes in currency exchange rates, subject to qualifying and maintaining our qualification as a REIT. In particular, we may use currency forward contracts and other currency-related derivatives to mitigate this risk.
Our Financing Strategies and Use of Leverage
We finance our assets with what we believe to be a prudent amount of leverage, the level of which varies from time to time based upon the particular characteristics of our portfolio, availability of financing, and market conditions. As of December 31, 2019, the majority of our debt financings consisted of repurchase agreements, or "repos." Currently, the majority of our repos are collateralized by Agency RMBS; however, we also have repo borrowings that are collateralized by our credit assets, and, from time to time, U.S. Treasury securities. In a repo, we sell an asset to a counterparty at a discounted value, or the loan amount, and simultaneously agree to repurchase the same asset from such counterparty at a specified later date at a price equal to the loan amount plus an interest factor. Despite being legally structured as sales and subsequent repurchases, repos are accounted for as collateralized borrowings. During the term of a repo, we generally receive the income and other payments distributed with respect to the underlying assets, and pay interest to the counterparty. While the proceeds of our repo financings are often used to purchase the assets subject to the transaction, our financing arrangements do not restrict our ability to use proceeds from these arrangements to support our other liquidity needs. Our repo arrangements are typically documented under the Securities Industry and Financial Markets Association's, or "SIFMA's," standard form master repurchase agreement with the ability for both parties to demand margin (i.e., to demand that the other party post additional collateral or repay a portion of the funds advanced) should the value of the underlying assets and posted collateral change. As the value of our collateral fluctuates, under most of our master repurchase agreements, we and our repo counterparties are required to post additional collateral to each other from time to time as part of the normal course of our business. Our repo financing counterparties generally have the right, to varying degrees, to determine the value of the underlying collateral for margining purposes, subject to the terms and


7


conditions of our agreement with the counterparty.
In addition to using repos to finance many of our assets, we have also entered into securitization transactions, and secured borrowing facilities, to finance other assets. For those secured financings, other than repos, for which the associated transfer of assets is not accounted for as a sale, the associated borrowings are included under the captions Other secured borrowings and Other secured borrowings, at fair value, on our Consolidated Balance Sheet. In addition, we have issued senior notes, or "Senior Notes," that are unsecured and are effectively subordinated to our secured indebtedness, to the extent of the value of the collateral securing such indebtedness. Finally, we have also raised equity capital to finance acquisitions of our targeted assets, including through public offerings of our common stock and our 6.750% Series A Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, $0.001 par value per share ("Series A Preferred Stock").
We may utilize other types of borrowings in the future, including more complex financing structures. We also may raise capital by issuing additional debt securities, additional preferred or common stock, warrants, or other securities.
Our use of leverage, especially in order to increase the amount of assets supported by our capital base, may have the effect of increasing losses when these assets underperform. Our investment policies require no minimum or maximum leverage, and our Manager's investment and risk management committee has the discretion, without the need for further approval by our Board of Directors, to change both our overall leverage and the leverage used for individual asset classes. Because our strategy is flexible, dynamic, and opportunistic, our overall leverage will vary over time. As a result, we do not have a targeted debt-to-equity ratio.
Management Agreement
We entered into a management agreement with our Manager upon our inception in August 2007, pursuant to which our Manager provides for the day-to-day management of our operations.
The management agreement, as amended, requires our Manager to manage our assets, operations, and affairs in conformity with the policies and the investment guidelines that are approved and monitored by our Board of Directors. Our Manager is under the supervision and direction of our Board of Directors. Our Manager is responsible for:
the selection, purchase, and sale of assets in our portfolio;
our financing and risk management activities;
providing us with advisory services; and
providing us with a management team, inclusive of a partially dedicated Chief Financial Officer and appropriate support personnel as necessary.
Our Manager is responsible for our day-to-day operations and performs (or causes to be performed) such services and activities relating to the management, operation, and administration of our assets and liabilities, and business as may be appropriate.
Under the management agreement, we pay our Manager a management fee quarterly in arrears, which includes a "base" component and an "incentive" component, and we reimburse certain expenses of our Manager.
If we invest at issuance in the equity of any collateralized debt obligation, or "CDO," that is managed, structured, or originated by Ellington or one of its affiliates, or if we invest in any other investment fund or other investment for which Ellington or one of its affiliates receives management, origination, or structuring fees, then, unless agreed otherwise by a majority of our independent directors, the base management and incentive fees payable by us to our Manager will be reduced by (or our Manager will otherwise rebate to us) an amount equal to the applicable portion (as described in the management agreement) of any such management, origination, or structuring fees.
The management agreement provides that 10% of each incentive fee payable to our Manager is to be paid in common shares, with the balance paid in cash; provided, however, that our Manager may, in its sole discretion, elect to receive a greater percentage of any incentive fee in the form of common shares by providing our Board of Directors with written notice of its election to receive a greater percentage of its incentive fee in common shares before the first day of the last calendar month in the quarter to which such incentive fee relates. Our management agreement further provides that our Manager may not elect to receive common shares as payment of its incentive fee, other than in accordance with all applicable securities exchange rules and securities laws (including prohibitions on insider trading). The number of our common shares to be received by our Manager is based on the fair market value of those common shares, which is determined based on the average of the closing prices of our common shares as reported by the NYSE during the last calendar month of the quarter to which such incentive fee relates. Common shares delivered as payment of the incentive fee are immediately vested, provided that our Manager has agreed not to sell such common shares prior to one year after the date they are issued to our Manager, provided further,


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however, that this transfer restriction will immediately lapse if the management agreement is terminated.
Base Management Fees, Incentive Fees, and Reimbursement of Expenses
Base Management Fees
Under the management agreement, we pay our Manager a base management fee quarterly in arrears in an amount equal to 1.50% per annum of the equity of the Operating Partnership (calculated in accordance with U.S Generally Accepted Accounting Principles, or "U.S. GAAP") as of the end of each fiscal quarter (before deductions for base management and incentive fees payable with respect to such fiscal quarter), provided that the equity of the Operating Partnership is adjusted to exclude one-time events pursuant to changes in U.S. GAAP, as well as non-cash charges after discussion between our Manager and our independent directors, and approval by a majority of our independent directors in the case of non-cash charges.
Incentive Fees
In addition to the base management fee, with respect to each fiscal quarter we pay our Manager an incentive fee equal to the excess, if any, of (i) the product of (A) 25% and (B) the excess of (1) our Adjusted Net Income (described below) for the Incentive Calculation Period (which means such fiscal quarter and the immediately preceding three fiscal quarters) over (2) the sum of the Hurdle Amounts (described below) for the Incentive Calculation Period, over (ii) the sum of the incentive fees already paid or payable for each fiscal quarter in the Incentive Calculation Period preceding such fiscal quarter.
For purposes of calculating the incentive fee, "Adjusted Net Income" for the Incentive Calculation Period means the net increase/(decrease) in equity resulting from operations of the Operating Partnership (or such equivalent U.S. GAAP measure based on the basis of presentation of our consolidated financial statements), after all base management fees but before any incentive fees for such period, and excluding any non-cash equity compensation expenses for such period, as reduced by any Loss Carryforward (as described below) as of the end of the fiscal quarter preceding the Incentive Calculation Period. Adjusted Net Income will be adjusted to exclude one-time events pursuant to changes in U.S. GAAP, as well as non-cash charges after discussion between our Manager and our independent directors and approval by a majority of our independent directors in the case of non-cash charges.
For purposes of calculating the incentive fee, the "Loss Carryforward" as of the end of any fiscal quarter is calculated by determining the excess, if any, of (1) the Loss Carryforward as of the end of the immediately preceding fiscal quarter over (2) the net increase in equity resulting from operations of the Operating Partnership (expressed as a positive number) or the net decrease in equity resulting from operations of the Operating Partnership (expressed as a negative number) for such fiscal quarter (or such equivalent U.S. GAAP measures as may be appropriate depending on the basis of presentation of our consolidated financial statements), as the case may be, calculated in accordance with U.S. GAAP, adjusted to exclude one-time events pursuant to changes in U.S. GAAP, as well as non-cash charges after discussion between our Manager and our independent directors and approval by a majority of our independent directors in the case of non-cash charges.
For purposes of calculating the incentive fee, the "Hurdle Amount" means, with respect to any fiscal quarter, the product of (i) one-fourth of the greater of (A) 9% and (B) 3% plus the 10-year U.S. Treasury rate for such fiscal quarter, (ii) the sum of (A) the weighted average gross proceeds per share of all common share and operating partnership unit, or "OP Unit," issuances since our inception and up to the end of such fiscal quarter, with each issuance weighted by both the number of shares and OP Units issued in such issuance and the number of days that such issued shares and OP Units were outstanding during such fiscal quarter, using a first-in first-out basis of accounting (i.e., attributing any share and OP Unit repurchases to the earliest issuances first) and (B) the result obtained by dividing (I) retained earnings attributable to common shares and OP Units at the beginning of such fiscal quarter by (II) the average number of common shares and OP Units outstanding for each day during such fiscal quarter, (iii) the sum of (x) the average number of common shares and long term incentive plan units, or "LTIP Units," outstanding for each day during such fiscal quarter and (y) the average number of OP Units, and limited liability company interests in the Operating Partnership which are designated as LTIP Units, or "OP LTIP Units," outstanding for each day during such fiscal quarter. For purposes of determining the Hurdle Amount, issuances of common shares, OP LTIP Units and OP Units (a) as equity incentive awards, (b) to the Manager as part of its base management fee or incentive fee and (c) to the Manager or any of its affiliates in privately negotiated transactions, are excluded from the calculation. The payment of the incentive fee will be in a combination of common shares and cash, provided that at least 10% of any quarterly payment will be made in common shares.
Reimbursement of Expenses
We do not maintain an office or employ personnel. We rely on the facilities and resources of our Manager to conduct our operations. We pay all of our direct operating expenses, except those specifically required to be borne by our Manager under the management agreement. Our Manager is responsible for all costs incident to the performance of its duties under the


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management agreement, including compensation of Ellington's employees and other related expenses, other than our allocable portion of the costs incurred by our Manager for certain dedicated or partially dedicated employees including a Chief Financial Officer, one or more controllers, an in-house legal counsel, an investor relations professional, certain internal audit staff in connection with Sarbanes-Oxley compliance initiatives and certain other personnel performing duties for us, based on the portion of their working time and efforts spent on our matters and subject to approval of the reimbursed amounts by the Compensation Committee of the Board of Directors. In addition, other than as expressly described in the management agreement, we are not required to pay any portion of rent, telephone, utilities, office furniture, equipment, machinery, and other office, internal and overhead expenses of our Manager and its affiliates. Expense reimbursements to our Manager are generally made within 60 days following delivery of the expense statement by our Manager.
Term and Termination
The management agreement has a current term that expires on December 31, 2020, and will automatically renew for a one year term on each anniversary date thereafter unless notice of non-renewal is delivered by either party to the other party at least 180 days prior to the expiration of the then current term. Our independent directors review our Manager's performance annually, and the management agreement may be terminated annually upon the affirmative vote of at least two-thirds of our independent directors, or by the affirmative vote of the holders of at least a majority of the outstanding common shares, based upon unsatisfactory performance by our Manager that is materially detrimental to us or a determination by our independent directors that the fees payable to our Manager are not fair, subject to our Manager's right to prevent a fee-based termination by accepting a mutually acceptable reduction of its fees. In the event we terminate the management agreement without cause or elect not to renew the management agreement, we will be required to pay our Manager a termination fee equal to the amount of three times the sum of (i) the average annual base management fee earned by our Manager during the 24-month period immediately preceding the date of notice of termination or non-renewal, calculated as of the end of the most recently completed fiscal quarter prior to the date of notice of termination or non-renewal and (ii) the average annual incentive fee earned by our Manager during the 24-month period immediately preceding the date of notice of termination or non-renewal, calculated as of the end of the most recently completed fiscal quarter prior to the date of notice of termination or non-renewal.
We may also terminate the management agreement without payment of the termination fee with 30 days prior written notice from our Board of Directors for cause, which is defined as:
our Manager's continued material breach of any provision of the management agreement following a period of 30 days after written notice of such breach;
our Manager's fraud, misappropriation of funds, or embezzlement against us;
our Manager's gross negligence in performance of its duties under the management agreement;
the occurrence of certain events with respect to the bankruptcy or insolvency of our Manager, including, but not limited to, an order for relief in an involuntary bankruptcy case or our Manager authorizing or filing a voluntary bankruptcy petition;
the dissolution of our Manager; and
certain changes of control of our Manager, including but not limited to the departure of Mr. Vranos from senior management of Ellington, whether through resignation, retirement, withdrawal, long-term disability, death or termination of employment with or without cause or for any other reason.
Our Manager may terminate the management agreement effective upon 60 days prior written notice of termination to us in the event that we default in the performance or observance of any material term, condition or covenant in the management agreement and the default continues for a period of 30 days after written notice to us specifying the default and requesting that the default be remedied in such 30-day period. In the event our Manager terminates the management agreement due to our default in the performance or observance of any material term, condition, or covenant in the management agreement, we will be required to pay our Manager the termination fee. Our Manager may also terminate the management agreement in the event we become regulated as an investment company under the Investment Company Act, with such termination deemed to occur immediately prior to such event; provided, however, that in the case of such termination, if our Manager was not at fault for our becoming regulated as an investment company under the Investment Company Act, we will be required to pay the termination fee.
Conflicts of Interest; Equitable Allocation of Opportunities
Ellington manages, and expects to continue to manage, other funds, accounts, and vehicles that have strategies that are similar to, or that overlap with, our strategy, including Ellington Residential Mortgage REIT, a REIT listed on the NYSE that focuses its investment strategy primarily on Agency RMBS. As of December 31, 2019, Ellington managed various funds, accounts, and other vehicles, comprising approximately $8.7 billion of assets under management (excluding our assets but


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including $2.8 billion of accounts that do not employ financial leverage), with strategies that are similar to, or that overlap with, our strategy. The $8.7 billion in assets under management include approximately $1.4 billion in Ellington-managed CLOs. For these purposes, the Ellington-managed CLO figure represents the aggregate outstanding balance of CLO notes and market value of CLO equity, excluding any notes and equity held by other Ellington-managed funds and accounts. Ellington makes available to our Manager all opportunities to acquire assets that it determines, in its reasonable and good faith judgment, based on our objectives, policies and strategies, and other relevant factors, are appropriate for us in accordance with Ellington's written investment allocation policy, it being understood that we might not participate in each such opportunity, but will on an overall basis equitably participate with Ellington's other accounts in all such opportunities. Ellington's Investment and Risk Management Committee and its Compliance Committee (headed by its Chief Compliance Officer) are responsible for monitoring the administration of, and facilitating compliance with, Ellington's investment allocation procedures and policies.
Because many of our targeted assets are typically available only in specified quantities and are also targeted assets for other Ellington accounts, Ellington often is not able to buy as much of any given asset as required to satisfy the needs of all its accounts. In these cases, Ellington's investment allocation procedures and policies typically allocate such assets to multiple accounts in proportion to their needs and available capital. Ellington may at times allocate opportunities on a preferential basis to accounts that are in a "start-up" or "ramp-up" phase. The policies permit departure from such proportional allocation under certain circumstances, including, for example, when such allocation would result in an inefficiently small amount of the security or assets being purchased for an account. In that case, the policies allow for a protocol of allocating assets so that, on an overall basis, each account is treated equitably. In addition, as part of these policies, we may be excluded from specified allocations of assets for tax, regulatory, risk management, or similar reasons.
Other policies of Ellington that our Manager applies to the management of our company include controls for:
Cross Transactions—defined as transactions between us or one of our subsidiaries, on the one hand, and an account (other than us or one of our subsidiaries) managed by Ellington or our Manager, on the other hand. It is Ellington's policy to engage in a cross transaction only when the transaction is in the best interests of, and is consistent with the objectives and policies of, both accounts involved in the transaction. Pursuant to the terms of the management agreement, Ellington or our Manager may enter into cross transactions where it acts both on our behalf and on behalf of the other party to the transaction. Although we believe such restrictions on our Manager's ability to engage in cross transactions on our behalf mitigate many risks, cross transactions, even at market prices, may potentially create a conflict of interest between our Manager's and our officers' duties to and interests in us and their duties to and interests in the other party. Upon written notice to our Manager, we may at any time revoke our consent to our Manager's executing cross transactions. Additionally, unless approved in advance by a majority of our independent directors or pursuant to and in accordance with a policy that has been approved by a majority of our independent directors, all cross transactions must be effected at the then-prevailing market prices. Pursuant to our Manager's current policies and procedures, assets for which there are no readily observable market prices may be purchased or sold in cross transactions (i) at prices based upon third-party bids received through auction, (ii) at the average of the highest bid and lowest offer quoted by third-party dealers, or (iii) according to another pricing methodology approved by our Manager's Chief Compliance Officer.
Principal Transactions—defined as transactions between Ellington or our Manager (or any related party of Ellington or our Manager, which includes employees of Ellington and our Manager and their families), on the one hand, and us or one of our subsidiaries, on the other hand. Certain cross transactions may also be considered principal transactions whenever our Manager or Ellington (or any related party of Ellington or our Manager, which includes employees of Ellington and our Manager and their families) have a substantial ownership interest in one of the transacting parties. Our Manager is only authorized to execute principal transactions with the prior approval of a majority of our independent directors and in accordance with applicable law. Such prior approval includes approval of the pricing methodology to be used, including with respect to assets for which there are no readily observable market prices.
Investment in Other Ellington Accounts—pursuant to our management agreement, if we invest at issuance in the equity of any CDO that is managed, structured, or originated by Ellington or one of its affiliates, or if we invest in any other investment fund or other investment for which Ellington or one of its affiliates receives management, origination, or structuring fees, then, unless agreed otherwise by a majority of our independent directors, the base management and incentive fees payable by us to our Manager will be reduced by (or our Manager will otherwise rebate to us) an amount equal to the applicable portion (as described in the management agreement) of any such management, origination or structuring fees.
Split Price Executions—pursuant to our management agreement, our Manager is authorized to combine purchase or sale orders on our behalf together with orders for other accounts managed by Ellington, our Manager or their affiliates and allocate the securities or other assets so purchased or sold, on an average price basis or other fair and consistent basis, among such accounts.


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Our Manager is authorized to follow very broad investment guidelines. Our independent directors will periodically review our investment guidelines and our portfolio. However, our independent directors generally will not review our proposed asset acquisitions, dispositions, or other management decisions. In addition, in conducting periodic reviews, our independent directors will rely primarily on information provided to them by our Manager. Furthermore, our Manager may arrange for us to use complex strategies or to enter into complex transactions that may be difficult or impossible to unwind by the time they are reviewed by our independent directors. Our Manager has great latitude within our broad investment guidelines to determine the types of assets it may decide are proper for purchase by us. The management agreement with our Manager does not restrict the ability of its officers and employees from engaging in other business ventures of any nature, whether or not such ventures are competitive with our business. We may acquire assets from entities affiliated with our Manager, even where the assets were originated by such entities. Affiliates of our Manager may also provide services to entities in which we have invested.
Our executive officers and the officers and employees of our Manager are also officers and employees of Ellington, and we compete with other Ellington accounts for access to these individuals. We have not adopted a policy that expressly prohibits our directors, officers, security holders, or affiliates from having a direct or indirect pecuniary interest in any asset to be acquired or disposed of by us or any of our subsidiaries or in any transaction to which we or any of our subsidiaries is a party or has an interest, nor do we have a policy that expressly prohibits any such persons from engaging for their own account in business activities of the types conducted by us. However, our code of business conduct and ethics contains a conflicts of interest policy that prohibits our directors, officers, and employees, as well as employees of our Manager who provide services to us, from engaging in any transaction that involves an actual or apparent conflict of interest with us, absent approval by the Board of Directors or except as expressly set forth above or as provided in the management agreement between us and our Manager. In addition, nothing in the management agreement binds or restricts our Manager or any of its affiliates, officers, or employees from buying, selling, or trading any securities or commodities for their own accounts or for the accounts of others for whom our Manager or any of its affiliates, officers, or employees may be acting.
Competition
In acquiring our assets, we compete with other mortgage REITs, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, financial institutions, governmental bodies, and other entities. Many of our competitors are significantly larger than us, have greater access to capital and other resources, and may have other advantages over us. Our competitors may include other investment vehicles managed by Ellington or its affiliates, including Ellington Residential Mortgage REIT. In addition to existing companies, other companies may be organized for similar purposes in the future, including companies focused on purchasing mortgage assets. A proliferation of such companies may increase the competition for equity capital and thereby adversely affect the market price of our common or preferred stock. An increase in the competition for sources of funding could adversely affect the availability and cost of financing, and thereby adversely affect the market price of our common or preferred stock. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of assets, or pay higher prices, than we can.
In the face of this competition, we have access to our Manager's and Ellington's professionals and their industry expertise, which may provide us with a competitive advantage and help us assess risks and determine appropriate pricing for certain potential assets. In addition, we believe that these relationships enable us to compete more effectively for attractive asset acquisition opportunities. However, we may not be able to achieve our business goals or expectations due to the competitive risks that we face.
Operating and Regulatory Structure
Tax Requirements
We will elect to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, or "the Code," upon the filing of our tax return for the taxable year ended December 31, 2019. For the year ended December 31, 2019, we believe that we were organized in conformity with, and have operated in a manner that has enabled us to meet, the requirements for qualification as a REIT for U.S. federal income tax purposes. Provided that we qualify and maintain our qualification as a REIT, we generally will not be subject to U.S. federal income tax on our REIT taxable income that is currently distributed to our stockholders. REITs are subject to a number of organizational and operational requirements, including a requirement that they currently distribute at least 90% of their annual REIT taxable income excluding net capital gains. We cannot assure you that we will be able to comply with such requirements. Failure to qualify as a REIT in any taxable year would cause us to be subject to U.S. federal income tax on our taxable income at regular corporate rates (and any applicable state and local taxes). Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state, local, and non-U.S. taxes on our income. For example, any income generated by our domestic TRSs will be subject to U.S. federal, state, and local income tax. Any taxes paid by a TRS will reduce the cash available for distribution to our stockholders.


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Investment Company Act Exclusions
Most of our business is conducted through various wholly-owned and majority-owned subsidiaries in a manner such that neither we nor our subsidiaries are subject to registration under the Investment Company Act. Under Section 3(a)(1) of the Investment Company Act, a company is deemed to be an "investment company" if:
it is, or holds itself out as being, engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities (Section 3(a)(1)(A)); or
it is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities and does own or proposes to acquire "investment securities" having a value exceeding 40% of the value of its total assets (excluding U.S. government securities and cash) on an unconsolidated basis, or "the 40% Test" (Section 3(a)(1)(C)). "Investment securities" excludes U.S. government securities and securities of majority-owned subsidiaries that are not themselves investment companies and are not relying on the exception from the definition of investment company for private funds under Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act.
We believe that we and our Operating Partnership, and a holding company subsidiary of our Operating Partnership, or the "Holding Subsidiary," will not be considered investment companies under Section 3(a)(1) of the Investment Company Act, because we and they satisfy the 40% Test and because we and they do not engage primarily (or hold ourselves or themselves out as being engaged primarily) in the business of investing, reinvesting, or trading in securities. Rather, through wholly-owned or majority-owned subsidiaries, we, our Operating Partnership, and the Holding Subsidiary are primarily engaged in the non-investment company businesses of these subsidiaries.
Our Operating Partnership currently has several subsidiaries that rely on the exclusion provided by Section 3(c)(7) of the Investment Company Act, each a "3(c)(7) subsidiary." In addition, the Holding Subsidiary currently has several 3(c)(7) subsidiaries and several subsidiaries that rely on the exclusion provided by Section 3(c)(5)(C) of the Investment Company Act, each a "3(c)(5)(C) subsidiary." While investments in 3(c)(7) subsidiaries are considered investment securities for the purposes of the 40% Test, investments in 3(c)(5)(C) subsidiaries are not considered investment securities for the purposes of the 40% Test, nor are investments in subsidiaries that rely on the exclusion provided by Section 3(a)(1)(C).
Therefore, our Operating Partnership's investments in its 3(c)(7) subsidiaries and its other investment securities cannot exceed 40% of the value of our Operating Partnership's total assets (excluding U.S. government securities and cash) on an unconsolidated basis. In addition, the Holding Subsidiary's investment in its 3(c)(7) subsidiaries and its other investment securities cannot exceed 40% of the value of our Holding Subsidiary's total assets (excluding U.S. government securities and cash) on an unconsolidated basis.
Section 3(c)(5)(C) of the Investment Company Act is designed for entities primarily engaged in the business of "purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." This exclusion generally requires that at least 55% of the entity's assets on an unconsolidated basis consist of qualifying real estate assets and at least 80% of the entity's assets on an unconsolidated basis consist of qualifying real estate assets or real estate-related assets. Both the 40% Test and the requirements of the Section 3(c)(5)(C) exclusion limit the types of businesses in which we may engage and the types of assets we may hold, as well as the timing of sales and purchases of assets.
On August 31, 2011, the SEC published a concept release entitled "Companies Engaged in the Business of Acquiring Mortgages and Mortgage Related Instruments" (Investment Company Act Rel. No. 29778). This release notes that the SEC is reviewing the Section 3(c)(5)(C) exclusion relied upon by companies similar to us that invest in mortgage loans and mortgage-backed securities. There can be no assurance that the laws and regulations governing the Investment Company Act status of companies similar to ours, or the guidance from the Division of Investment Management of the SEC regarding the treatment of assets as qualifying real estate assets or real estate-related assets, will not change in a manner that adversely affects our operations as a result of this review. To the extent that the SEC staff provides more specific guidance regarding any of the matters bearing upon our exclusion from the need to register under the Investment Company Act, we may be required to adjust our strategy accordingly. Any additional guidance from the SEC staff could provide additional flexibility to us, or it could further inhibit our ability to pursue the strategies that we have chosen. Furthermore, although we intend to monitor the assets of our 3(c)(5)(C) subsidiaries regularly, there can be no assurance that any such subsidiary will be able to maintain this exclusion from registration. In that case, our investment in any such subsidiary would be classified as an investment security, and we might not be able to maintain our overall exclusion from registering as an investment company under the Investment Company Act.
If we or our subsidiaries were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the Investment Company Act), and portfolio composition, including restrictions with respect to diversification and industry concentration and other matters. Compliance


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with the restrictions imposed by the Investment Company Act would require us to make material changes to our strategy which could materially adversely affect our business, financial condition and results of operations, and our ability to make distributions to our stockholders. Accordingly, to avoid that result, we may be required to adjust our strategy, which could limit our ability to make certain investments or require us to sell assets in a manner, at a price or at a time that we otherwise would not have chosen. This could negatively affect the value of our common or preferred stock, the sustainability of our business model and our ability to make distributions. See "Item 1A. Risk Factors—Maintenance of our exclusion from registration as an investment company under the Investment Company Act imposes significant limitations on our operations."
Investment Advisers Act of 1940
Both Ellington and our Manager are registered as investment advisers under the Investment Advisers Act of 1940, as amended, and are subject to the regulatory oversight of the Division of Investment Management of the SEC.
Staffing
We have no employees. All of our executive officers, and our dedicated or partially dedicated personnel, which include our Chief Financial Officer, Chief Accounting Officer, controller, accounting staff, in-house legal counsel, internal audit staff, and other personnel providing services to us are employees of Ellington or one or more of its affiliates. See "—Management Agreement" above.
Additional Information
A copy of this Annual Report on Form 10-K, as well as our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available, free of charge, on our internet website at www.ellingtonfinancial.com. All of these reports are made available on our internet website as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Our Corporate Governance Guidelines and Code of Business Conduct and Ethics and the charters of the Audit, Compensation and Nominating and Corporate Governance Committees of our Board of Directors are also available at www.ellingtonfinancial.com and are available in print to any stockholder upon request in writing to Ellington Financial LLC, c/o Investor Relations, 53 Forest Avenue, Old Greenwich, CT 06870. The information on our website is not, and shall not be deemed to be, a part of this report or incorporated into any other filing we make with the SEC.
In addition, all of our reports filed with or furnished to the SEC can be obtained at the SEC's website at www.sec.gov.
Item 1A. Risk Factors
If any of the following risks occurs, our business, financial condition or results of operations could be materially and adversely affected. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us, or not presently deemed material by us, may also impair our operations and performance. In connection with the forward-looking statements that appear in our periodic reports on Form 10-Q and Form 10-K, our Current Reports on Form 8-K, our press releases and our other written and oral communications, you should also carefully review the cautionary statements referred to in such reports and other communications referred to under "Special Note Regarding Forward-Looking Statements."
Risks Related To Our Business
Difficult conditions in the mortgage and residential real estate markets as well as general market concerns may adversely affect the value of the assets in which we invest.
Our business is materially affected by conditions in the residential mortgage market, the residential real estate market, the financial markets, and the economy, including inflation, energy costs, unemployment, geopolitical issues, concerns over the creditworthiness of governments worldwide and the stability of the global banking system. In particular, the residential mortgage markets in the U.S. and Europe have experienced a variety of difficulties and challenging economic conditions in the past, including defaults, credit losses, and liquidity concerns. Certain commercial banks, investment banks, insurance companies, and mortgage-related investment vehicles incurred extensive losses from exposure to the residential mortgage market as a result of these difficulties and conditions. These factors have impacted, and may in the future impact, investor perception of the risks associated with residential mortgage loans, RMBS, other real estate-related securities and various other asset classes in which we may invest. As a result, values for residential mortgage loans, RMBS, other real estate-related securities and various other asset classes in which we may invest have experienced, and may in the future experience, significant volatility. Any deterioration of the mortgage market and investor perception of the risks associated with residential mortgage loans, RMBS, other real estate-related securities, and various other assets that we acquire could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.


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The federal conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship between Fannie Mae, Freddie Mac, and Ginnie Mae and the U.S. Government, may materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
The payments we receive on our Agency RMBS depend upon a steady stream of payments on the underlying mortgages and such payments are guaranteed by the Federal National Mortgage Association, or "Fannie Mae," the Federal Home Loan Mortgage Corporation, or "Freddie Mac," or the Government National Mortgage Association, within the U.S. Department of Housing and Urban Development, or "Ginnie Mae." Fannie Mae and Freddie Mac are government-sponsored enterprises, or "GSEs," but their guarantees are not backed by the full faith and credit of the United States. Ginnie Mae, which guarantees MBS backed by federally insured or guaranteed loans primarily consisting of loans insured by the Federal Housing Administration, or "FHA," or guaranteed by the Department of Veterans Affairs, or "VA," is part of a U.S. Government agency and its guarantees are backed by the full faith and credit of the United States.
In September 2008, in response to the deteriorating financial condition of Fannie Mae and Freddie Mac, the U.S. Government placed Fannie Mae and Freddie Mac into the conservatorship of the Federal Housing Finance Agency, or "FHFA," their federal regulator, pursuant to its powers under The Federal Housing Finance Regulatory Reform Act of 2008, a part of the Housing and Economic Recovery Act of 2008. Under this conservatorship, Fannie Mae and Freddie Mac are required to reduce the amount of mortgage loans they own or for which they provide guarantees on Agency RMBS.
Shortly after Fannie Mae and Freddie Mac were placed in federal conservatorship, the Secretary of the U.S. Treasury noted that the guarantee structure of Fannie Mae and Freddie Mac required examination and that changes in the structures of the entities were necessary to reduce risk to the financial system. The future roles of Fannie Mae and Freddie Mac could be significantly reduced, and the nature of their guarantees could be considerably limited relative to historical measurements or even eliminated. The substantial financial assistance provided by the U.S. Government to Fannie Mae and Freddie Mac, especially in the course of their being placed into conservatorship and thereafter, together with the substantial financial assistance provided by the U.S. Government to the mortgage-related operations of other GSEs and government agencies, such as the FHA, VA, and Ginnie Mae, has stirred debate among many federal policymakers over the continued role of the U.S. Government in providing such financial support for the mortgage-related GSEs in particular, and for the mortgage and housing markets in general.
In September 2019, the U.S. Treasury and the U.S. Department of Housing and Urban Development, or "HUD," announced plans for housing finance reform, which included the goals of ending the conservatorship of the GSEs and reducing the market share of the GSEs vis-à-vis private capital. However, no definitive proposals or legislation have been released or enacted with respect to ending the conservatorship, unwinding the GSEs or a material reduction in the roles of the GSEs in the U.S. mortgage market, and it is not possible at this time to predict the scope and nature of the actions that the U.S. Government will ultimately take with respect to these GSEs.
Fannie Mae, Freddie Mac, and Ginnie Mae could each be dissolved, and the U.S. Government could determine to stop providing liquidity support of any kind to the mortgage market. If Fannie Mae, Freddie Mac, or Ginnie Mae were eliminated, or their structures were to change radically, or if the U.S. Government significantly reduced its support for any or all of them, we may be unable or significantly limited in our ability to acquire Agency RMBS, which would drastically reduce the amount and type of Agency RMBS available for purchase which, in turn, could materially adversely affect our ability to maintain our exclusion from registration as an investment company under the Investment Company Act and our ability to qualify and maintain our qualification as a REIT. Moreover, any changes to the nature of the guarantees provided by, or laws affecting, Fannie Mae, Freddie Mac, and Ginnie Mae could materially adversely affect the credit quality of the guarantees, could increase the risk of loss on purchases of Agency RMBS issued by these GSEs and could have broad adverse market implications for the Agency RMBS they currently guarantee. Any action that affects the credit quality of the guarantees provided by Fannie Mae, Freddie Mac, and Ginnie Mae could materially adversely affect the value of our Agency RMBS. In addition, any market uncertainty that arises from such proposed changes could have a similar impact on us and our Agency RMBS.
In addition, we rely on our Agency RMBS as collateral for our financings under the repos that we enter into. Any decline in their value, or perceived market uncertainty about their value, would make it more difficult for us to obtain financing on our Agency RMBS on acceptable terms or at all, or to maintain compliance with the terms of any financing transactions.
Mortgage loan modification programs and future legislative action may adversely affect the value of, and the returns on, our targeted assets.
The U.S. Government, through the U.S. Treasury, FHA, and the Federal Deposit Insurance Corporation, or "FDIC," has in the past, and may in the future, implement programs designed to provide homeowners with assistance in avoiding mortgage


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loan foreclosures. The programs may involve, among other things, the modification of mortgage loans to reduce the principal amount of the loans or the rate of interest payable on the loans, or to extend the payment terms of the loans.
Loan modification and refinance programs may adversely affect the performance of Agency and non-Agency RMBS and residential mortgage loans. In the case of non-Agency RMBS, a significant number of loan modifications with respect to a given security, including those related to principal forgiveness and coupon reduction, could negatively impact the realized yields and cash flows on such security. Similarly, principal forgiveness and/or coupon reduction could negatively impact the performance of any residential mortgage loans we own. In addition, it is also likely that loan modifications would result in increased prepayments on some RMBS. See "—Prepayment rates can change, adversely affecting the performance of our assets," below.
The U.S. Congress and various state and local legislatures may pass mortgage-related legislation that would affect our business, including legislation that would permit limited assignee liability for certain violations in the mortgage loan origination process, and legislation that would allow judicial modification of loan principal in the event of personal bankruptcy. We cannot predict whether or in what form Congress or the various state and local legislatures may enact legislation affecting our business or whether any such legislation will require us to change our practices or make changes in our portfolio in the future. These changes, if required, could materially adversely affect our business, results of operations and financial condition, and our ability to pay dividends to our stockholders, particularly if we make such changes in response to new or amended laws, regulations or ordinances in any state where we acquire a significant portion of our mortgage loans, or if such changes result in us being held responsible for any violations in the mortgage loan origination process.
The existing loan modification programs, together with future legislative or regulatory actions, including possible amendments to the bankruptcy laws, which result in the modification of outstanding residential mortgage loans and/or changes in the requirements necessary to qualify for refinancing mortgage loans with Fannie Mae, Freddie Mac, or Ginnie Mae, may adversely affect the value of, and the returns on, our assets, which could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
The principal and interest payments on our non-Agency RMBS are not guaranteed by any entity, including any government entity or GSE, and therefore are subject to increased risks, including credit risk.
Our portfolio includes non-Agency RMBS which are backed by residential mortgage loans that do not conform to the Fannie Mae or Freddie Mac underwriting guidelines, including subprime, manufactured housing, Alt-A, and prime jumbo mortgage loans. Consequently, the principal and interest on non-Agency RMBS, unlike those on Agency RMBS, are not guaranteed by GSEs such as Fannie Mae and Freddie Mac or, in the case of Ginnie Mae, the U.S. Government.
Non-Agency RMBS are subject to many of the risks of the respective underlying mortgage loans. A residential mortgage loan is typically secured by single-family residential property and is subject to risks of delinquency and foreclosure and risk of loss. The ability of a borrower to repay a loan secured by a residential property is dependent upon the income or assets of the borrower. A number of factors, including a general economic downturn, unemployment, acts of God, pandemics such as novel coronavirus (COVID-19), terrorism, social unrest, and civil disturbances, may impair borrowers' abilities to repay their mortgage loans. In periods following home price declines, "strategic defaults" (decisions by borrowers to default on their mortgage loans despite having the ability to pay) also may become more prevalent. In addition, the Tax Cuts and Jobs Act, or "TCJA," reduced the mortgage interest deduction limit, eliminated the deduction for interest with respect to home equity indebtedness, with certain exceptions, and limited the state and local income and property tax deduction. These changes could reduce home affordability and adversely impact housing prices in certain regions, which could lead to an increase in defaults on the mortgage loans underlying many of our investments.
In the event of defaults under mortgage loans backing any of our non-Agency RMBS, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan.
Additionally, in the event of the bankruptcy of a mortgage loan borrower, the mortgage loan to such borrower will be deemed to be secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law. Foreclosure of a mortgage loan can be an expensive and lengthy process which could have a substantial negative effect on our anticipated return on the foreclosed mortgage loan. If borrowers default on the mortgage loans backing our non-Agency RMBS and we are unable to recover any resulting loss through the foreclosure process, our business, financial condition and results of operations, and our ability to pay dividends to our stockholders, could be materially adversely affected.


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Less stringent underwriting guidelines and the resultant potential for delinquencies or defaults on certain mortgage loans could lead to losses on many of the non-Agency RMBS and non-prime RMBS that we hold.
Many of the non-Agency RMBS in which we invest are collateralized by Alt-A and subprime mortgage loans, which are mortgage loans that were originated using less stringent underwriting guidelines than those used in underwriting prime mortgage loans (mortgage loans that generally conform to Fannie Mae or Freddie Mac underwriting guidelines). In addition, we opportunistically acquire "non-prime RMBS," which are RMBS issued in the United Kingdom and other European countries that are backed by residential mortgage loans that were typically originated using less stringent underwriting guidelines. These underwriting guidelines were more permissive as to borrower credit history or credit score, borrower debt-to-income ratio, loan-to-value ratio, and/or as to documentation (such as whether and to what extent borrower income was required to be disclosed or verified). In addition, even when specific underwriting guidelines were represented by loan originators as having been used in connection with the origination of mortgage loans, these guidelines were in many cases not followed as a result of aggressive lending practices, fraud (including borrower or appraisal fraud), or other factors. Mortgage loans that were underwritten pursuant to less stringent or looser underwriting guidelines, or that were poorly underwritten to their stated guidelines, have experienced, and should be expected to experience in the future, substantially higher rates of delinquencies, defaults, and foreclosures than those experienced by mortgage loans that were underwritten in a manner more consistent with Fannie Mae or Freddie Mac guidelines. Thus, because of the higher delinquency rates and losses associated with Alt-A, subprime mortgage loans and non-prime mortgage loans, the performance of RMBS backed by Alt-A, subprime mortgage loans, and non-prime mortgage loans that we may acquire could be correspondingly adversely affected, which could adversely impact our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
We rely on analytical models and other data to analyze potential asset acquisition and disposition opportunities and to manage our portfolio. Such models and other data may be incorrect, misleading or incomplete, which could cause us to purchase assets that do not meet our expectations or to make asset management decisions that are not in line with our strategy.
Our Manager relies on the analytical models (both proprietary and third-party models) of Ellington and information and data supplied by third parties. These models and data may be used to value assets or potential asset acquisitions and dispositions and also in connection with our asset management activities. If Ellington's models and data prove to be incorrect, misleading, or incomplete, any decisions made in reliance thereon could expose us to potential risks. Our Manager's reliance on Ellington's models and data may induce it to purchase certain assets at prices that are too high, to sell certain other assets at prices that are too low, or to miss favorable opportunities altogether. Similarly, any hedging activities that are based on faulty models and data may prove to be unsuccessful.
Some of the risks of relying on analytical models and third-party data include the following:
collateral cash flows and/or liability structures may be incorrectly modeled in all or only certain scenarios, or may be modeled based on simplifying assumptions that lead to errors;
information about assets or the underlying collateral may be incorrect, incomplete, or misleading;
asset, collateral or MBS historical performance (such as historical prepayments, defaults, cash flows, etc.) may be incorrectly reported, or subject to interpretation (e.g., different MBS issuers may report delinquency statistics based on different definitions of what constitutes a delinquent loan); and
asset, collateral or MBS information may be outdated, in which case the models may contain incorrect assumptions as to what has occurred since the date information was last updated.
Some models, such as prepayment models or default models, may be predictive in nature. The use of predictive models has inherent risks. For example, such models may incorrectly forecast future behavior, leading to potential losses. In addition, the predictive models used by our Manager may differ substantially from those models used by other market participants, with the result that valuations based on these predictive models may be substantially higher or lower for certain assets than actual market prices. Furthermore, because predictive models are usually constructed based on historical data supplied by third parties, the success of relying on such models may depend heavily on the accuracy and reliability of the supplied historical data, and, in the case of predicting performance in scenarios with little or no historical precedent (such as extreme broad-based declines in home prices, or deep economic recessions or depressions), such models must employ greater degrees of extrapolation and are therefore more speculative and of more limited reliability.
All valuation models rely on correct market data inputs. If incorrect market data is entered into even a well-founded valuation model, the resulting valuations will be incorrect. However, even if market data is input correctly, "model prices" will often differ substantially from market prices, especially for securities with complex characteristics or whose values are particularly sensitive to various factors. If our market data inputs are incorrect or our model prices differ substantially from


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market prices, our business, financial condition and results of operations, and our ability to pay dividends to our stockholders could be materially adversely affected.
Valuations of some of our assets are inherently uncertain, may be based on estimates, may fluctuate over short periods of time, and may differ from the values that would have been used if a ready market for these assets existed.
The values of some of the assets in our portfolio are not readily determinable. We value these assets monthly at fair value, as determined in good faith by our Manager, subject to the oversight of our Manager's valuation committee. Because such valuations are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our Manager's determinations of fair value may differ from the values that would have been used if a ready market for these assets existed or from the prices at which trades occur. Furthermore, we may not obtain third-party valuations for all of our assets. Changes in the fair value of our assets directly impact our net income through recording unrealized appreciation or depreciation of our investments and derivative instruments, and so our Manager's determination of fair value has a material impact on our net income.
While in many cases our Manager's determination of the fair value of our assets is based on valuations provided by third-party dealers and pricing services, our Manager can and does value assets based upon its judgment and such valuations may differ from those provided by third-party dealers and pricing services. Valuations of certain assets are often difficult to obtain or are unreliable. In general, dealers and pricing services heavily disclaim their valuations. Additionally, dealers and pricing services may claim to furnish valuations only as an accommodation and without special compensation, and so they may disclaim any and all liability for any direct, incidental, or consequential damages arising out of any inaccuracy or incompleteness in valuations, including any act of negligence or breach of any warranty. Depending on the complexity and illiquidity of an asset, valuations of the same asset can vary substantially from one dealer or pricing service to another. Higher valuations of our assets have the effect of increasing the amount of base management fees and incentive fees we pay to our Manager. Therefore, conflicts of interest exist because our Manager is involved in the determination of the fair value of our assets.
Our business, financial condition and results of operations, and our ability to pay dividends to our stockholders could be materially adversely affected if our Manager's fair value determinations of these assets were materially different from the values that would exist if a ready market existed for these assets.
We depend on third-party service providers, including mortgage servicers, for a variety of services related to our non-Agency RMBS, European assets, securitizations, and whole mortgage loans and loan pools. We are, therefore, subject to the risks associated with third-party service providers.
We depend on a variety of services provided by third-party service providers related to our non-Agency RMBS, European assets, securitizations, and whole mortgage loans and loan pools. We rely on the mortgage servicers who service the mortgage loans backing our non-Agency RMBS, our European assets, our securitizations, as well as the mortgage loans and loan pools that we own directly, to, among other things, collect principal and interest payments on the underlying mortgages and perform loss mitigation services. These mortgage servicers and other service providers to our non-Agency RMBS, European assets, and securitizations, such as trustees, bond insurance providers, due diligence vendors, and custodians, may not perform in a manner that promotes our interests. In addition, legislation that has been enacted or that may be enacted in order to reduce or prevent foreclosures through, among other things, loan modifications, may reduce the value of mortgage loans backing our non-Agency RMBS or whole mortgage loans that we acquire. Mortgage servicers may be incentivized by U.S. federal, state, or local governments to pursue such loan modifications, as well as forbearance plans and other actions intended to prevent foreclosure, even if such loan modifications and other actions are not in the best interests of the beneficial owners of the mortgage loans. In addition to legislation that creates financial incentives for mortgage loan servicers to modify loans and take other actions that are intended to prevent foreclosures, legislation has also been adopted that creates a safe harbor from liability to creditors for servicers that undertake loan modifications and other actions that are intended to prevent foreclosures. Finally, legislation has been adopted that delays the initiation or completion of foreclosure proceedings on specified types of residential mortgage loans or otherwise limits the ability of mortgage servicers to take actions that may be essential to preserve the value of the mortgage loans underlying the mortgage servicing rights. Any such limitations are likely to cause delayed or reduced collections from mortgagors and generally increase servicing costs. As a result of these legislative actions, the mortgage loan servicers on which we rely may not perform in our best interests or up to our expectations. If our third-party service providers, including mortgage servicers, do not perform as expected, our business, financial condition and results of operations, and ability to pay dividends to our stockholders may be materially adversely affected.
We rely on mortgage servicers for our loss mitigation efforts, and we also may engage in our own loss mitigation efforts with respect to whole mortgage loans that we own directly. Such loss mitigation efforts may be unsuccessful or not cost effective.
Both default frequency and default severity of mortgage loans are highly dependent on the quality of the mortgage


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servicer. We depend on the loss mitigation efforts of mortgage servicers and in some cases "special servicers," which are mortgage servicers who specialize in servicing non-performing loans. If mortgage servicers are not vigilant in encouraging borrowers to make their monthly payments, the borrowers are far less likely to make those payments. In addition, for the whole mortgage loans that we own directly, we may engage in our own loss mitigation efforts over and beyond the efforts of the mortgage servicers, including more hands-on mortgage servicer oversight and management, borrower refinancing solicitations, as well as other efforts. Our and our mortgage servicers' loss mitigation efforts may be unsuccessful in limiting delinquencies, defaults, and losses, or may not be cost effective, which may materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders. Furthermore, our ability to accomplish such loss mitigation may be limited by the tax rules governing REITs.
We may be affected by deficiencies in foreclosure practices of third parties, as well as related delays in the foreclosure process.
One of the biggest risks overhanging the residential mortgage loan, non-Agency RMBS, and non-prime RMBS markets has been uncertainty around the timing and ability of servicers to foreclose on defaulted loans, so that they can liquidate the underlying properties and ultimately pass the liquidation proceeds through to RMBS holders. Given the magnitude of the housing crisis, and in response to the well-publicized failures of many servicers to follow proper foreclosure procedures, mortgage servicers are being held to much higher foreclosure-related documentation standards than they previously were. However, because many mortgages have been transferred and assigned multiple times (and by means of varying assignment procedures) throughout the origination, warehouse, and securitization processes, mortgage servicers are generally having much more difficulty furnishing the requisite documentation to initiate or complete foreclosures. This leads to stalled or suspended foreclosure proceedings, and ultimately additional foreclosure-related costs. Foreclosure-related delays also tend to increase ultimate loan loss severities as a result of property deterioration, amplified legal and other costs, and other factors. Many factors delaying foreclosure, such as borrower lawsuits and judicial backlog and scrutiny, are outside of a servicer's control and have delayed, and will likely continue to delay, foreclosure processing in both judicial states (where foreclosures require court involvement) and non-judicial states. The concerns about deficiencies in foreclosure practices of servicers and related delays in the foreclosure process may impact our loss assumptions and affect the values of, and our returns on, our investments in RMBS and residential whole loans.
To the extent that due diligence is conducted on potential assets, such due diligence may not reveal all of the risks associated with such assets and may not reveal other weaknesses in such assets, which could lead to losses.
Before making an investment, our Manager may decide to conduct (either directly or using third parties) certain due diligence. There can be no assurance that our Manager will conduct any specific level of due diligence, or that, among other things, our Manager's due diligence processes will uncover all relevant facts or that any purchase will be successful, which could result in losses on these assets, which, in turn, could adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Sellers of the mortgage loans that we acquire, or that underlie the non-Agency RMBS or non-prime RMBS in which we invest, may be unable to repurchase defective mortgage loans, which could have a material adverse effect on the value of our loans, or the loans held by the trust that issued the RMBS, and could cause shortfalls in the payments due on the RMBS or losses on the mortgage loans.
Sellers of mortgage loans that we acquire or that are sold to the trusts that issued the non-Agency RMBS or non-prime RMBS in which we invest made various representations and warranties related to the mortgage loans sold by them to us or the trusts that issued the RMBS. If a seller fails to cure a material breach of its representations and warranties with respect to any mortgage loan in a timely manner, then we, or the trustee or the servicer of the loans, may have the right to require that the seller repurchase the defective mortgage loan (or in some cases substitute a performing mortgage loan). It is possible, however, that for financial or other reasons, the seller either may not be capable of repurchasing defective mortgage loans, or may dispute the validity of or otherwise resist its obligation to repurchase defective mortgage loans. The inability or unwillingness of a seller to repurchase defective mortgage loans from us or from a non-Agency RMBS trust or non-prime RMBS trust in which we invest would likely cause higher rates of delinquencies, defaults, and losses for the mortgage loans we hold, or the mortgage loans backing such non-Agency RMBS or non-prime RMBS, and ultimately greater losses for our investment in such assets.
Our assets include subordinated and lower-rated securities that generally have greater risk of loss than senior and higher-rated securities.
Certain securities that we acquire are deemed by rating agencies to have substantial vulnerability to default in payment of interest and/or principal. Other securities we acquire have the lowest quality ratings or are unrated. Many securities that we acquire are subordinated in cash flow priority to other more "senior" securities of the same securitization. The exposure to


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defaults on the underlying mortgages is severely magnified in subordinated securities. Certain subordinated securities ("first loss securities") absorb all losses from default before any other class of securities is at risk. Such securities therefore are considered to be highly speculative investments. Also, the risk of declining real estate values, in particular, is amplified in subordinated RMBS and CMBS, as are the risks associated with possible changes in the market's perception of the entity issuing or guaranteeing them, or by changes in government regulations and tax policies. Accordingly, the subordinated and lower-rated (or unrated) securities in which we invest may experience significant price and performance volatility relative to more senior or higher-rated securities, and they are subject to greater risk of loss than more senior or higher-rated securities which, if realized, could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Investments in second lien mortgage loans could subject us to increased risk of losses.
We may invest in second-lien mortgage loans or RMBS backed by such loans. If a borrower defaults on a second-lien mortgage loan or on its senior debt (i.e., a first-lien loan, in the case of a residential mortgage loan), or in the event of a borrower bankruptcy, such loan will be satisfied only after all senior debt is paid in full. As a result, if we invest in second-lien mortgage loans and the borrower defaults, we may lose all or a significant part of our investment.
Prepayment rates can change, adversely affecting the performance of our assets.
The frequency at which prepayments (including both voluntary prepayments by borrowers and liquidations due to defaults and foreclosures) occur on mortgage loans, including those underlying our RMBS, is affected by a variety of factors, including the prevailing level of interest rates as well as economic, demographic, tax, social, legal, and other factors. Generally, borrowers tend to prepay their mortgages when prevailing mortgage rates fall below the interest rates on their mortgage loans. When borrowers prepay their mortgage loans at rates that are faster or slower than expected, it results in prepayments that are faster or slower than expected on such loans or the related RMBS. These faster or slower than expected payments may adversely affect our profitability.
We may purchase securities or loans that have a higher interest rate than the then-prevailing market interest rate. In exchange for this higher interest rate, we may pay a premium to par value to acquire the security or loan. In accordance with U.S. GAAP, we amortize this premium as an expense over the expected term of the security or loan based on our prepayment assumptions. If a security or loan is prepaid in whole or in part at a faster than expected rate, however, we must expense all or a part of the remaining unamortized portion of the premium that was paid at the time of the purchase, which will adversely affect our profitability.
We also may purchase securities or loans that have a lower interest rate than the then-prevailing market interest rate. In exchange for this lower interest rate, we may pay a discount to par value to acquire the security or loan. We accrete this discount as income over the expected term of the security or loan based on our prepayment assumptions. If a security or loan is prepaid at a slower than expected rate, however, we must accrete the remaining portion of the discount at a slower than expected rate. This will extend the expected life of our investment portfolio and result in a lower than expected yield on securities and loans purchased at a discount to par.
Prepayment rates generally increase when interest rates fall and decrease when interest rates rise. Since many RMBS, especially fixed rate RMBS, will be discount securities when interest rates are high, and will be premium securities when interest rates are low, these RMBS may be adversely affected by changes in prepayments in any interest rate environment. Prepayment rates are also affected by factors not directly tied to interest rates, and these factors are difficult to predict. Prepayments can also occur when borrowers sell their properties or when borrowers default on their mortgages and the mortgages are prepaid from the proceeds of a foreclosure sale of the underlying property and/or from the proceeds of a mortgage insurance policy or other guarantee. Fannie Mae and Freddie Mac will generally, among other conditions, purchase mortgages that are 120 days or more delinquent from the Agency RMBS pools that they have issued when the cost of guaranteed payments to security holders, including advances of interest at the security coupon rate, exceeds the cost of holding the non-performing loans in their portfolios. Consequently, prepayment rates also may be affected by conditions in the housing and financial markets, which may result in increased delinquencies on mortgage loans. Prepayment rates can also be affected by actions of the GSEs and their cost of capital, general economic conditions, and the relative interest rates on fixed and adjustable rate loans. Additionally, changes in the GSEs' decisions as to when to repurchase delinquent loans can materially impact prepayment rates on Agency RMBS.
The adverse effects of prepayments may impact us in various ways. First, particular investments may experience outright losses, as in the case of interest only securities, or "IOs," and inverse interest only securities, or "IIOs," in an environment of faster actual or anticipated prepayments. Second, particular investments may underperform relative to any hedges that our Manager may have constructed for these assets, resulting in a loss to us. In particular, prepayments (at par) may limit the potential upside of many RMBS to their principal or par amounts, whereas their corresponding hedges often have the potential


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for unlimited loss. Furthermore, to the extent that faster prepayment rates are due to lower interest rates, the principal payments received from prepayments will tend to be reinvested in lower-yielding assets, which may reduce our income in the long run. Therefore, if actual prepayment rates differ from anticipated prepayment rates our business, financial condition and results of operations, and ability to pay dividends to our stockholders could be materially adversely affected.
Increases in interest rates could negatively affect the value of our assets and increase the risk of default on our assets.
Our fixed rate investments, especially most fixed rate mortgage loans, fixed rate MBS, and most MBS backed by fixed rate mortgage loans, decline in value when long-term interest rates increase. Even in the case of Agency RMBS, the guarantees provided by GSEs do not protect us from declines in market value caused by changes in interest rates. In the case of RMBS backed by adjustable rate mortgages, or "ARMs," increases in interest rates can lead to increases in delinquencies and defaults as borrowers become less able to make their mortgage payments following interest payment resets. Additionally, an increase in short-term interest rates would increase the amount of interest owed on our repo borrowings. See "—Interest rate mismatches between our assets and our borrowings may reduce our income during periods of changing interest rates, and increases in interest rates could adversely affect the value of our assets" below.
An increase in interest rates may cause a decrease in the issuance volumes of certain of our targeted assets, which could adversely affect our ability to acquire targeted assets that satisfy our investment objectives and to generate income and pay dividends.
Rising interest rates generally reduce the demand for mortgage loans due to the higher cost of borrowing. A reduction in the volume of mortgage loans originated may affect the volume of targeted assets available to us, which could adversely affect our ability to acquire assets that satisfy our investment objectives. If rising interest rates cause us to be unable to acquire a sufficient volume of our targeted assets with a yield that is above our borrowing cost, our ability to satisfy our investment objectives and to generate income and pay dividends to our stockholders may be materially and adversely affected.
Interest rate caps on the ARMs and hybrid ARMs that back our RMBS may reduce our net interest margin during periods of rising or high interest rates.
ARMs and hybrid ARMs (i.e., residential mortgage loans that have interest rates that are fixed for a specified period of time (typically three, five, seven or ten years) and, thereafter, adjust to a fixed increment over a specified interest rate index) are typically subject to periodic and lifetime interest rate caps. Periodic interest rate caps limit the amount an interest rate can increase during any given period. Lifetime interest rate caps limit the amount an interest rate can increase through the maturity of the loan. Our borrowings typically are not subject to similar restrictions. Accordingly, in a period of rapidly increasing interest rates, our financing costs could increase without limitation while caps could limit the interest we earn on our RMBS backed by ARMs and hybrid ARMs. This problem is magnified for ARMs and hybrid ARMs that are not fully indexed because such periodic interest rate caps prevent the coupon on the security from fully reaching the specified rate in one reset. Further, some ARMs and hybrid ARMs may be subject to periodic payment caps that result in a portion of the interest being deferred and added to the principal outstanding. As a result, we may receive less cash income on RMBS backed by ARMs and hybrid ARMs than necessary to pay interest on our related borrowings. Interest rate caps on RMBS backed by ARMs and hybrid ARMs could reduce our net interest margin if interest rates were to increase beyond the level of the caps, which could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Residential mortgage loans, including residential NPLs, non-QM loans, and residential transition loans, are subject to increased risks.
We acquire and manage residential mortgage loans. Residential mortgage loans, including residential NPLs, non-QM loans, and residential transition loans, are subject to increased risk of loss. Unlike Agency RMBS, residential mortgage loans generally are not guaranteed by the U.S. Government or any GSE, though in some cases they may benefit from private mortgage insurance. Additionally, by directly acquiring residential mortgage loans, we do not receive the structural credit enhancements that benefit senior tranches of RMBS. A residential whole mortgage loan is directly exposed to losses resulting from default. Therefore, the value of the underlying property, the creditworthiness and financial position of the borrower, and the priority and enforceability of the lien will significantly impact the value of such mortgage loan. In the event of a foreclosure, we may assume direct ownership of the underlying real estate. The liquidation proceeds upon sale of such real estate may not be sufficient to recover our cost basis in the loan, and any costs or delays involved in the foreclosure or liquidation process may increase losses.
Residential mortgage loans are also subject to property damage caused by hazards, such as earthquakes or environmental hazards, not covered by standard property insurance policies, or "special hazard risk," and to reduction in a borrower's mortgage debt by a bankruptcy court, or "bankruptcy risk." In addition, claims may be assessed against us on account of our


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position as a mortgage holder or property owner, including assignee liability, environmental hazards, and other liabilities. We could also be responsible for property taxes. In some cases, these liabilities may be "recourse liabilities" or may otherwise lead to losses in excess of the purchase price of the related mortgage or property.
If we subsequently resell any whole mortgage loans that we acquire, we may be required to repurchase such loans or indemnify purchasers if we breach representations and warranties.
If we subsequently resell any whole mortgage loans that we acquire, we would generally be required to make customary representations and warranties about such loans to the loan purchaser. Our residential mortgage loan sale agreements and terms of any securitizations into which we sell loans will generally require us to repurchase or substitute loans in the event we breach a representation or warranty given to the loan purchaser. In addition, we may be required to repurchase loans as a result of borrower fraud or in the event of early payment default on a mortgage loan. The remedies available to a purchaser of mortgage loans are generally broader than those available to us against an originating broker or correspondent. Repurchased loans are typically worth only a fraction of the original price. Significant repurchase activity could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
The commercial mortgage loans that we acquire or originate, and the mortgage loans underlying our CMBS investments, are subject to the ability of the commercial property owner to generate net income from operating the property as well as to the risks of delinquency and foreclosure.
Commercial mortgage loans are secured by commercial property and are subject to risks of delinquency and foreclosure, and risk of loss that may be greater than similar risks associated with loans made on the security of single-family residential property. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower's ability to repay the loan may be impaired. Net operating income of an income-producing property can be adversely affected by, among other things:
tenant mix;
declines in tenant income and/or changes to tenant businesses;
property management decisions;
property location, condition, and design;
new construction of competitive properties;
changes in laws that increase operating expenses or limit rents that may be charged;
changes in national, regional, or local economic conditions and/or specific industry segments, including the credit and securitization markets;
declines in regional or local real estate values;
declines in regional or local rental or occupancy rates;
increases in interest rates, real estate tax rates, and other operating expenses;
costs of remediation and liabilities associated with environmental conditions;
the potential for uninsured or underinsured property losses;
changes in governmental laws and regulations, including fiscal policies, zoning ordinances and environmental legislation, and the related costs of compliance; and
acts of God, pandemics such as novel coronavirus (COVID-19), terrorist attacks, social unrest, and civil disturbances.
In the event of any default under a mortgage loan held directly by us, we will bear a risk of loss to the extent of any deficiency between the value of the collateral and our cost basis in the outstanding principal and accrued interest of the mortgage loan, and any such losses could have a material adverse effect on our cash flow from operations and our ability to pay dividends to our stockholders.
In the event of the bankruptcy of a mortgage loan borrower, the mortgage loan to such borrower will be deemed to be secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law. Foreclosure of a mortgage loan can be an expensive and lengthy process, which could have a substantial negative effect on our anticipated return on the foreclosed mortgage loan.
CMBS are secured by a single commercial mortgage loan or a pool of commercial mortgage loans. Accordingly, the


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CMBS we invest in are subject to all of the risks of the respective underlying commercial mortgage loans.
Our investments in CMBS are at risk of loss.
Our investments in CMBS are at risk of loss. In general, losses on real estate securing a mortgage loan included in a securitization will be borne first by the owner of the property, then by the holder of a mezzanine loan or a subordinated participation interest in a bifurcated first lien loan, or "B-Note," if any, then by the "first loss" subordinated security holder (generally, the B-piece buyer) and then by the holder of a higher-rated security. In the event of losses on mortgage loans included in a securitization and the subsequent exhaustion of any applicable reserve fund, letter of credit, or classes of securities junior to those in which we invest, we may not be able to recover all of our investment in the securities we purchase. In addition, if any of the real estate underlying the securitization mortgage portfolio has been overvalued by the originator, or if real estate values subsequently decline and, as a result, less collateral is available to satisfy interest and principal payments due on the related CMBS, we may incur losses. The prices of lower credit quality securities are generally less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual issuer developments.
We may not control the special servicing of the mortgage loans included in the CMBS in which we invest and, in such cases, the special servicer may take actions that could adversely affect our interests.
With respect to the CMBS in which we invest, overall control over the special servicing of the related underlying mortgage loans will be held by a "directing certificateholder" or a "controlling class representative," which is generally appointed by the holders of the most subordinate class of CMBS in such series. In connection with the servicing of the specially serviced mortgage loans, the related special servicer may, at the direction of the directing certificateholder, take actions with respect to the specially serviced mortgage loans that could adversely affect our interests. For further discussion of the risks of our reliance on special servicers, see "—We rely on mortgage servicers for our loss mitigation efforts, and we also may engage in our own loss mitigation efforts with respect to whole mortgage loans that we own directly. Such loss mitigation efforts may be unsuccessful or not cost effective" above.
A portion of our investments currently are, and in the future may be, in the form of non-performing and sub-performing commercial and residential mortgage loans, or loans that may become non-performing or sub-performing, which are subject to increased risks relative to performing loans.
A portion of our investments currently are, and in the future may be, in the form of commercial and residential whole mortgage loans, including subprime mortgage loans and non-performing and sub-performing mortgage loans, which are subject to increased risks of loss. Such loans may already be, or may become, non-performing or sub-performing for a variety of reasons, including because the underlying property is too highly leveraged or the borrower falls upon financial distress. Such non-performing or sub-performing loans may require a substantial amount of workout negotiations and/or restructuring, which may divert the attention of our Manager from other activities and entail, among other things, a substantial reduction in the interest rate, capitalization of interest payments, and a substantial write-down of the principal of the loan. However, even if such restructuring were successfully accomplished, a risk exists that the borrower will not be able or willing to maintain the restructured payments or refinance the restructured mortgage upon maturity. In addition, such modifications could affect our compliance with the tests applicable to REITs, including by increasing our distribution requirement.
In addition, certain non-performing or sub-performing loans that we acquire may have been originated by financial institutions that are or may become insolvent, suffer from serious financial stress, or are no longer in existence. As a result, the standards by which such loans were originated, the recourse to the selling institution, and/or the standards by which such loans are being serviced or operated may be adversely affected. Further, loans on properties operating under the close supervision of a mortgage lender are, in certain circumstances, subject to certain additional potential liabilities that may exceed the value of our investment.
In the future, it is possible that we may find it necessary or desirable to foreclose on some, if not many, of the loans we acquire, and the foreclosure process may be lengthy and expensive. Borrowers or junior lenders may resist mortgage foreclosure actions by asserting numerous claims, counterclaims, and defenses against us including, without limitation, numerous lender liability claims and defenses, even when such assertions may have no basis in fact, in an effort to prolong the foreclosure action and force the lender into a modification of the loan or capital structure or a favorable buy-out of the borrower's or junior lender's position. In some states, foreclosure actions can sometimes take several years or more to litigate. At any time prior to or during the foreclosure proceedings, the borrower may file, or a junior lender may cause the borrower to file, for bankruptcy, which would have the effect of staying the foreclosure actions and further delaying the foreclosure process. Foreclosure and associated litigation may create a negative public perception of the related mortgaged property, resulting in a diminution of its value. Even if we are successful in foreclosing on a loan, the liquidation proceeds upon sale of the underlying real estate may not be sufficient to recover our cost basis in the loan, resulting in a loss to us, and the borrower or junior lenders


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may continue to challenge whether the foreclosure process was commercially reasonable, which could result in additional costs and potential liability. Any costs or delays involved in the effectuation of a foreclosure of the loan or a liquidation of the underlying property, or defending challenges brought after the completion of a foreclosure, will further reduce the liquidation proceeds and thus increase the loss. Any such reductions could materially and adversely affect the value we realize from the loans in which we invest.
Whether or not our Manager has participated in the negotiation of the terms of any such mortgage loans, there can be no assurance as to the adequacy of the protection of the terms of the loan, including the validity or enforceability of the loan and the maintenance of the anticipated priority and perfection of the applicable security interests. Furthermore, claims may be asserted that might interfere with enforcement of our rights. In the event of a foreclosure, we may assume direct ownership of the underlying real estate. The liquidation proceeds upon sale of such real estate may not be sufficient to recover our cost basis in the loan, resulting in a loss to us.
Commercial whole mortgage loans are also subject to special hazard risk and to bankruptcy risk. In addition, claims may be assessed against us on account of our position as mortgage holder or property owner, including assignee liability, responsibility for tax payments, environmental hazards and other liabilities. In some cases, these liabilities may be "recourse liabilities" or may otherwise lead to losses in excess of the purchase price of the related mortgage or property.
Our real estate assets and our real estate-related assets (including mortgage loans and MBS) are subject to the risks associated with real property.
We own assets secured by real estate, we own real estate directly, and may acquire additional real estate directly in the future, either through direct acquisitions or upon a default of mortgage loans. Real estate assets are subject to various risks, including:
declines in the value of real estate;
acts of God, including pandemics, earthquakes, floods, wildfires, hurricanes, mudslides, volcanic eruptions and other natural disasters, which may result in uninsured losses;
acts of war or terrorism, including the consequences of terrorist attacks, such as those that occurred on September 11, 2001;
adverse changes in national and local economic and market conditions;
changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance with laws and regulations, fiscal policies and zoning ordinances;
costs of remediation and liabilities associated with environmental conditions such as indoor mold;
potential liabilities for other legal actions related to property ownership including tort claims; and
the potential for uninsured or under-insured property losses.
The occurrence of any of the foregoing or similar events may reduce our return from an affected property or asset and, consequently, materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
We engage in short selling transactions, which may subject us to additional risks.
Many of our hedging transactions, and occasionally our investment transactions, are short sales. Short selling may involve selling securities that are not owned and typically borrowing the same securities for delivery to the purchaser, with an obligation to repurchase the borrowed securities at a later date. Short selling allows the investor to profit from declines in market prices to the extent such declines exceed the transaction costs and the costs of borrowing the securities. A short sale may create the risk of an unlimited loss, in that the price of the underlying security might theoretically increase without limit, thus increasing the cost of repurchasing the securities. There can be no assurance that securities sold short will be available for repurchase or borrowing. Repurchasing securities to close out a short position can itself cause the price of the securities to rise further, thereby exacerbating the loss.
We use leverage in executing our business strategy, which may adversely affect the return on our assets and may reduce cash available for distribution to our stockholders, as well as increase losses when economic conditions are unfavorable.
We use leverage to finance our investment activities and to enhance our financial returns. Most of our leverage is in the form of short-term repos for our Agency and credit portfolio assets. Other forms of leverage include our term secured bank facilities, our securitizations, our Senior Notes, and may in the future include credit facilities, including term loans and revolving credit facilities.


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Through the use of leverage, we may acquire positions with market exposure significantly greater than the amount of capital committed to the transaction. For example, by entering into repos with advance rates, or haircut levels, of 5%, we could theoretically leverage capital allocated to Agency RMBS by an asset-to-equity ratio of as much as 20 to 1. A haircut is the percentage discount that a repo lender applies to the market value of an asset serving as collateral for a repo borrowing, for the purpose of determining whether such repo borrowing is adequately collateralized.
Although we may from time to time enter into certain contracts with third parties that may limit our leverage, such as certain financing arrangements with lenders, our governing documents do not specifically limit the amount of leverage that we may use. Leverage can enhance our potential returns but can also exacerbate losses. Even if an asset increases in value, if the asset fails to earn a return that equals or exceeds our cost of borrowing, the leverage will diminish our returns.
Leverage also increases the risk of our being forced to precipitously liquidate our assets. See "—Our lenders and derivative counterparties may require us to post additional collateral, which may force us to liquidate assets, and if we fail to post sufficient collateral our debts may be accelerated and/or our derivative contracts terminated on unfavorable terms" below.
Our access to financing sources, which may not be available on favorable terms, or at all, may be limited, and this may materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
We depend upon the availability of adequate capital and financing sources to fund our operations. Our lenders are primarily large global financial institutions, with exposures both to global financial markets and to more localized conditions. In addition to borrowing from large banks, we borrow from smaller non-bank financial institutions as well. Whether because of a global or local financial crisis or other circumstances, such as if one or more of our lenders experiences severe financial difficulties, they or other lenders could become unwilling or unable to provide us with financing, could increase the costs of that financing, or could become insolvent, as was the case with Lehman Brothers in 2008. Moreover, we are currently party to short-term borrowings (in the form of repos) and there can be no assurance that we will be able to replace these borrowings, or "roll" them, as they mature on a continuous basis and it may be more difficult for us to obtain debt financing on favorable terms, or at all. In addition, if regulatory capital requirements imposed on our lenders change, they may be required to limit, or increase the cost of, the financing they provide to us. In general, this could potentially increase our financing costs and reduce our liquidity or require us to sell assets at an inopportune time or price. Consequently, depending on market conditions at the relevant time, we may have to rely on additional equity issuances to meet our capital and financing needs, which may be dilutive to our stockholders, or we may have to rely on less efficient forms of debt financing that consume a larger portion of our cash flow from operations, thereby reducing funds available for our operations, future business opportunities, cash dividends to our stockholders, and other purposes. We cannot assure you that we will have access to such equity or debt capital on favorable terms (including, without limitation, cost and term) at the desired times, or at all, which may cause us to curtail our asset acquisition activities and/or dispose of assets, which could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
A failure to comply with restrictive covenants in our financing arrangements would have a material adverse effect on us, and any future financings may require us to provide additional collateral or pay down debt.
We are subject to various restrictive covenants contained in our existing financing arrangements and may become subject to additional covenants in connection with future financings. For example, the indenture governing our Senior Notes contains covenants that, subject to a number of exceptions and adjustments, among other things: limit our ability to incur additional indebtedness; require us to maintain a minimum Net Asset Value (as defined in the indenture governing the Senior Notes); require us to maintain a ratio of Consolidated Unencumbered Assets (as defined in indenture governing the Senior Notes) to the aggregate principal amount of the outstanding Senior Notes at or above a specified threshold, and impose certain conditions on our merger or consolidation with another person. In addition, the interest rate on our Senior Notes is subject to upward adjustment based on certain changes, if any, in the ratings of the Senior Notes. Furthermore, several of our repo agreements contain financial covenants of a similar nature, including requiring us to maintain a minimum level of liquidity.
The covenants in our financing arrangements may limit our flexibility to pursue certain investments or incur additional debt. If we fail to meet or satisfy any of these covenants, subject to certain cure provisions, as applicable, we would be in default under these agreements and our indebtedness could be declared due and payable. In addition, our lenders could terminate their commitments, require the posting of additional collateral and enforce their interests against existing collateral. We may also be subject to cross-default and acceleration rights under our financing arrangements, whereby a default (such as a failure to comply with a covenant) under one financing arrangement can trigger a default under other financing arrangements.


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Our securitizations may expose us to additional risks.
In order to generate additional cash for funding new investments, we have securitized, and may in the future seek to securitize, certain of our assets, especially our loan assets. Some securitizations are treated as financing transactions for U.S. GAAP, while others are treated as sales. In a typical securitization, we convey assets to a special purpose vehicle, the issuer, which then issues one or more classes of notes secured by the assets pursuant to the terms of an indenture. To the extent that we retain the most subordinated economic interests in the issuer, we would continue to be exposed to losses on the assets for as long as those retained interests remained outstanding and therefore able to absorb such losses. Furthermore, our retained interests in a securitization could be less liquid than the underlying assets themselves, and may be subject to U.S. Risk Retention Rules (See "—We, Ellington, or its affiliates may be subject to adverse legislative or regulatory changes," below) and similar European rules. Moreover, even though we might accumulate assets with a view towards possible securitization, we cannot be assured that we will be able to access the securitization market, or be able to do so under favorable terms. The inability to securitize certain segments of our portfolio, especially certain of our loan assets, could hurt our performance and our ability to grow our business.
In addition, in anticipation of a securitization transaction, we (either alone or in conjunction with other investors, including other Ellington affiliates) may provide capital to a vehicle accumulating assets for the securitization. If the securitization is not ultimately completed, or if the assets do not perform as expected during the accumulation period, we could lose all or a portion of the capital that we provided to the vehicle. Furthermore, because we may enter into these types of transactions along with other investors, including other Ellington affiliates, there may be conflicts between us, on the one hand, and the other investors, including other Ellington affiliates, on the other hand. These accumulation vehicles typically enter into warehouse financing facilities to facilitate their accumulation of assets, and so such vehicles carry with them the additional risks associated with financial leverage and covenant compliance.
In connection with our securitizations, we generally are required to prepare disclosure documentation for investors, including term sheets and offering memoranda, which contain information regarding the securitization generally, the securities being issued, and the assets being securitized. If our disclosure documentation for a securitization is alleged or found to contain material inaccuracies or omissions, we may be liable under federal securities laws, state securities laws or other applicable laws for damages to the investors in such securitization, we may be required to indemnify the underwriters of the securitization or other parties, or we may incur other expenses and costs in connection with disputing these allegations or settling claims. Such liabilities, expenses, and/or losses could be significant.
We will typically be required to make representations and warranties in connection with our securitizations regarding, among other things, certain characteristics of the assets being securitized. If any of the representations and warranties that we have made concerning the assets are alleged or found to be inaccurate, we may incur expenses disputing the allegations, and we may be obligated to repurchase certain assets, which may result in losses. Even if we previously obtained representations and warranties from loan originators or other parties from whom we originally acquired the assets, such representations and warranties may not align with those that we have made for the benefit of the securitization, or may otherwise not protect us from losses (e.g., because of a deterioration in the financial condition of the party that provided representations and warranties to us).
Interest rate mismatches between our assets and our borrowings may reduce our income during periods of changing interest rates, and increases in interest rates could adversely affect the value of our assets.
Some of our assets are fixed rate or have a fixed rate component (such as RMBS backed by hybrid ARMs). This means that the interest we earn on these assets will not vary over time based upon changes in a short-term interest rate index. Although the interest we earn on our ARM loans and our RMBS backed by ARMs generally will adjust for changing interest rates, such interest rate adjustments may not occur as quickly as the interest rate adjustments to any related borrowings, and such interest rate adjustments will generally be subject to interest rate caps, which potentially could cause such RMBS to acquire many of the characteristics of fixed rate assets if interest rates were to rise above the cap levels. We generally fund our targeted assets with borrowings whose interest rates reset frequently, and as a result we generally have an interest rate mismatch between our assets and liabilities. While our interest rate hedges are intended to mitigate a portion of this mismatch, the use of interest rate hedges also introduces the risk of other interest rate mismatches and exposures, as will the use of other financing techniques. Additionally, to the extent cash flows from RMBS we hold are reinvested in new RMBS, the spread between the yields of the new RMBS and available borrowing rates may decline, which could reduce our net interest margin or result in losses.
Fixed income assets, including many RMBS, typically decline in value if interest rates increase. If long-term rates were to increase significantly, not only would the market value of these assets be expected to decline, but these assets could lengthen in duration because borrowers would be less likely to prepay their mortgages.


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Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors beyond our control. During 2019, the U.S. Federal Reserve, or the "Federal Reserve," decreased the target range for the federal funds rate three separate times, but at its most recent meeting in December 2019, chose to keep the target range unchanged. Prior to 2019, the Federal Reserve had been increasing the target range for the federal funds rate, from December 2015 through December 2018, and further interest rate increases may occur in the near future.
While we opportunistically hedge our exposure to changes in interest rates, such hedging may be limited by our intention to qualify and remain qualified as a REIT, and we can provide no assurance that our hedges will be successful, or that we will be able to enter into or maintain such hedges. As a result, interest rate fluctuations can cause significant losses, reductions in income, and can limit the cash available to pay dividends to our stockholders.
Changes in banks' inter-bank lending rate reporting practices or the method pursuant to which LIBOR is determined may adversely affect the value of the financial obligations to be held or issued by us that are linked to LIBOR.
LIBOR and other indices which are deemed "benchmarks" are the subject of recent national, international, and other regulatory guidance and proposals for reform. Some of these reforms are already effective, whereas others are still to be implemented. These reforms may cause such benchmarks to perform differently than in the past, or have other consequences which cannot be predicted. In particular, regulators and law enforcement agencies in the U.K. and elsewhere conducted criminal and civil investigations into whether the banks that contributed information to the British Bankers' Association ("BBA") in connection with the daily calculation of LIBOR may have been under-reporting or otherwise manipulating or attempting to manipulate LIBOR. A number of BBA member banks have entered into settlements with their regulators and law enforcement agencies with respect to this alleged manipulation of LIBOR. LIBOR is calculated by reference to a market for interbank lending that continues to shrink, as it is based on increasingly fewer actual transactions. This increases the subjectivity of the LIBOR calculation process and increases the risk of manipulation. 
Actions by the regulators or law enforcement agencies, as well as ICE Benchmark Administration (the current administrator of LIBOR), or the "IBA," may result in changes to the manner in which LIBOR is determined or the establishment of alternative reference rates. For example, on July 27, 2017, the U.K. Financial Conduct Authority, the "FCA," announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. The FCA has statutory powers to require panel banks to contribute to LIBOR where necessary. The FCA has decided not to ask, or to require, that panel banks continue to submit contributions to LIBOR beyond the end of 2021. The FCA has indicated that it expects that the current panel banks will voluntarily sustain LIBOR until the end of 2021. The FCA's intention is that after 2021, it will no longer be necessary for the FCA to ask, or to require, banks to submit contributions to LIBOR. The FCA does not intend to sustain LIBOR through using its influence or legal powers beyond that date. It is possible that the IBA and the panel banks could continue to produce LIBOR on the current basis after 2021, if they are willing and able to do so, but we cannot make assurances that LIBOR will survive in its current form, or at all.
It is possible that, over time, the Secured Overnight Financing Rate ("SOFR") published by the Federal Reserve Bank of New York will replace U.S. Dollar LIBOR as the principal reference rate for U.S. Dollar-denominated floating rate instruments, such as standard fixed-to-floating interest rate swaps. However, the manner and timing of this shift is currently unknown. SOFR is an overnight rate instead of a term rate, making SOFR an inexact replacement for LIBOR.  Market participants are still considering how various types of financial instruments and securitization vehicles should be modified following a discontinuation of LIBOR. It is possible that not all of our assets and liabilities (including our derivatives) will transition away from LIBOR at the same time, and it is possible that not all of our assets and liabilities (including our derivatives) will transition to the same alternative reference rate, in each case increasing the difficulty of hedging. Switching an existing financial instrument from referencing LIBOR to referencing SOFR would generally require the application of a spread between the two indices. Industry organizations are attempting to structure the spread calculations for various financial instruments in a manner that would minimize the possibility of value transfer between counterparties, borrowers, and lenders by virtue of the transition, but there is no assurance that the resulting spreads would be fair and accurate or that all asset types and all types of securitization vehicles will use the same spreads. We and other market participants have less experience understanding and modeling SOFR-based assets and liabilities (including derivatives) than LIBOR-based assets and liabilities (including derivatives), increasing the difficulty of investing, hedging, and risk management. The process of transition also involves operational risks. It is also possible that no transition will occur for many financial instruments, meaning that those instruments would continue to be subject to the weaknesses of the LIBOR calculation process. At this time, it is not possible to predict the effect of any such changes that may be implemented, including any establishment of alternative reference rates. Uncertainty as to the nature or timing of any such potential changes may affect the market for, or value of, any securities, loans, derivatives, and other financial instruments that are based directly or indirectly on LIBOR, and as a result may adversely affect our overall financial condition and results of operations.


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Our investments that are denominated in foreign currencies subject us to foreign currency risk, which may adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Our investments that are denominated in foreign currencies subject us to foreign currency risk arising from fluctuations in exchange rates between such foreign currencies and the U.S. dollar. While we currently attempt to hedge the vast majority of our foreign currency exposure, subject to qualifying and maintaining our qualification as a REIT, we may not always choose to hedge such exposure, or we may not be able to hedge such exposure. To the extent that we are exposed to foreign currency risk, changes in exchange rates of such foreign currencies to the U.S. dollar may adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Our lenders and derivative counterparties may require us to post additional collateral, which may force us to liquidate assets, and if we fail to post sufficient collateral our debts may be accelerated and/or our derivative contracts terminated on unfavorable terms.
Most of our repo agreements and our derivative contracts allow, to varying degrees, our lenders and derivative counterparties (including clearinghouses) to determine an updated market value of our collateral and derivative contracts to reflect current market conditions. If the market value of our collateral or our derivative contracts with a particular lender or derivative counterparty declines in value, we generally will be required by the lender or derivative counterparty to provide additional collateral or repay a portion of the funds advanced on minimal notice, which is known as a margin call. Posting additional collateral will reduce our liquidity and limit our ability to leverage our assets. Additionally, in order to satisfy a margin call, we may be required to liquidate assets at a disadvantageous time, which could cause us to incur further losses and adversely affect our results of operations and financial condition, and may impair our ability to pay dividends to our stockholders. We receive margin calls from our lenders and derivative counterparties from time to time in the ordinary course of business similar to other entities in the mortgage finance and other specialty finance businesses. In the event that we default on our obligation to satisfy these margin calls, our lenders or derivative counterparties can accelerate our indebtedness, terminate our derivative contracts (potentially on unfavorable terms requiring additional payments, including additional fees and costs), increase our borrowing rates, liquidate our collateral, and terminate our ability to borrow. In certain cases, a default on one reverse repo agreement or derivative contract (whether caused by a failure to satisfy margin calls or another event of default) can trigger "cross defaults" on other such agreements. A significant increase in margin calls could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders, and could increase our risk of insolvency.
To the extent that we might be compelled to liquidate qualifying real estate assets to repay debts, our compliance with the REIT asset tests, income tests, and distribution requirements, could be negatively affected, which could jeopardize our qualification as a REIT. Losing our REIT qualification would cause us to be subject to U.S. federal income tax (and any applicable state and local taxes) on all of our income and decrease profitability and cash available to pay dividends to our shareholders.
Hedging against credit events, interest rate changes, foreign currency fluctuations, and other risks may materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Subject to qualifying and maintaining our qualification as a REIT and maintaining our exclusion from registration as an investment company under the Investment Company Act, we opportunistically pursue various hedging strategies to seek to reduce our exposure to losses from adverse credit events, interest rate changes, foreign currency fluctuations, and other risks. Hedging against a decline in the values of our portfolio positions does not prevent losses if the values of such positions decline, nor does it eliminate the possibility of fluctuations in the value of our portfolio. Hedging transactions generally will limit the opportunity for gain should the values of our other portfolio positions increase. Further, certain hedging transactions could result in significant losses. Qualification as a REIT may require that we undertake certain hedging activities in a TRS. Our domestic TRSs are subject to U.S. federal, state, and local income tax. Moreover, at any point in time we may choose not to hedge all or a portion of our risks, and we generally will not hedge those risks that we believe are appropriate for us to take at such time, or that we believe would be impractical or prohibitively expensive to hedge. Even if we do choose to hedge certain risks, for a variety of reasons we generally will not seek to establish a perfect correlation between our hedging instruments and the risks being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss. Our hedging activity will vary in scope based on the composition of our portfolio, our market views, and changing market conditions, including the level and volatility of interest rates. When we do choose to hedge, hedging may fail to protect or could materially adversely affect us because, among other things:
our Manager may fail to correctly assess the degree of correlation between the hedging instruments and the assets being hedged;
our Manager may fail to recalculate, re-adjust, and execute hedges in an efficient and timely manner;
the hedging transactions may actually result in poorer overall performance for us than if we had not engaged in the


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hedging transactions;
credit hedging can be expensive, particularly when the market is forecasting future credit deterioration and when markets are more illiquid;
interest rate hedging can be expensive, particularly during periods of volatile interest rates;
available hedges may not correspond directly with the risks for which protection is sought;
the durations of the hedges may not match the durations of the related assets or liabilities being hedged;
many hedges are structured as over-the-counter contracts with counterparties whose creditworthiness is not guaranteed, raising the possibility that the hedging counterparty may default on their payment obligations;
to the extent that the creditworthiness of a hedging counterparty deteriorates, it may be difficult or impossible to terminate or assign any hedging transactions with such counterparty; and
our hedging instruments are generally structured as derivative contracts and, as a result, are subject to additional risks such as those described above under "—Our lenders and derivative counterparties may require us to post additional collateral, which may force us to liquidate assets, and if we fail to post sufficient collateral our debts may be accelerated and/or our derivative contracts terminated on unfavorable terms" and below under "—Our use of derivatives may expose us to counterparty risk."
For these and other reasons, our hedging activity may materially adversely affect our business, financial condition and results of operations, our ability to pay dividends to our stockholders, and our ability to qualify as a REIT.
Hedging instruments and other derivatives, including some credit default swaps, may not, in many cases, be traded on regulated exchanges, or may not be guaranteed or regulated by any U.S. or foreign governmental authority and involve risks and costs that could result in material losses.
Hedging instruments and other derivatives, including certain types of credit default swaps, involve risk because they may not, in many cases, be traded on exchanges and may not be guaranteed or regulated by any U.S. or foreign governmental authorities. Consequently, for these instruments there may be less stringent requirements with respect to record keeping and compliance with applicable statutory and commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. Our Manager is not restricted from dealing with any particular counterparty or from concentrating any or all of its transactions with one counterparty. Furthermore, our Manager has only a limited internal credit function to evaluate the creditworthiness of its counterparties, mainly relying on its experience with such counterparties and their general reputation as participants in these markets. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in a default under the agreement governing the hedging arrangement. Default by a party with whom we enter into a hedging transaction, may result in losses and may force us to re-initiate similar hedges with other counterparties at the then-prevailing market levels. Generally we will seek to reserve the right to terminate our hedging transactions upon a counterparty's insolvency, but absent an actual insolvency, we may not be able to terminate a hedging transaction without the consent of the hedging counterparty, and we may not be able to assign or otherwise dispose of a hedging transaction to another counterparty without the consent of both the original hedging counterparty and the potential assignee. If we terminate a hedging transaction, we may not be able to enter into a replacement contract in order to cover our risk. There can be no assurance that a liquid secondary market will exist for hedging instruments purchased or sold, and therefore we may be required to maintain any hedging position until exercise or expiration, which could adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
In addition, some portion of our hedges are cleared through a central counterparty clearinghouse, or "CCP," which we access through a futures commission merchant, or "FCM." If an FCM that holds our cleared derivatives account were to become insolvent, the CCP will make an effort to move our futures positions to an alternate FCM, though it is possible that such transfer would fail, which would result in a total cancellation of our positions in the account; in such a case, if we wished to reinstate such hedging positions, we would have to re-initiate such positions with an alternate FCM. In the event of the insolvency of an FCM that holds our cleared over-the-counter derivatives, the rules of the CCP require that its direct members submit bids to take over the portfolio of the FCM, and would further require the CCP to move our existing positions and related margin to an alternate FCM. If this were to occur, we believe that our risk of loss would be limited to the excess equity in the account at the insolvent FCM due to the "legally segregated, operationally commingled" treatment of client assets under the rules governing FCMs in respect of cleared over-the-counter derivatives. In addition, in the case of both futures and cleared over-the-counter derivatives, there could be knock-on effects of our FCM's insolvency, such as the failure of co-customers of the FCM or other FCMs of the same CCP.  In such cases, there could be a shortfall in the funds available to the CCP due to such additional insolvencies and/or exhaustion of the CCP's guaranty fund that could lead to total loss of our positions in the FCM account.  Finally, we face a risk of loss (including total cancellation) of positions in the account in the event of fraud by our FCM or other FCMs of the CCP, where ordinary course remedies would not apply.


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The U.S. Commodity Futures Trading Commission, or "CFTC," and certain commodity exchanges have established limits referred to as speculative position limits or position limits on the maximum net long or net short position which any person or group of persons may hold or control in particular futures and options. Limits on trading in options contracts also have been established by the various options exchanges. It is possible that trading decisions may have to be modified and that positions held may have to be liquidated in order to avoid exceeding such limits. Such modification or liquidation, if required, could adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Certain of our hedging instruments are regulated by the CFTC and such regulations may adversely impact our ability to enter into such hedging instruments and cause us to incur increased costs.
We enter into interest rate swaps and credit default swaps, or "CDS," on corporations or on corporate indices, or "CDX," to hedge risks associated with our portfolio. Entities entering into such swaps are exposed to credit losses in the event of non-performance by counterparties to these transactions. Effective October 12, 2012, the CFTC issued rules regarding such swaps under the authority granted to it pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the "Dodd-Frank Act."
The rules primarily impact our trading of these instruments in two ways. First, beginning on June 10, 2013, certain newly executed swaps, including many interest rate and credit default swaps, became subject to mandatory clearing through a CCP. It is the intent of the Dodd-Frank Act that, by mandating the clearing of swaps in this manner, swap counterparty risk would not become overly concentrated in any single entity, but rather would be spread and centralized among the CCP and its members. We are not a direct member of any CCP, so we must access the CCPs through a FCM, which acts as intermediary between us and the CCP with respect to all facets of the transaction, including the posting and receipt of required collateral. If we lost access to our FCMs or CCPs, we could potentially be unable to use interest rate swaps and credit default swaps to hedge our risks.
The second way that the rules impact our trading of these instruments is the Swap Execution Facility, or "SEF," mandate, which came into effect on October 2, 2013, and requires that we execute most interest rate swaps and CDX on an electronic platform, rather than over the phone or in some other manner. If we were to lose access to our selected SEFs or we were otherwise unable to communicate with them, this would prevent us from being able to trade these instruments. If we were unable to execute our hedging trades in a timely manner, particularly in a volatile market environment, we may not be able to execute our strategies in the most advantageous manner.
In addition to subjecting our swap transactions to greater initial margin requirements and additional transaction fees charged by CCPs, FCMs, and SEFs, our swap transactions are now subjected to greater regulation by both the CFTC and the SEC. These additional fees, costs, margin requirements, documentation, and regulation could adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Additionally, for all interest rate swaps and CDX entered into prior to June 10, 2013, we were not required to clear them through a CCP and as a result these swaps are still subject to the risks of nonperformance by any of the individual counterparties with whom we entered into these transactions described above in "—Hedging instruments and other derivatives, including some credit default swaps, may not, in many cases, be traded on regulated exchanges, or may not be guaranteed or regulated by any U.S. or foreign governmental authority and involve risks and costs that could result in material losses."
Our use of derivatives may expose us to counterparty risk.
We enter into interest rate swaps and other derivatives that have not been cleared by a CCP. If a derivative counterparty cannot perform under the terms of the derivative contract, we would not receive payments due under that agreement, we may lose any unrealized gain associated with the derivative, and the hedged liability would cease to be hedged by such instrument. If a derivative counterparty becomes insolvent or files for bankruptcy, we may also be at risk for any collateral we have pledged to such counterparty to secure our obligations under derivative contracts, and we may incur significant costs in attempting to recover such collateral.
Our rights under our repos are subject to the effects of the bankruptcy laws in the event of the bankruptcy or insolvency of us or our lenders.
In the event of our insolvency or bankruptcy, certain repos may qualify for special treatment under the U.S. Bankruptcy Code, the effect of which, among other things, would be to allow the lender to avoid the automatic stay provisions of the U.S. Bankruptcy Code and to foreclose on and/or liquidate the collateral pledged under such agreements without delay. In the event of the insolvency or bankruptcy of a lender during the term of a repo, the lender may be permitted, under applicable insolvency laws, to repudiate the contract, and our claim against the lender for damages may be treated simply as an unsecured creditor. In


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addition, if the lender is a broker or dealer subject to the Securities Investor Protection Act of 1970, or an insured depository institution subject to the Federal Deposit Insurance Act, our ability to exercise our rights to recover our securities under a reverse repo or to be compensated for any damages resulting from the lenders' insolvency may be further limited by those statutes. These claims would be subject to significant delay and costs to us and, if and when received, may be substantially less than the damages we actually incur.
Certain actions by the Federal Reserve could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Since the 2008 financial crisis, the Federal Reserve has announced and completed several rounds of quantitative easing, which are programs designed to expand the Federal Reserve's holdings of long-term securities by purchasing U.S. Treasury securities and/or Agency RMBS, in order to provide stability to the market. As of December 31, 2019, the Federal Reserve was rolling over at auction all principal repayments from U.S. Treasury securities; it was reinvesting all principal payments from Agency RMBS into U.S. Treasury securities, up to $20 billion per month; and it was reinvesting principal payments in excess of $20 billion into Agency RMBS. To help prevent future spikes in overnight repo rates, such as those that occurred in September 2019, the Federal Reserve began buying short-term U.S. Treasury bills in October 2019, and committed to continue purchasing them at least into the second quarter of 2020. The Federal Reserve also conducted overnight and term repo operations to provide liquidity to the repo market and stabilize repo rates, and committed to continue doing so through January 2020 to address any year-end liquidity issues. These actions have put downward pressure on interest rates and have stabilized repo rates, but they could be changed and/or discontinued at any time.
During 2019, the Federal Reserve also decreased the target range for the federal funds rate three separate times. Portions of the yield curve inverted during 2019, and prepayments increased significantly. Among other effects, these interest reductions by the Federal Reserve could continue to increase prepayment rates (resulting from lower long-term interest rates, including mortgage rates), continue to impact the shape of the yield curve, and cause a narrowing of our net interest margin.
Should the U.S. economy begin to deteriorate, the Federal Reserve could further modify its asset purchase program or institute other measures designed to reduce interest rates, which could adversely impact our business, including lowering the yields that we are able to generate on our investments.
Prior to 2019, the Federal Reserve had been increasing the target range for the federal funds rate, from December 2015 through December 2018. At its most recent meeting in December 2019, it chose to keep the target range unchanged, and further interest rate increases may occur in the near future. See "—Increases in interest rates could negatively affect the value of our assets and increase the risk of default on our assets" above. These and other actions by the Federal Reserve could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
We may change our investment strategy, investment guidelines, hedging strategy, and asset allocation, operational, and management policies without notice or stockholder consent, which may materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders. In addition, our Board of Directors may authorize us to revoke or otherwise terminate our REIT election without the approval of our stockholders.
We may change our investment strategy, investment guidelines, hedging strategy, and asset allocation, operational, and management policies at any time without notice to or consent from our stockholders. As a result, the types or mix of assets, liabilities, or hedging transactions in our portfolio may be different from, and possibly riskier than, the types or mix of assets, liabilities, and hedging transactions that we have historically held, or that are otherwise described in this report. A change in our strategy may increase our exposure to real estate values, interest rates, and other factors. Our Board of Directors determines our investment guidelines and our operational policies, and may amend or revise our policies, including those with respect to our acquisitions, growth, operations, indebtedness, capitalization, and dividends or approve transactions that deviate from these policies without a vote of, or notice to, our stockholders. Policy or strategy changes could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Although we will elect to be treated as a REIT upon the filing of our tax return for the taxable year ended December 31, 2019, our Board of Directors may authorize us to revoke or otherwise terminate our REIT election, without the approval of our stockholders, at any time. These changes could materially adversely affect our business, financial condition and results of operations and our ability to pay dividends to our stockholders.
We, Ellington, or its affiliates may be subject to adverse legislative or regulatory changes.
At any time, U.S. federal, state, local, or foreign laws or regulations that impact our business, or the administrative interpretations of those laws or regulations, may be enacted or amended. For example, on July 21, 2010 the Dodd-Frank Act was enacted, which significantly revised many financial regulations. Certain portions of the Dodd-Frank Act were effective immediately, while other portions have become or will become effective following rulemaking and transition periods, but many of these changes could materially impact the profitability of our business or the business of our Manager or Ellington, our


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access to financing or capital, the value of the assets that we hold, expose us to additional costs, require changes to business practices, or adversely affect our ability to pay dividends. For example, the Dodd-Frank Act alters the regulation of commodity interests, imposes regulation on the over-the-counter derivatives market, places restrictions on residential mortgage loan originations, and reforms the asset-backed securitization markets most notably by imposing credit requirements. While there continues to be uncertainty about the exact impact of all of these changes, we do know that we and our Manager are subject to a more complex regulatory framework, and are incurring and will in the future incur costs to comply with new requirements as well as to monitor compliance in the future.
In addition, certain U.S. and European regulations implementing credit risk retention requirements for debt securitizations may adversely affect us. The impact of these risk retention rules on the securitization market are uncertain, and such rules may prevent us from completing any future securitization transactions or from purchasing the B-pieces of CMBS securitizations. In October 2014, the U.S. risk retention rules, or the "U.S. Risk Retention Rules," were issued. The U.S. Risk Retention Rules require the sponsor of a debt securitization subject to such rules, in the absence of an exemption, to retain (directly or through a majority-owned affiliate) a 5% economic interest in the credit risk of the assets being securitized. The retained economic interest may take the form of an eligible horizontal residual interest (retention of the most subordinated tranches of the securitization), an eligible vertical interest (retention of 5% of every tranche of the securitization), or a combination thereof, in accordance with the requirements of the U.S. Risk Retention Rules. The U.S. Risk Retention Rules became effective December 24, 2016.
We cannot predict when or if any new law, regulation, or administrative interpretation, including those related to the Dodd-Frank Act, or any amendment to or repeal of any existing law, regulation, or administrative interpretation, will be adopted or promulgated or will become effective. Additionally, the adoption or implementation of any new law, regulation, or administrative interpretation, or any revisions in or repeals of these laws, regulations, or administrative interpretations, including those related to the Dodd-Frank Act, could cause us to change our portfolio, could constrain our strategy, or increase our costs. We could be adversely affected by any change in or any promulgation of new law, regulation, or administrative interpretation.
We, Ellington, or its affiliates may be subject to regulatory inquiries and proceedings, or other legal proceedings.
At any time, industry-wide or company-specific regulatory inquiries or proceedings can be initiated and we cannot predict when or if any such regulatory inquiries or proceedings will be initiated that involve us or Ellington or its affiliates, including our Manager. We believe that the heightened scrutiny of the financial services industry increases the risk of inquiries and requests from regulatory or enforcement agencies. For example, as discussed under the caption Item 3. Legal Proceedings, over the years, Ellington and its affiliates have received, and we expect in the future that we and they may receive, inquiries and requests for documents and information from various federal, state, and foreign regulators.
We can give no assurances that, whether the result of regulatory inquiries or otherwise, neither we nor Ellington nor its affiliates will become subject to investigations, enforcement actions, fines, penalties or the assertion of private litigation claims. If any such events were to occur, we, or our Manager's ability to perform its obligations to us under the management agreement between us and our Manager, or Ellington's ability to perform its obligations to our Manager under the services agreement between Ellington and our Manager, could be materially adversely impacted, which could in turn have a material adverse effect on our business, financial condition and results of operations, and our ability to pay dividends to our shareholders.
We operate in a highly competitive market.
Our profitability depends, in large part, on our ability to acquire targeted assets at favorable prices. We compete with a number of entities when acquiring our targeted assets, including other mortgage REITs, financial companies, public and private funds, commercial and investment banks, and residential and commercial finance companies. We may also compete with (i) the Federal Reserve and the U.S. Treasury to the extent they purchase assets in our targeted asset classes and (ii) companies that partner with and/or receive financing from the U.S. Government or consumer bank deposits. Many of our competitors are substantially larger and have considerably more favorable access to capital and other resources than we do. Furthermore, new companies with significant amounts of capital have been formed or have raised additional capital, and may continue to be formed and raise additional capital in the future, and these companies may have objectives that overlap with ours, which may create competition for assets we wish to acquire. Some competitors may have a lower cost of funds and access to funding sources that are not available to us, such as funding from the U.S. Government. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of assets to acquire, or pay higher prices than we can. We also may have different operating constraints from those of our competitors including, among others, (i) tax-driven constraints such as those arising from our qualification as a REIT and in some cases to avoid adverse tax consequences to our stockholders, (ii) restraints imposed on us by our attempt to comply with certain exclusions from the definition of an "investment company" or other exemptions under the Investment Company Act and (iii) restraints and


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additional costs arising from our status as a public company. Furthermore, competition for assets in our targeted asset classes may lead to the price of such assets increasing, which may further limit our ability to generate desired returns. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
We are highly dependent on Ellington's information systems and those of third-party service providers and system failures could significantly disrupt our business, which may, in turn, materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Our business is highly dependent on Ellington's communications and information systems and those of third-party service providers. Any failure or interruption of Ellington's or certain third-party service providers' systems or cyber-attacks or security breaches of their networks or systems could cause delays or other problems in our securities trading activities, could allow unauthorized access for purposes of misappropriating assets, stealing proprietary and confidential information, corrupting data or causing operational disruption, which could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Computer malware, ransomware, viruses, and computer hacking and phishing attacks have become more prevalent in the financial services industry and may occur on Ellington's or certain third party service providers' systems in the future. We rely heavily on Ellington's financial, accounting and other data processing systems. Although Ellington has not detected a breach to date, financial services institutions have reported breaches of their systems, some of which have been significant. Even with all reasonable security efforts, not every breach can be prevented or even detected. It is possible that Ellington or certain third-party service providers have experienced an undetected breach, and it is likely that other financial institutions have experienced more breaches than have been detected and reported. There is no assurance that we, Ellington, or certain of the third parties that facilitate our and Ellington's business activities, have not or will not experience a breach. It is difficult to determine what, if any, negative impact may directly result from any specific interruption or cyber-attacks or security breaches of Ellington's networks or systems (or the networks or systems of certain third parties that facilitate our and Ellington's business activities) or any failure to maintain performance, reliability and security of Ellington's or certain third-party service providers' technical infrastructure, but such computer malware, ransomware, viruses, and computer hacking and phishing attacks may negatively affect our operations.
Because we are highly dependent on information systems when sharing information with third party service providers, systems failures, breaches or cyber-attacks could significantly disrupt our business, which could have a material adverse effect on our results of operations and cash flows.
When we acquire certain investments, including residential mortgage loans and consumer loans, we may come into possession of non-public personal information that an identity thief could utilize in engaging in fraudulent activity or theft. We may share this information with third party service providers, including those interested in acquiring such loans from us or financing such loans, or with other third parties, as required or permitted by law. We may be liable for losses suffered by individuals whose personal information is stolen as a result of a breach of the security of the systems on which Ellington, or third-party service providers of ours store this information, or as a result of other mismanagement of such information, and any such liability could be material. Even if we are not liable for such losses, any breach of these systems could expose us to material costs in notifying affected individuals or other parties and providing credit monitoring services, as well as to regulatory fines or penalties. In addition, any breach of these systems could disrupt our normal business operations and expose us to reputational damage and lost business, revenues, and profits.
Lack of diversification in the number of assets we acquire would increase our dependence on relatively few individual assets.
Our management objectives and policies do not place a limit on the amount of capital used to support, or the exposure to (by any other measure), any individual asset or any group of assets with similar characteristics or risks. As a result, our portfolio may be concentrated in a small number of assets or may be otherwise undiversified, increasing the risk of loss and the magnitude of potential losses to us and our stockholders if one or more of these assets perform poorly.
For example, our portfolio of mortgage-related assets may at times be concentrated in certain property types that are subject to higher risk of foreclosure, or secured by properties concentrated in a limited number of geographic locations. To the extent that our portfolio is concentrated in any one region or type of security, downturns or other significant events or developments relating generally to such region or type of security may result in defaults on a number of our assets within a short time period, which may materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.


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The lack of liquidity in our assets may materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
We acquire assets and other instruments that are not publicly traded, including privately placed RMBS, residential and commercial mortgage loans, CLOs, consumer loans, ABS backed by consumer and commercial assets, distressed corporate debt, and other private investments. As such, these assets may be subject to legal and other restrictions on resale, transfer, pledge or other disposition, or will otherwise be less liquid than publicly traded securities. Other assets that we acquire, while publicly traded, have limited liquidity on account of their complexity, turbulent market conditions, or other factors. In addition, mortgage-related assets from time to time have experienced extended periods of illiquidity, including during times of financial stress (such as during the 2008 financial crisis), which is often the time that liquidity is most needed. Illiquid assets typically experience greater price volatility, because a ready market does not exist, and they can be more difficult to value or sell if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value at which we have previously recorded our assets. We may also face other restrictions on our ability to liquidate any assets for which we or our Manager has or could be attributed with material non-public information. Furthermore, assets that are illiquid are more difficult to finance, and to the extent that we finance assets that are or become illiquid, we may lose that financing or have it reduced. If we are unable to sell our assets at favorable prices or at all, it could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
We could be subject to liability for potential violations of predatory lending laws, which could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Loan originators and servicers are required to comply with various federal, state and local laws and regulations, including anti-predatory lending laws and laws and regulations imposing certain restrictions on requirements on high cost loans. Failure of loan originators or servicers to comply with these laws, to the extent any of their loans become part of our assets, could subject us, as an assignee or purchaser of the related loans, to monetary penalties and could result in the borrowers rescinding the affected loans. Lawsuits have been brought in various states making claims against assignees or purchasers of high cost loans for violations of state law. Named defendants in these cases have included assignees or purchasers of certain types of loans we invest in. If the loans are found to have been originated in violation of predatory or abusive lending laws, we could incur losses, which could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
We may be exposed to environmental liabilities with respect to properties in which we have an interest.
In the course of our business, we may take title to real estate, and, if we do take title, we could be subject to environmental liabilities with respect to these properties. In such a circumstance, we may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation, and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, the presence of hazardous substances may adversely affect an owner's ability to sell real estate or borrow using real estate as collateral. To the extent that an owner of an underlying property becomes liable for removal costs, the ability of the owner to make debt payments may be reduced, which in turn may materially adversely affect the value of the relevant mortgage-related assets held by us.
Consumer loans are subject to delinquency and loss, which could have a negative impact on our financial results.
We are exposed to the performance of consumer loans both through the consumer loans that we own directly, and through those consumer loans to which we are exposed indirectly through our ownership of consumer-loan-backed ABS. The ability of borrowers to repay consumer loans may be adversely affected by numerous borrower-specific factors, including unemployment, divorce, major medical expenses or personal bankruptcy. General factors, including an economic downturn, high energy costs or acts of God, pandemics such as novel coronavirus (COVID-19), or terrorism, may also affect the financial stability of borrowers and impair their ability or willingness to repay their loans. Whenever any of our consumer loans defaults, we are at risk of loss to the extent of any deficiency between the liquidation value of the collateral, if any, securing the loan, and the principal and accrued interest of the loan. Many of our consumer loans are unsecured, or are secured by collateral (such as an automobile) that depreciates rapidly; as a result, these loans may be at greater risk of loss than residential real estate loans. Pursuing any remaining deficiency following a default is often difficult or impractical, especially when the borrower has a low credit score, making further substantial collection efforts unwarranted. In addition, repossessing personal property securing a consumer loan can present additional challenges, including locating and taking physical possession of the collateral. We rely on servicers who service these consumer loans, to, among other things, collect principal and interest payments on the loans and perform loss mitigation services, and these servicers may not perform in a manner that promotes our interests. Since we purchase some of our consumer loans and our consumer-loan-backed ABS at a premium to the remaining unpaid principal balance, we may incur a loss when such loans are voluntarily prepaid. There can be no guarantee that we will not suffer


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unexpected losses on our investments as a result of the factors set out above, which could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Increased regulatory attention and potential regulatory action on certain areas within the consumer credit or reverse mortgage businesses could have a negative impact on our reputation, or cause losses on our investments in consumer loans or our equity investment in loan originators.
Certain consumer advocacy groups, media reports, and federal and state legislators have asserted that laws and regulations should be tightened to severely limit, if not eliminate, the availability of certain loan products. The consumer advocacy groups and media reports generally focus on higher cost consumer loans, which are typically made to less creditworthy borrowers, and which bear interest rates that are higher than the interest rates typically charged by lending institutions to more creditworthy consumers. These consumer advocacy groups and media reports have characterized these consumer loans as predatory or abusive. In addition, reverse mortgage loans have faced similar issues in terms of media reports and potential legislative hurdles. If the negative characterization of these types of loans becomes increasingly accepted by consumers, legislators or regulators, our reputation, as a purchaser of such loans and as an equity investor in a both a consumer loan originator and a reverse mortgage originator, could be negatively impacted. Furthermore, if legislators or regulators take action against originators of consumer loans or reverse mortgages or provide for payment relief for borrowers, we could incur additional losses on the consumer loans that we have purchased and/or with respect to the equity investments that we have made in a consumer loan originator and a reverse mortgage originator.
Our investments in distressed debt and equity have significant risk of loss, and our efforts to protect these investments may involve large costs and may not be successful.
Our investments in distressed debt and equity have significant risk of loss, and our efforts to protect these investments may involve large costs and may not be successful. We also will be subject to significant uncertainty as to when and in what manner and for what value the distressed debt or equity in which we invest will eventually be satisfied (e.g., in the case of distressed debt, through liquidation of the obligor's assets, an exchange offer or plan of reorganization involving the distressed debt securities or a payment of some amount in satisfaction of the obligation). In addition, even if an exchange offer is made or plan of reorganization is adopted with respect to distressed debt we hold, there can be no assurance that the securities or other assets received by us in connection with such exchange offer or plan of reorganization will not have a lower value or income potential than may have been anticipated when the investment was made. Moreover, any securities received by us upon completion of an exchange offer or plan of reorganization may be restricted as to resale. If we participate in negotiations with respect to any exchange offer or plan of reorganization with respect to an issuer of distressed debt, we may be restricted from disposing of such securities.
The pools of loans underlying Ellington-sponsored CLO securitizations ("Ellington-Sponsored CLOs") have historically had lower ratings than the loan portfolios in typical CLOs focusing on below investment grade loans, and could therefore be considered "stressed" or "distressed." As such, the credit rating agencies would anticipate a higher rate of defaults in the Ellington-Sponsored CLO loan portfolios as compared to other CLOs. Additionally, Ellington-Sponsored CLOs may be less diversified than other CLOs, which could increase the adverse impact of one or more loan defaults on Ellington-Sponsored CLOs. It is anticipated that future Ellington-Sponsored CLOs will have similarly lower-rated loan portfolios and may not be diversified as other CLOs. As a result, the risks associated with our investments in Ellington-Sponsored CLOs may be even more significant than investments in other CLOs because of the loan portfolio composition of Ellington-Sponsored CLOs.
We may hold the debt securities, loans or equity of companies that are more likely to enter into bankruptcy proceedings or have other risks.
We may hold the debt securities, loans or equity of companies that are more likely to experience bankruptcy or similar financial distress, such as companies that are thinly capitalized, employ a high degree of financial leverage, are in highly competitive or risky businesses, are in a start-up phase, or are experiencing losses. The bankruptcy process has a number of significant inherent risks. Many events in a bankruptcy proceeding are the product of contested matters and adversarial proceedings and are beyond the control of the creditors. A bankruptcy filing by a company whose debt or equity we have purchased may adversely and permanently affect such company. If the proceeding results in liquidation, the liquidation value of the company may have deteriorated significantly from what we believed to be the case at the time of our initial investment. The duration of a bankruptcy proceeding is also difficult to predict, and a return on investment to a creditor or equity investor can be adversely affected by delays until a plan of reorganization or liquidation ultimately becomes effective. The administrative costs in connection with a bankruptcy proceeding are frequently high and would be paid out of the debtor's estate prior to any return to creditors. Because the standards for classification of claims under bankruptcy law are vague, our influence with respect to the class of securities or other obligations we own may be lost by increases in the number and amount of claims in the same class or by different classification and treatment. In the early stages of the bankruptcy process, it is often difficult to estimate the extent of, or even to identify, any contingent claims that might be made. In addition, certain claims that have


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priority by law (for example, claims for taxes) may be substantial, eroding the value of any recovery by holders of other securities of the bankrupt entity.
A bankruptcy court may also re-characterize our debt investment as equity, and subordinate all or a portion of our claim to that of other creditors. This could occur even if our investment had initially been structured as senior debt, and we could lose all or a significant part of our investment.
We have made and may in the future make loans secured by, or invest in structures tied to, individual, or portfolios of, legal claims, or "litigation finance loans." There is no assurance our Manager will be able to predict several aspects of the cases underlying our investments, including to which courts and judges the cases are assigned, the development of evidence during discovery and its presentation at trial, the composition and decisions of juries, timing of the judicial process, likelihood of settlements and collectibility of judgments.
In addition, we will not have the ability to control decisions made by the claimholder, defendant, or the law firm, nor can we share details of the underlying cases with our stockholders. We rely on, among other things, the advice and opinion of outside counsel and other experts in assessing potential claims and on the skills and efforts of independent law firms to litigate cases. There is no guarantee that the ultimate outcome of any case will be in line with a law firm's or expert's initial assessment of the validity and merit of a legal claim.
Various laws restrict the ability to assign certain legal claims or to participate in a lawyer's contingent fee interest in a claim. While we intend to analyze all relevant restrictions prior to investment, there is a risk that failure to comply with a federal, state or local law, rule or regulation could subject us to liability and jeopardize the enforceability of our investment.
We may be subject to risks associated with syndicated loans.
Under the documentation for syndicated loans, a financial institution or other entity typically is designated as the administrative agent and/or collateral agent. This agent is granted a lien on any collateral on behalf of the other lenders and distributes payments on the indebtedness as they are received. The agent is the party responsible for administering and enforcing the loan and generally may take actions only in accordance with the instructions of a majority or two-thirds in commitments and/or principal amount of the associated indebtedness. In most cases for our syndicated loan investments, we do not expect to hold a sufficient amount of the indebtedness to be able to compel any actions by the agent. Consequently, we would only be able to direct such actions if instructions from us were made in conjunction with other holders of associated indebtedness that together with us compose the requisite percentage of the related indebtedness then entitled to take action. Conversely, if holders of the required amount of the associated indebtedness other than us desire to take certain actions, such actions may be taken even if we did not support such actions. Furthermore, if a syndicated loan is subordinated to one or more senior loans made to the applicable obligor, the ability of us to exercise such rights may be subordinated to the exercise of such rights by the senior lenders. Whenever we are unable to direct such actions, the parties taking such actions may not have interests that are aligned with us, and the actions taken may not be in our best interests.
If an investment is a syndicated revolving loan or delayed drawdown loan, other lenders may fail to satisfy their full contractual funding commitments for such loan, which could create a breach of contract, result in a lawsuit by the obligor against the lenders and adversely affect the fair market value of our investment.
There is a risk that a loan agent may become bankrupt or insolvent. Such an event would delay, and possibly impair, any enforcement actions undertaken by holders of the associated indebtedness, including attempts to realize upon the collateral securing the associated indebtedness and/or direct the agent to take actions against the related obligor or the collateral securing the associated indebtedness and actions to realize on proceeds of payments made by obligors that are in the possession or control of any other financial institution. In addition, we may be unable to remove the agent in circumstances in which removal would be in our best interests. Moreover, agented loans typically allow for the agent to resign with certain advance notice, and we may not find a replacement agent on a timely basis, or at all, in order to protect our investment.
We have made and may in the future make investments in companies that we do not control.
Some of our investments in loan originators and other operating entities include, or may include, debt instruments and/or equity securities of companies that we do not control. Those investments will be subject to the risk that the company in which the investment is made may make business, financial or management decisions with which we do not agree or that the majority stakeholders or the management of such company may take risks or otherwise act in a manner that does not serve our interests. The entities in which we invest could be thinly capitalized, highly leveraged, dependent on a small number of key individuals, subject to regulatory concerns, or face other obstacles that could adversely affect the business and results of operations of any such entity. If any of the foregoing were to occur, our investments in these operating entities could be lost in their entirety, and our financial condition, results of operations and cash flow could suffer as a result.


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We have invested and may in the future invest in securities in the developing CRT sector that are subject to mortgage credit risk.
We have invested and may in the future invest in credit risk transfer securities, or "CRTs." CRTs are designed to transfer a portion of the mortgage credit risk of a pool of insured or guaranteed mortgage loans from the insurer or guarantor of such loans to CRT investors. In a CRT transaction, interest and/or principal of the CRT is written off following certain credit events, such as delinquencies, defaults, and/or realized losses, on the underlying mortgage pool. To date, the vast majority of CRTs consist of risk sharing transactions issued by the GSEs, namely Fannie Mae's Connecticut Avenue Securities program, or "CAS," and Freddie Mac's Structured Agency Credit Risk program, or "STACR." These securities have historically been structured as unsecured debt of the related GSE, but where the principal payments and principal write-offs are determined by the prepayments, delinquencies, and/or realized losses on a reference pool of mortgage loans guaranteed by such GSE. However, in 2018, Fannie Mae's CAS program began structuring some of its offerings as real estate mortgage investment conduit, or "REMIC," securities, and Freddie Mac followed suit in 2019. It is anticipated that in the future Fannie Mae and Freddie Mac may issue CRTs with a variety of other structures.
Risks Related to our Relationship with our Manager and Ellington
We cannot assure you that our Manager's past experience will be sufficient to successfully manage our business as a REIT.
Our Manager has limited experience operating REITs. The REIT provisions of the Code are complex, and any failure to comply with those provisions in a timely manner could prevent us from qualifying and maintaining our qualification as a REIT or force us to pay unexpected taxes and penalties. In such event, our net income would be reduced and we could incur a loss.
We are dependent on our Manager and certain key personnel of Ellington that are provided to us through our Manager and may not find a suitable replacement if our Manager terminates the management agreement or such key personnel are no longer available to us.
We do not have any employees of our own. Our officers are employees of Ellington or one or more of its affiliates. We have no separate facilities and are completely reliant on our Manager, which has significant discretion as to the implementation of our operating policies and execution of our business strategies and risk management practices. We also depend on our Manager's access to the professionals of Ellington as well as information and deal flow generated by Ellington. The employees of Ellington identify, evaluate, negotiate, structure, close, and monitor our portfolio. The departure of any of the senior officers of our Manager, or of a significant number of investment professionals of Ellington or the inability of such personnel to perform their duties due to acts of God, including pandemics such as novel coronavirus (COVID-19), could have a material adverse effect on our ability to achieve our objectives. We can offer no assurance that our Manager will remain our manager or that we will continue to have access to our Manager's senior management. We are subject to the risk that our Manager will terminate the management agreement or that we may deem it necessary to terminate the management agreement or prevent certain individuals from performing services for us and that no suitable replacement will be found to manage us.
The base management fee payable to our Manager is payable regardless of the performance of our portfolio, which may reduce our Manager's incentive to devote the time and effort to seeking profitable opportunities for our portfolio.
We pay our Manager substantial base management fees based on our equity capital (as defined in the management agreement) regardless of the performance of our portfolio. The base management fee takes into account the net issuance proceeds of both common and preferred stock offerings. Our Manager's entitlement to non-performance-based compensation might reduce its incentive to devote the time and effort of its professionals to seeking profitable opportunities for our portfolio, which could result in a lower performance of our portfolio and materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Our Manager's incentive fee may induce our Manager to acquire certain assets, including speculative or high risk assets, or to acquire assets with increased leverage, which could increase the risk to our portfolio.
In addition to its base management fee, our Manager is entitled to receive an incentive fee based, in large part, upon our achievement of targeted levels of net income. In evaluating asset acquisition and other management strategies, the opportunity to earn an incentive fee based on net income may lead our Manager to place undue emphasis on the maximization of net income at the expense of other criteria, such as preservation of capital, maintaining liquidity, and/or management of credit risk or market risk, in order to achieve a higher incentive fee. Assets with higher yield potential are generally riskier or more speculative. This could result in increased risk to our portfolio.


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Our Board of Directors has approved very broad investment guidelines for our Manager and will not approve each decision made by our Manager to acquire, dispose of, or otherwise manage an asset.
Our Manager is authorized to follow very broad guidelines in pursuing our strategy. While our Board of Directors periodically reviews our guidelines and our portfolio and asset-management decisions, it generally does not review all of our proposed acquisitions, dispositions, and other management decisions. In addition, in conducting periodic reviews, our Board of Directors relies primarily on information provided to them by our Manager. Furthermore, our Manager may arrange for us to use complex strategies or to enter into complex transactions that may be difficult or impossible to unwind by the time they are reviewed by our Board of Directors. Our Manager has great latitude within the broad guidelines in determining the types of assets it may decide are proper for us to acquire and other decisions with respect to the management of those assets. Poor decisions could have a material adverse effect on our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
We compete with Ellington's other accounts for access to Ellington.
Ellington has sponsored and/or currently manages accounts with a focus that overlaps with our investment focus, and expects to continue to do so in the future. Ellington is not restricted in any way from sponsoring or accepting capital from new accounts, even for investing in asset classes or strategies that are similar to, or overlapping with, our asset classes or strategies. Therefore, we compete for access to the benefits that our relationship with our Manager and Ellington provides us. For the same reasons, the personnel of Ellington and our Manager may be unable to dedicate a substantial portion of their time to managing our assets.
We compete with other Ellington accounts for opportunities to acquire assets, which are allocated in accordance with Ellington's investment allocation policies.
Many of our targeted assets are also targeted assets of other Ellington accounts, and Ellington has no duty to allocate such opportunities in a manner that preferentially favors us. Ellington makes available to us all opportunities to acquire assets that it determines, in its reasonable and good faith judgment, based on our objectives, policies and strategies, and other relevant factors, are appropriate for us in accordance with Ellington's written investment allocation policy, it being understood that we might not participate in each such opportunity, but will on an overall basis equitably participate with Ellington's other accounts in all such opportunities.
Since many of our targeted assets are typically available only in specified quantities and are also targeted assets for other Ellington accounts, Ellington often is not able to buy as much of any asset or group of assets as would be required to satisfy the needs of all of Ellington's accounts. In these cases, Ellington's investment allocation procedures and policies typically allocate such assets to multiple accounts in proportion to their needs and available capital. As part of these policies, accounts that are in a "start-up" or "ramp-up" phase may get allocations above their proportion of available capital, which could work to our disadvantage, particularly because there are no limitations surrounding Ellington's ability to create new accounts. In addition, the policies permit departure from proportional allocations under certain circumstances, for example when such allocation would result in an inefficiently small amount of the security or assets being purchased for an account, which may also result in our not participating in certain allocations.
There are conflicts of interest in our relationships with our Manager and Ellington, which could result in decisions that are not in the best interests of our stockholders.
We are subject to conflicts of interest arising out of our relationship with Ellington and our Manager. Currently, all of our executive officers, and one of our directors, are employees of Ellington or one or more of its affiliates. As a result, our Manager and our officers may have conflicts between their duties to us and their duties to, and interests in, Ellington or our Manager. For example, Mr. Penn, our President and Chief Executive Officer and one of our directors, also serves as the President and Chief Executive Officer of, and as a member of the Board of Trustees of, Ellington Residential Mortgage REIT, and as Vice Chairman and Chief Operating Officer of Ellington. Mr. Vranos, our Co-Chief Investment Officer, also serves as the Co-Chief Investment Officer of, and as a member of the Board of Trustees of, Ellington Residential Mortgage REIT, and as Chairman of Ellington. Mr. Tecotzky, our Co-Chief Investment Officer, also serves as the Co-Chief Investment Officer of Ellington Residential Mortgage REIT, and as a Managing Director of Ellington. Mr. Herlihy, our Chief Financial Officer, also serves as the Chief Operating Officer of Ellington Residential Mortgage REIT, and as a Director of Ellington. Mr. Smernoff, our Chief Accounting Officer, also serves as the Chief Financial Officer of Ellington Residential Mortgage REIT.
We may acquire or sell assets in which Ellington or its affiliates have or may have an interest. Similarly, Ellington or its affiliates may acquire or sell assets in which we have or may have an interest. Although such acquisitions or dispositions may present conflicts of interest, we nonetheless may pursue and consummate such transactions. Additionally, we may engage in transactions directly with Ellington or its affiliates, including the purchase and sale of all or a portion of a portfolio asset. We


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may also, either directly or indirectly through an entity in which we invest, pay Ellington or an affiliate of Ellington to perform administrative services for us. Furthermore, if we securitize any of our assets, Ellington or an affiliate of Ellington may be required under the U.S. Risk Retention Rules to acquire and retain an economic interest in the credit risk of such assets. In connection with any of these transactions we may indemnify, alongside other Ellington affiliates, Ellington or its affiliates or third parties.
Acquisitions made for entities with similar objectives may be different from those made on our behalf. Ellington may have economic interests in, or other relationships with, others in whose obligations or securities we may acquire. In particular, such persons may make and/or hold an investment in securities that we acquire that may be pari passu, senior, or junior in ranking to our interest in the securities or in which partners, security holders, officers, directors, agents, or employees of such persons serve on boards of directors or otherwise have ongoing relationships. Each of such ownership and other relationships may result in securities laws restrictions on transactions in such securities and otherwise create conflicts of interest. In such instances, Ellington may, in its sole discretion, make recommendations and decisions regarding such securities for other entities that may be the same as or different from those made with respect to such securities and may take actions (or omit to take actions) in the context of these other economic interests or relationships the consequences of which may be adverse to our interests.
In deciding whether to issue additional debt or equity securities, we will rely in part on recommendations made by our Manager. While such decisions are subject to the approval of our Board of Directors, one of our directors is also an Ellington employee. Because our Manager earns base management fees that are based on the total amount of our equity capital, and earns incentive fees that are based in part on the total net income that we are able to generate, our Manager may have an incentive to recommend that we issue additional debt or equity securities. See "—Future offerings of debt securities, which would rank senior to our common and preferred stock upon our liquidation, and future offerings of equity securities, which could dilute our existing stockholders and, in the case of preferred equity, may be senior to our common stock for the purposes of dividend and liquidating distributions, may adversely affect the market price of our common stock."
The officers of our Manager and its affiliates devote as much time to us as our Manager deems appropriate; however, these officers may have conflicts in allocating their time and services among us and Ellington and its affiliates' accounts. During turbulent conditions in the mortgage industry, distress in the credit markets or other times when we will need focused support and assistance from our Manager and Ellington employees, other entities that Ellington advises or manages will likewise require greater focus and attention, placing our Manager and Ellington's resources in high demand. In such situations, we may not receive the necessary support and assistance we require or would otherwise receive if we were internally managed or if Ellington or its affiliates did not act as a manager for other entities.
We, directly or through Ellington, may obtain confidential information about the companies or securities in which we have invested or may invest. If we do possess confidential information about such companies or securities, there may be restrictions on our ability to dispose of, increase the amount of, or otherwise take action with respect to the securities of such companies. Our Manager's and Ellington's management of other accounts could create a conflict of interest to the extent our Manager or Ellington is aware of material non-public information concerning potential investment decisions. We have implemented compliance procedures and practices designed to ensure that investment decisions are not made while in possession of material non-public information. We cannot assure you, however, that these procedures and practices will be effective. In addition, this conflict and these procedures and practices may limit the freedom of our Manager to make potentially profitable investments, which could have an adverse effect on our operations. These limitations imposed by access to confidential information could therefore materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
As of December 31, 2019, the Manager Group owned approximately 9.3% of our outstanding common shares and other equity interests convertible into our common shares. In evaluating opportunities for us and other management strategies, this may lead our Manager to emphasize certain asset acquisition, disposition, or management objectives over others, such as balancing risk or capital preservation objectives against return objectives. This could increase the risks, or decrease the returns, of your investment.
The management agreement with our Manager was not negotiated on an arm's-length basis and may not be as favorable to us as if it had been negotiated with an unaffiliated third party and may be costly and difficult to terminate.
Our management agreement with our Manager was negotiated between related parties, and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third party. Various potential and actual conflicts of interest may arise from the activities of Ellington and its affiliates by virtue of the fact that our Manager is controlled by Ellington.
Termination of our management agreement without cause, including termination for poor performance or non-renewal, is


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subject to several conditions which may make such a termination difficult and costly. The management agreement has a current term that expires on December 31, 2020, and will be automatically renewed for successive one-year terms thereafter unless notice of non-renewal is delivered by either party to the other party at least 180 days prior to the expiration of the then current term. The management agreement provides that it may be terminated by us based on performance upon the affirmative vote of at least two-thirds of our independent directors, or by a vote of the holders of at least a majority of our outstanding common stock, based either upon unsatisfactory performance by our Manager that is materially detrimental to us or upon a determination by the Board of Directors that the fees payable to our Manager are not fair, subject to our Manager's right to prevent such a termination by accepting a mutually acceptable reduction of the fees. In the event we terminate the management agreement as discussed above or elect not to renew the management agreement, we will be required to pay our Manager a termination fee equal to the amount of three times the sum of the average annual base management fee and the average annual incentive fee earned by our Manager during the 24-month period immediately preceding the date of notice of termination or non-renewal, calculated as of the end of the most recently completed fiscal quarter prior to the date of notice of termination or non-renewal. These provisions will increase the effective cost to us of terminating the management agreement, thereby adversely affecting our ability to terminate our Manager without cause.
Pursuant to the management agreement, our Manager will not assume any responsibility other than to render the services called for thereunder and will not be responsible for any action of our Board of Directors in following or declining to follow its advice or recommendations. Under the terms of the management agreement, our Manager, Ellington, and their affiliates and each of their officers, directors, members, shareholders, managers, investment and risk management committee members, employees, agents, successors and assigns, will not be liable to us for acts or omissions performed in accordance with and pursuant to the management agreement, except because of acts or omissions constituting bad faith, willful misconduct, gross negligence, or reckless disregard of their duties under the management agreement. In addition, we will indemnify our Manager, Ellington, and their affiliates and each of their officers, directors, members, shareholders, managers, investment and risk management committee members, employees, agents, successors and assigns, with respect to all liabilities, judgments, costs, charges, losses, expenses, and claims arising from acts or omissions of our Manager not constituting bad faith, willful misconduct, gross negligence, or reckless disregard of duties under the management agreement.
If our Manager ceases to be our Manager pursuant to the management agreement or one or more of our Manager's key personnel ceases to provide services to us, our lenders and our derivative counterparties may cease doing business with us.
If our Manager ceases to be our Manager, including upon non-renewal of our management agreement, or if one or more of our Manager's key personnel ceases to provide services to us, it could constitute an event of default or early termination event under many of our repo or derivative transaction agreements, upon which our counterparties would have the right to terminate their agreements with us. If our Manager ceases to be our Manager for any reason, including upon the non-renewal of our management agreement and we are unable to obtain or renew financing or enter into or maintain derivative transactions, our business, financial condition and results of operations, and our ability to pay dividends to our stockholders may be materially adversely affected.
Our Manager's failure to identify and acquire assets that meet our asset criteria or perform its responsibilities under the management agreement could materially adversely affect our business, financial condition and results of operations, our ability to qualify and maintain our qualification as a REIT, and our ability to pay dividends to our stockholders.
Our ability to achieve our objectives depends on our Manager's ability to identify and acquire assets that meet our asset criteria. Accomplishing our objectives is largely a function of our Manager's structuring of our investment process, our access to financing on acceptable terms, and general market conditions. Our stockholders do not have input into our investment decisions. All of these factors increase the uncertainty, and thus the risk, of investing in our common or preferred stock. The senior management team of our Manager has substantial responsibilities under the management agreement. In order to implement certain strategies, our Manager may need to hire, train, supervise, and manage new employees successfully. Any failure to manage our future growth effectively could have a material adverse effect on our business, financial condition and results of operations, our ability to qualify and maintain our qualification as a REIT, and our ability to pay dividends to our stockholders.
We do not own the Ellington brand or trademark, but may use the brand and trademark as well as our logo pursuant to the terms of a license granted by Ellington.
Ellington has licensed the "Ellington" brand, trademark, and logo to us for so long as our Manager or another affiliate of Ellington continues to act as our manager. We do not own the brand, trademark, or logo that we will use in our business and may be unable to protect this intellectual property against infringement from third parties. Ellington retains the right to continue using the "Ellington" brand and trademark. We will further be unable to preclude Ellington from licensing or transferring the ownership of the "Ellington" brand and trademark to third parties, some of whom may compete against us. Consequently, we


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will be unable to prevent any damage to goodwill that may occur as a result of the activities of Ellington or others.
Furthermore, in the event our Manager or another affiliate of Ellington ceases to act as our manager, or in the event Ellington terminates the license, we will be required to change our name and trademark. Any of these events could disrupt our recognition in the marketplace, damage any goodwill we may have generated, and otherwise harm our business. Finally, the license is a domestic license in the United States only and does not give us any right to use the "Ellington" brand, trademark, and logo overseas even though we are using the brand, trademark, and logo overseas. Our use of the "Ellington" brand, trademark, and logo overseas will therefore be unlicensed and could expose us to a claim of infringement.
Risks Related to Our Common Stock
The market for our common stock may be limited, which may adversely affect the price at which our common stock trades and make it difficult to sell our common stock.
While our common stock is listed on the NYSE, such listing does not provide any assurance as to:
whether the market price of our common stock will reflect our actual financial performance;
the liquidity of our common stock;
the ability of any holder to sell common stock; or
the prices that may be obtained for our common stock.
The market price and trading volume of our common stock may be volatile.
The market price of our common stock may be highly volatile and could be subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly in the future. Some of the factors that could negatively affect our stock price or result in fluctuations in the price or trading volume of our common stock include:
actual or anticipated variations in our quarterly operating results or dividends;
changes in our earnings estimates, failure to meet earnings or operating results expectations of public market analysts and investors, or publication of research reports about us or the real estate specialty finance industry;
increases in market interest rates that lead purchasers of our common stock to demand a higher yield;
repurchases and issuances by us of our common stock;
passage of legislation, changes in applicable law, court rulings, enforcement actions, or regulatory developments that adversely affect us or our industry;
changes in government policies or changes in timing of implementation of government policies, including with respect to Fannie Mae, Freddie Mac, and Ginnie Mae;
changes in market valuations of similar companies;
adverse market reaction to any increased indebtedness we incur in the future;
additions or departures of key management personnel;
actions by stockholders;
speculation in the press or investment community;
adverse changes in global, national, regional and local economic and market conditions, including those relating to pandemics, such as the recent outbreak of novel coronavirus (COVID-19);
our inclusion in, or exclusion from, various stock indices;
our operating performance and the performance of other similar companies; and
changes in accounting principles.
Future offerings of debt securities, which would rank senior to our common and preferred stock upon our liquidation, and future offerings of equity securities, which could dilute our existing stockholders and, in the case of preferred equity, may be senior to our common stock for the purposes of dividend and liquidating distributions, may adversely affect the market price of our common stock.
In the future, we may attempt to increase our capital resources by making additional offerings of debt or equity securities, including commercial paper, medium-term notes, senior or subordinated notes, convertible securities, and additional classes of preferred stock. If we decide to issue additional senior securities in the future, it is likely that they will be governed by an


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indenture or other instrument containing covenants restricting our operating flexibility. Holders of senior securities may be granted specific rights, including the right to hold a perfected security interest in certain of our assets, the right to accelerate payments due under an indenture, rights to restrict dividend payments, and rights to require approval to sell assets. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences, and privileges more favorable than those of our then-outstanding securities and could dilute our existing stockholders. We and, indirectly, our stockholders, will bear the cost of issuing and servicing such securities. Upon liquidation, holders of our debt securities and preferred stock, and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings, including offerings of our common or preferred stock or other securities convertible into our common stock, may dilute the holdings of our existing stockholders or reduce the market price of our existing equity securities, or both. We cannot predict the effect, if any, of future sales of our common or preferred stock or other securities convertible into our common stock, or the availability of such securities for future sales, on the market price of our common stock. Sales of substantial amounts of our common or preferred stock or other securities convertible into our common stock, or the perception that such sales could occur, may adversely affect the prevailing market price for our common stock. Our preferred stock has a preference on liquidating distributions and a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing, or nature of our future offerings. Thus, holders of our securities bear the risk of our future offerings reducing the market price of our securities and, in the case of holders of our equity securities, diluting their holdings.
Our stockholders may not receive dividends or dividends may not grow over time.
We have not established a minimum distribution payment level and our ability to pay dividends on our common and preferred stock may be adversely affected by a number of factors, including the risk factors described herein. All dividends will be declared at the discretion of our Board of Directors and will depend on our earnings, our financial condition, REIT distribution requirements, and other factors as our Board of Directors may deem relevant from time to time. Our Board of Directors is under no obligation or requirement to declare a dividend distribution. We cannot assure you that we will achieve results that will allow us to pay a specified level of dividends or to increase dividends from one year to the next. Among the factors that could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders are:
our inability to realize positive or attractive returns on our portfolio, whether because of defaults in our portfolio, decreases in the value of our portfolio, or otherwise;
margin calls or other expenditures that reduce our cash flow and impact our liquidity; and
increases in actual or estimated operating expenses.
An increase in interest rates may have an adverse effect on the market price of our equity or debt securities and our ability to pay dividends to our stockholders.
One of the factors that investors may consider in deciding whether to buy or sell our common stock is our dividend rate (or expected future dividend rates) as a percentage of our common stock price, relative to prevailing market interest rates. Similarly, investors in our preferred equity securities or our debt securities may consider the dividend rate or yield on such securities relative to prevailing market interest rates. If market interest rates increase, prospective investors in our equity or debt securities may demand a higher dividend rate or yield on our securities or seek alternative investments paying higher dividends or interest. As a result, interest rate fluctuations and capital market conditions can affect the market price of our securities independent of the effects such conditions may have on our portfolio. For instance, if interest rates rise without an increase in our dividend rate, the market price of our common stock could decrease because potential investors may require a higher dividend yield on our common stock as market rates on interest-bearing instruments such as bonds rise. In addition, to the extent we have variable rate debt, such as our repo financings, rising interest rates would result in increased interest expense on this variable rate debt, thereby potentially adversely affecting our cash flow and our ability to service our indebtedness and pay dividends to our stockholders.
Investing in our securities involves a high degree of risk.
The assets we purchase in accordance with our objectives may result in a higher amount of risk than other alternative asset acquisition options. The assets we acquire may be highly speculative and aggressive and may be subject to a variety of risks, including credit risk, prepayment risk, interest rate risk, and market risk. As a result, an investment in our securities may not be suitable for investors with lower risk tolerance.


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Risks Related To Our Organization and Structure
Our certificate of incorporation, bylaws and management agreement contain provisions that may inhibit potential acquisition bids that stockholders may consider favorable, and the market price of our common stock may be lower as a result.
Our certificate of incorporation and bylaws contain provisions that may have an anti-takeover effect and inhibit a change in our Board of Directors. These provisions include:
allowing only our Board of Directors to fill newly created directorships resulting from any increase in the authorized number of directors and any vacancies in the Board of Directors resulting from death, resignation, retirement, disqualification, removal from office or other cause, even if the remaining directors do not constitute a quorum;
requiring advance notice for our stockholders to nominate candidates for election to our Board of Directors or to propose business to be considered by our stockholders at a meeting of stockholders;
the ability of our Board of Directors to cause us to issue additional authorized but unissued shares of common stock or preferred stock without the approval of our stockholders;
the ability of the Board of Directors to amend, modify or repeal our bylaws without the approval of our stockholders;
restrictions on the ability of stockholders to call a special meeting without a majority of all the votes entitled to be cast at such meeting; and
limitations on the ability of stockholders to act by written consent.
Certain provisions of the management agreement also could make it more difficult for third parties to acquire control of us by various means, including limitations on our right to terminate the management agreement and a requirement that, under certain circumstances, we make a substantial payment to our Manager in the event of a termination.
There are ownership limits and restrictions on transferability in our certificate of incorporation.
Our certificate of incorporation provides that (subject to certain exceptions described below) no person may own, or be deemed to own by virtue of the attribution provisions of the Code, more than 9.8%, in value or in number of shares, whichever is more restrictive, of the outstanding shares of any class or series of our capital stock.
Any person who acquires or attempts or intends to acquire beneficial or constructive ownership of shares of our capital stock that will or may violate any of the foregoing restrictions on transferability and ownership will be required to give written notice immediately to us, or in the case of proposed or attempted transactions will be required to give at least 15 days written notice to us, and provide us with such other information as we may request in order to determine the effect of such transfer on our status as a REIT.
Our Board of Directors, in its sole discretion, may exempt any person from the foregoing restrictions. Any person seeking such an exemption must provide to our Board of Directors such representations, covenants, and undertakings as our Board of Directors may deem appropriate. Our Board of Directors may also condition any such exemption on the receipt of a ruling from the Internal Revenue Service, or "IRS," or an opinion of counsel as it deems appropriate. Our Board of Directors has granted an exemption from this limitation to Ellington and certain affiliated entities of Ellington, subject to certain conditions.
Our rights and the rights of our stockholders to take action against our directors and officers or against our Manager or Ellington are limited, which could limit your recourse in the event actions are taken that are not in your best interests.
Our certificate of incorporation provides that each person that is or was a director, officer, employee, or agent of ours shall not be liable to us or any of our stockholders for any acts or omissions by any such person arising from the performance of their duties and obligations in connection with us, except to the extent such exemption from liability or limitation thereof is not permitted under the Delaware General Corporation Law.
In addition, our certificate of incorporation provides that we may indemnify, to the fullest extent permitted by law, each person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding (other than an action by or in our right), by reason of the fact that the person is or was a director, officer, employee, or agent of ours, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding, if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to our best interests, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person's conduct was unlawful. Our certificate of incorporation also provides that we may indemnify, to the fullest extent permitted by law, any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in our right to procure a judgment in our favor by reason of the fact that the person is or was a director, officer, employee, or agent of ours, against expenses (including attorneys'


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fees) actually and reasonably incurred by the person in connection with the defense or settlement of such action or suit if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to our best interests, except that no indemnification may be made in respect of any claim, issue or matter as to which such person had been adjudged to be liable to us unless and only to the extent that the Court of Chancery of the State of Delaware or the court in which such action or suit was brought determines that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses. We have entered into indemnification agreements with our directors and officers implementing these indemnification provisions that obligate us to indemnify them to the maximum extent permitted by Delaware law. Such indemnification includes defense costs and expenses incurred by such officers and directors.
Our management agreement with our Manager requires us to indemnify our Manager and its affiliates against any and all claims and demands arising out of claims by third parties caused by acts or omissions of our Manager and its affiliates not constituting bad faith, willful misconduct, gross negligence, or reckless disregard of our Manager's duties under the management agreement.
In light of the liability limitations contained in our certificate of incorporation and our management agreement with our Manager, as well as our indemnification arrangements with our directors and officers and our Manager, our and our stockholders' rights to take action against our directors, officers, and Manager are limited, which could limit your recourse in the event actions are taken that are not in your best interests.
Our certificate of incorporation designates the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders' ability to obtain a favorable judicial forum for disputes with us or our directors or officers.
Our certificate of incorporation provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will be the sole and exclusive forum for: any derivative action or proceeding brought on our behalf; any action asserting a claim of breach of fiduciary duty owed by any current or former director, officer or stockholder of ours to us or our stockholders; any action asserting a claim against us arising pursuant to any provision of the Delaware General Corporation Law or our certificate of incorporation or bylaws; or any action asserting a claim against us governed by the internal affairs doctrine. This choice of forum provision may limit a stockholder's ability to bring a claim in a judicial forum that the stockholder believes is favorable for disputes with us or our directors or officers, which may discourage lawsuits against us and our directors or officers. Alternatively, if a court were to find these provisions of our certificate of incorporation inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition or results of operations.
Certain provisions of Delaware law may inhibit potential acquisition bids that stockholders may consider favorable, and the market price of our common stock may be lower as a result.
We are a Delaware corporation, and Section 203 of the Delaware General Corporation Law applies to us. In general, Section 203 prevents an "interested stockholder" (as defined below) from engaging in a "business combination" (as defined in the statute) with us for three years following the date that person becomes an interested stockholder unless one or more of the following occurs:
before that person became an interested stockholder, our board of directors approved the transaction in which the interested stockholder became an interested stockholder or approved the business combination;
upon completion of the transaction that resulted in the interested stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of our voting stock outstanding at the time the transaction commenced, excluding for purposes of determining the voting stock outstanding (but not the outstanding voting stock owned by the interested stockholder) stock held by directors who are also officers of our company and by employee stock plans that do not provide employees with the right to determine confidentially whether shares held under the plan will be tendered in a tender or exchange offer; and
following the transaction in which that person became an interested stockholder, the business combination is approved by our board of directors and authorized at a meeting of stockholders by the affirmative vote of the holders of at least two-thirds of our outstanding voting stock not owned by the interested stockholder.
The statute defines "interested stockholder" as any person that is the owner of 15% or more of our outstanding voting stock or is an affiliate or associate of us and was the owner of 15% or more of our outstanding voting stock at any time within the three-year period immediately before the date of determination.
These provisions may delay, deter or prevent a change in control of our company, even if a proposed transaction is at a premium over the then current market price for our common stock. Further, these provisions may apply in instances where


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some stockholders consider a transaction beneficial to them. As a result, our stock price may be negatively affected by these provisions.
Maintenance of our exclusion from registration as an investment company under the Investment Company Act imposes significant limitations on our operations.
We have conducted and intend to continue to conduct our operations so that neither we nor any of our subsidiaries are required to register as an investment company under the Investment Company Act. Both we and our Operating Partnership are organized as holding companies and conduct our business primarily through wholly-owned subsidiaries of our Operating Partnership. Our Operating Partnership's investments in its 3(c)(7) subsidiaries and its other investment securities cannot exceed 40% of the value of our Operating Partnership's total assets (excluding U.S. government securities and cash) on an unconsolidated basis. In addition, the Holding Subsidiary's investment in its 3(c)(7) subsidiaries and its other investment securities cannot exceed 40% of the value of our Holding Subsidiary's total assets (excluding U.S. government securities and cash) on an unconsolidated basis. These requirements limit the types of businesses in which we may engage and the assets we may hold. Our 3(c)(5)(C) subsidiaries rely on the exclusion provided by Section 3(c)(5)(C) of the Investment Company Act. Section 3(c)(5)(C) of the Investment Company Act is designed for entities "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." This exclusion generally requires that at least 55% of the entity's assets on an unconsolidated basis consist of qualifying real estate assets and at least 80% of the entity's assets on an unconsolidated basis consist of qualifying real estate assets or real estate-related assets. Both the 40% Test and the requirements of the Section 3(c)(5)(C) limit the types of businesses in which we may engage and the types of assets we may hold, as well as the timing of sales and purchases of those assets.
To classify the assets held by our subsidiaries as qualifying real estate assets or real estate-related assets, we rely on no-action letters and other guidance published by the SEC staff regarding those kinds of assets, as well as upon our analyses (in consultation with outside counsel) of guidance published with respect to other types of assets. There can be no assurance that the laws and regulations governing the Investment Company Act status of companies similar to ours, or the guidance from the SEC staff regarding the treatment of assets as qualifying real estate assets or real estate-related assets, will not change in a manner that adversely affects our operations. In fact, in August 2011, the SEC published a concept release in which it asked for comments on this exclusion from registration. To the extent that the SEC staff provides more specific guidance regarding any of the matters bearing upon our exclusion from the definition of an investment company under the Investment Company Act, we may be required to adjust our strategy accordingly. Any additional guidance from the SEC staff could further inhibit our ability to pursue the strategies that we have chosen. Furthermore, although we monitor the assets of our subsidiaries regularly, there can be no assurance that our subsidiaries will be able to maintain their exclusion from registration. Any of the foregoing could require us to adjust our strategy, which could limit our ability to make certain investments or require us to sell assets in a manner, at a price or at a time that we otherwise would not have chosen. This could negatively affect the value of our common stock, the sustainability of our business model, and our ability to pay dividends to our stockholders.
If we were required to register as an investment company under the Investment Company Act, we would be subject to the restrictions imposed by the Investment Company Act, which would require us to make material changes to our strategy.
If we are deemed to be an investment company under the Investment Company Act, we would be required to materially restructure our activities or to register as an investment company under the Investment Company Act, which would have a material adverse effect on our business, financial condition, and results of operations. In connection with any such restructuring, we may be required to sell portfolio assets at a time we otherwise might not choose to do so, and we may incur losses in connection with such sales. Further, our Manager may unilaterally terminate the management agreement if we become regulated as an investment company under the Investment Company Act. Further, if it were established that we were an unregistered investment company, there would be a risk that we would be subject to monetary penalties and injunctive relief in an action brought by the SEC, that we would be unable to enforce contracts with third parties and that third parties could seek to obtain rescission of transactions undertaken during the period it was established that we were an unregistered investment company.
Failure to procure adequate funding and capital would adversely affect our results and may, in turn, negatively affect the value of our common shares and our ability to pay dividends to our stockholders.
We depend upon the availability of adequate funding and capital for our operations. To qualify and maintain our status as a REIT, we are required to distribute to our shareholders at least 90% of our REIT taxable income annually, determined excluding any net capital gains and without regard to the deduction for dividends paid. As a result, we are not able to retain much or any of our earnings for new investments. We cannot assure you that any, or sufficient, funding or capital will be available to us in the future on terms that are acceptable to us. In the event that we cannot obtain sufficient funding and capital


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on acceptable terms, there may be a negative impact on the value of our shares of common stock and our ability to pay dividends to our stockholders, and you may lose part or all of your investment.
U.S. Federal Income Tax Risks
Your investment has various U.S. federal, state, and local income tax risks.
We strongly urge you to consult your tax advisor concerning the effects of U.S. federal, state, and local income tax law on an investment in our common stock and on your individual tax situation.
Our failure to qualify as a REIT would subject us to U.S. federal, state and local income taxes, which could adversely affect the value of our common stock and would substantially reduce the cash available for distribution to our stockholders.
We will elect to be treated as a REIT for U.S. federal income tax purposes upon the filing of our tax return for the taxable year ended December 31, 2019. While we believe that we operated and intend to continue to operate in a manner that will enable us to meet the requirements for taxation as a REIT commencing on January 1, 2019, we cannot assure you that we will qualify and remain qualified as a REIT.
The U.S. federal income tax laws governing REITs are complex, and interpretations of the U.S. federal income tax laws governing qualification as a REIT are limited. Qualifying as a REIT requires us to meet various tests regarding the nature of our assets, our income and our earnings and profits, or "E&P" (calculated pursuant to Sections 316 and 857(d) of the Code and the regulations thereunder), the ownership of our outstanding stock, and the amount of our distributions on an ongoing basis. Our ability to satisfy the asset tests depends upon the characterization and fair market values of our assets, some of which are not precisely determinable, and for which we may not obtain independent appraisals. Our compliance with the REIT income and asset tests and the accuracy of our tax reporting to stockholders also depend upon our ability to successfully manage the calculation and composition of our gross and net taxable income, our E&P and our assets on an ongoing basis. Even a technical or inadvertent mistake could jeopardize our REIT status. Although we operated and intend to operate so as to qualify as a REIT, given the complex nature of the rules governing REITs, the ongoing importance of factual determinations, including the potential tax treatment of the investments we make, and the possibility of future changes in our circumstances, no assurance can be given that our actual results of operations for any particular taxable year will satisfy such requirements.
We also own an entity that has elected to be taxed as a REIT under the U.S. federal income tax laws, or a "Subsidiary REIT." Our Subsidiary REIT is subject to the same REIT qualification requirements that are applicable to us. If our Subsidiary REIT were to fail to qualify as a REIT, then (i) that Subsidiary REIT would become subject to regular U.S. federal, state and local corporate income tax, (ii) our interest in such Subsidiary REIT would cease to be a qualifying asset for purposes of the REIT asset tests, and (iii) it is possible that we would fail certain of the REIT asset tests, in which event we also would fail to qualify as a REIT unless we could avail ourselves of certain relief provisions. While we believe that the Subsidiary REIT has qualified as a REIT under the Code, we have joined the Subsidiary REIT in filing a "protective" TRS election under Section 856(l) of the Code for each taxable year in which we have owned an interest in the Subsidiary REIT. We cannot assure you that such "protective" TRS election would be effective to avoid adverse consequences to us. Moreover, even if the "protective" election were to be effective, the Subsidiary REIT would be subject to regular corporate income tax, and we cannot assure you that we would not fail to satisfy the requirement that not more than 20% of the value of our total assets may be represented by the securities of one or more TRSs. See "Our ownership of and relationship with our TRSs will be limited, and a failure to comply with the limits would jeopardize our REIT status and may result in the application of a 100% excise tax," below.
If we fail to qualify as a REIT in any calendar year, and do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax (and any applicable state and local taxes) on our taxable income at regular corporate rates, and dividends paid to our stockholders would not be deductible by us in computing our taxable income (although such dividends received by certain non-corporate U.S. taxpayers generally would be subject to a preferential rate of taxation). Further, if we fail to qualify as a REIT, we might need to borrow money or sell assets in order to pay any resulting tax. Our payment of income tax would decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to maintain our qualification as a REIT, we no longer would be required under U.S. federal tax laws to distribute substantially all of our REIT taxable income to our stockholders. Unless our failure to qualify as a REIT was subject to relief under the U.S. federal tax laws, we could not re-elect to qualify as a REIT until the fifth calendar year following the year in which we failed to qualify.
Complying with REIT requirements may cause us to forego or liquidate otherwise attractive investments.
To qualify as a REIT, we must continually satisfy various tests regarding the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our shares of beneficial interest. In order to meet these tests, we may be required to forego investments we might otherwise make and reduce or


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eliminate investments we made prior to the effective date of our qualification as a REIT. The tests applicable to REITs are different from the tests applicable to us in prior years when we were a partnership. Thus, we may choose not to make certain types of investments that we made in prior years or pursue certain strategies that we pursued in prior years, which could include certain hedges that would otherwise reduce certain investment risks, or we could make such investments or pursue such strategies in a TRS. Any domestic TRS will be subject to regular U.S. federal, state and local corporate income tax, which may reduce the cash available to be distributed to our stockholders as compared with prior years.
As a REIT, we may be required to pay dividends to stockholders at disadvantageous times or when we do not have funds readily available for distribution, and may be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source of income or asset diversification requirements for qualifying as a REIT. Thus, compliance with the REIT requirements may hinder our investment performance.
In particular, we must ensure that at the end of each calendar quarter, we satisfy the REIT 75% asset test, which requires that at least 75% of the value of our total assets consist of cash, cash items, government securities and qualified REIT real estate assets, including RMBS. The remainder of our investments in securities (other than government securities and qualified REIT real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our total assets (other than government securities, TRS securities and qualified REIT real estate assets) can consist of the securities of any one issuer, and no more than 20% of the value of our total assets can be represented by securities of one or more TRSs. Generally, if we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and becoming subject to U.S. federal income tax and any applicable state and local taxes on all of our income.
In addition, we must also ensure that each taxable year we satisfy the REIT 75% and 95% gross income tests, which require that, in general, 75% of our gross income come from certain real estate-related sources and 95% of our gross income consist of gross income that qualifies for the 75% gross income test or certain other passive income sources. As a result of the requirement that we satisfy both the REIT 75% asset test and the REIT 75% and 95% gross income tests, we may be required to liquidate from our portfolio otherwise attractive investments or contribute such investments to a TRS, in which event they would be subject to regular corporate U.S. federal, state and local taxes assuming that the TRS is organized in the United States. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.
Failure to make required distributions would subject us to tax, which would reduce the cash available for distribution to our stockholders.
To qualify as a REIT, we must distribute to our stockholders each calendar year at least 90% of our REIT taxable income (including certain items of non-cash income), determined excluding any net capital gains and without regard to the deduction for dividends paid. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to U.S. federal corporate income tax on our undistributed income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any calendar year are less than the sum of:
85% of our REIT ordinary income for that year;
95% of our REIT capital gain net income for that year; and
any undistributed taxable income from prior years.
We intend to distribute our taxable income to our stockholders in a manner intended to satisfy the 90% distribution requirement and to avoid the corporate income tax. However, there is no requirement that TRSs distribute their after-tax net income to their parent REIT.
Our taxable income may substantially exceed our net income as determined based on GAAP, because, for example, realized capital losses will be deducted in determining our GAAP net income, but may not be deductible in computing our taxable income. Our Operating Partnership and certain of its subsidiaries have made an election under Section 475(f) of the Code to mark their securities to market, which may cause us to recognize taxable gains for a taxable year with respect to such securities without the receipt of any cash corresponding to such gains. Losses in our TRSs will not reduce our taxable income, and will generally not provide any tax benefit to us, except for being carried forward against future TRS taxable income in the case of a domestic TRS. In addition, we may invest in assets that generate taxable income in excess of economic income or in advance of the corresponding cash flow from the assets, or we may modify assets in a way that produces taxable income prior to or in excess of economic income. As a result of the foregoing, we may generate less cash flow than taxable income in a particular year. To the extent that we generate such non-cash taxable income in a taxable year, we may incur corporate income tax and the 4% nondeductible excise tax on that income if we do not distribute such income to stockholders in that year. In that event, we may be required to use cash reserves, incur debt, sell assets, make taxable distributions of our shares or debt


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securities or liquidate non-cash assets at rates or at times that we regard as unfavorable to satisfy the distribution requirement and to avoid corporate income tax and the 4% nondeductible excise tax in that year.
Determination of our REIT taxable income involves the application of highly technical and complex Code provisions for which only limited judicial and administrative authorities exist. If the IRS disagrees with our determination, it could affect our satisfaction of the distribution requirement. Under certain circumstances, we may be able to correct a failure to meet the distribution requirement for a year by paying "deficiency dividends" to our stockholders in a later year. We may include such deficiency dividends in our deduction for dividends paid for the earlier year. Although we may be able to avoid income tax on amounts distributed as deficiency dividends, we will be required to pay interest and a penalty to the IRS based upon the amount of any deduction we take for deficiency dividends.
Even if we qualify as a REIT, we may face other tax liabilities that reduce our cash flows.
Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes. In addition, our domestic TRSs will be subject to regular corporate U.S. federal, state and local taxes. Any of these taxes would decrease cash available for distributions to stockholders.
The failure of MBS subject to a repurchase agreement to qualify as real estate assets would adversely affect our ability to qualify as a REIT.
We have entered into repurchase agreements under which we nominally sell certain of our MBS to a counterparty and simultaneously enter into an agreement to repurchase the sold assets. We believe that, for U.S. federal income tax purposes, these transactions will be treated as secured debt and we will be treated as the tax owner of the MBS that are the subject of any such repurchase agreement, notwithstanding that such agreements may transfer record ownership of such assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could successfully assert that we do not own the MBS during the term of the repurchase agreement, in which case we could fail to qualify as a REIT.
Uncertainty exists with respect to the treatment of our TBAs for purposes of the REIT asset and income tests.
We purchase and sell Agency RMBS through TBAs and recognize income or gains from the disposition of those TBAs, through dollar roll transactions or otherwise, and may continue to do so in the future. While there is no direct authority with respect to the qualification of TBAs as real estate assets or U.S. Government securities for purposes of the REIT 75% asset test or the qualification of income or gains from dispositions of TBAs as gains from the sale of real property or other qualifying income for purposes of the REIT 75% gross income test, we treat the GAAP value of our TBAs under which we contract to purchase to-be-announced Agency RMBS ( "long TBAs") as qualifying assets for purposes of the REIT 75% asset test, and we treat income and gains from our long TBAs as qualifying income for purposes of the REIT 75% gross income test, based on an opinion of Hunton Andrews Kurth LLP substantially to the effect that (i) for purposes of the REIT asset tests, our ownership of a long TBA should be treated as ownership of real estate assets, and (ii) for purposes of the REIT 75% gross income test, any gain recognized by us in connection with the settlement of our long TBAs should be treated as gain from the sale or disposition of an interest in mortgages on real property. Opinions of counsel are not binding on the IRS, and no assurance can be given that the IRS will not successfully challenge the conclusions set forth in such opinions. In addition, it must be emphasized that the opinion of counsel is based on various assumptions relating to our TBAs and is conditioned upon fact-based representations and covenants made by our management regarding our TBAs. No assurance can be given that the IRS would not assert that such assets or income are not qualifying assets or income. If the IRS were to successfully challenge the opinion of counsel, we could be subject to a penalty tax or we could fail to remain qualified as a REIT if a sufficient portion of our assets consists of TBAs or a sufficient portion of our income consists of income or gains from the disposition of TBAs.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Code substantially limit our ability to hedge. Under these provisions, any income that we generate from transactions intended to hedge our interest rate or foreign currency risks will be excluded from gross income for purposes of the REIT 75% and 95% gross income tests if the instrument hedges (i) interest rate risk on liabilities incurred to carry or acquire real estate or (ii) risk of foreign currency fluctuations with respect to any item of income or gain that would be qualifying income under the REIT 75% or 95% gross income tests, and such instrument is properly identified under applicable Treasury Regulations. Income from hedging transactions that are not properly identified or hedge different risks will generally constitute nonqualifying income for purposes of both the REIT 75% and 95% gross income tests. To the extent that we enter into hedging transactions that do not meet these requirements or other types of hedging transactions, our aggregate gross income from such non-qualifying hedges, fees, and certain other non-qualifying sources cannot exceed 5% of our annual gross income. As a result, we might have to limit our use of advantageous hedging techniques, and we expect to implement certain hedges through a TRS. Any hedging income earned by a domestic TRS would be subject to U.S. federal, state and local income t


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ax at regular corporate rates. This could increase the cost of our hedging activities or expose us to greater risks associated with interest rate changes or other changes than we would otherwise want to bear. In addition, losses in our TRSs will generally not provide any tax benefit, except for being carried forward against future TRS taxable income in the case of a domestic TRS. Even if the income from certain of our hedging transactions is excluded from gross income for purposes of the REIT 75% and 95% gross income tests, such income and any loss will be taken into account in determining our REIT taxable income and our distribution requirement.  If the IRS disagrees with our calculation of the amount or timing of recognition of gain or loss with respect to our hedging transactions, including the impact of our elections under Section 475(f) of the Code and the treatment of hedging expense and losses under Section 163(j) of the Code and Treasury Regulation Section 1.446-4, our distribution requirement could increase, which could require that we correct any shortfall in distributions by paying deficiency dividends to our stockholders in a later year.
Our ownership of and relationship with our TRSs will be limited, and a failure to comply with the limits would jeopardize our REIT status and may result in the application of a 100% excise tax.
A REIT may own up to 100% of the stock of one or more TRSs. A TRS may earn income that would not be qualifying income for purposes of the REIT 75% or 95% gross income tests if earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation (other than a REIT) of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 20% of the value of a REIT's total assets may consist of stock or securities of one or more TRSs. Many of the investments that we made and activities we undertook prior to our REIT election have been contributed to or will be made in one of our TRSs; thus, we hold a significant portion of our assets through, and derive a significant portion of our taxable income and gains in, TRSs. While we intend to manage our affairs so as to satisfy the requirement that no more than 20% of the value of our total assets consists of stock or securities of our TRSs, as well as the requirement that taxable income from our TRSs plus other non-qualifying gross income not exceed 25% of our total gross income, there can be no assurance that we will be able to do so in all market circumstances. Even if we are able to do so, compliance with these rules may reduce our flexibility in operating our business. In addition, the two rules may conflict with each other in that our ability to reduce the value of our TRSs below 20% of our assets by causing a TRS to distribute a dividend to us may be limited by our need to comply with the REIT 75% gross income test, which requires that, in general, 75% of our gross income come from certain real estate-related sources (and TRS dividends are not qualifying income for such test). There can be no assurance that we will be able to comply with either or both of these tests in all market conditions. Our inability to comply with both of these tests could have a material adverse effect on our business, financial condition, liquidity, results of operations, qualification as a REIT and ability to make distributions to our stockholders.
The TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm's-length basis. Our domestic TRSs will pay U.S. federal, state and local income tax on their taxable income at regular corporate tax rates, and their after-tax net income will be available for distribution to us but is not required to be distributed to us. In certain circumstances, the ability to deduct interest expense by any TRS that we may form could be limited. In addition, losses in our domestic TRSs generally will not provide any tax benefit prior to liquidation, except for being carried forward against future TRS taxable income.
We generally structure our foreign TRSs with the intent that their income and operations will not be subject to U.S. federal, state and local income tax. If the IRS successfully challenged that tax treatment, it would reduce the amount that those foreign TRSs would have available to distribute to us. E&P in our foreign TRSs are taxable to us, and are not qualifying income for the purposes of the REIT 75% gross income tests, regardless of whether such earnings are distributed to us. In addition, losses in our foreign TRSs generally will not provide any tax benefit prior to liquidation.
We intend to monitor the value of and the income from our respective investments in our domestic and foreign TRSs for the purpose of ensuring compliance with TRS ownership limitations and the REIT 75% gross income test. In addition, we will review all of our transactions with our TRSs to ensure that they are entered into on arm's-length terms to avoid incurring the 100% excise tax described above. There can be no assurance, however, that we will be able to comply with the 20% limitation, the REIT 75% gross income test or avoid application of the 100% excise tax discussed above.
Our ownership limitation may restrict change of control or business combination opportunities in which our shareholders might receive a premium for their common shares.
In order for us to qualify as a REIT, no more than 50% in value of our outstanding shares may be owned, directly or indirectly, by five or fewer individuals during the last half of any calendar year. "Individuals" for this purpose include natural persons, private foundations, some employee benefit plans and trusts, and some charitable trusts. In order to help us qualify as a REIT, among other purposes, our certificate of incorporation provides that no person may own, or be deemed to own by virtue


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of the attribution provisions of the Code, more than 9.8%, in value or in number of shares, whichever is more restrictive, of the outstanding shares of any class or series of our capital stock.
The ownership limitation and other restrictions could have the effect of discouraging a takeover or other transaction in which holders of our common shares might receive a premium for their common shares over the then-prevailing market price or which holders might believe to be otherwise in their best interests.
Dividends payable by REITs do not qualify for the reduced tax rates available for "qualified dividend income."
The maximum U.S. federal income tax rate applicable to "qualified dividend income" paid to U.S. taxpayers taxed at individual rates is currently 20%. Common and preferred dividends payable by REITs, however, generally are not eligible for the reduced rates on qualified dividend income. For taxable years beginning prior to January 1, 2026, non-corporate taxpayers may deduct up to 20% of certain pass-through business income, including "qualified REIT dividends" (generally, dividends received by a REIT stockholder that are not designated as capital gain dividends or qualified dividend income), subject to certain limitations, resulting in an effective maximum U.S. federal income tax rate of 29.6% on such income. Although the reduced U.S. federal income tax rate applicable to qualified dividend income does not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable rates applicable to regular corporate qualified dividends and the reduction in the corporate tax rate under the TCJA could cause investors who are taxed at individual rates and regulated investment companies to perceive investments in the stocks of REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends treated as qualified dividend income, which could adversely affect the value of the stock of REITs, including our common stock.
We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our common stock.
At any time, the U.S. federal income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be amended. We cannot predict when or if any new U.S. federal income tax law, regulation or administrative interpretation, or any amendment to any existing U.S. federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation or interpretation may take effect retroactively. The TCJA significantly changed the U.S. federal income tax laws applicable to businesses and their owners, including REITs and their stockholders. Additional technical corrections or other amendments to the TCJA or administrative guidance interpreting the TCJA may be forthcoming at any time. We cannot predict the long-term effect of the TCJA or assure our stockholders that any such changes will not adversely affect the taxation of a stockholder. We and our stockholders could be adversely affected by any such change in, or any new, U.S. federal income tax law, regulation or administrative interpretation.
Our recognition of "phantom" income may reduce a stockholder's after-tax return on an investment in our common stock.
We may recognize phantom income, which is taxable income in excess of our economic income, in the earlier years that we hold certain investments in the year that we modify certain loan investments, and we may only experience an offsetting excess of economic income over our taxable income in later years, if at all. As a result, stockholders at times may be required to pay U.S. federal income tax on distributions taxable as dividends that economically represent a return of capital rather than a dividend. Taking into account the time value of money, this acceleration or increase of U.S. federal income tax liabilities may reduce a stockholder's after-tax return on his or her investment to an amount less than the after-tax return on an investment with an identical before-tax rate of return that did not generate phantom income.
Liquidation of our assets may jeopardize our REIT qualification or may be subject to a 100% tax.
To maintain our qualification as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our assets to repay obligations to our lenders or for other reasons, we may be unable to comply with these requirements, thereby jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as inventory or property held primarily for sale to customers in the ordinary course of business.
The tax on prohibited transactions will limit our ability to engage in transactions, including certain methods of securitizing MBS, that would be treated as sales of dealer property for U.S. federal income tax purposes.
A REIT's net income from prohibited transactions is subject to a 100% tax with no offset for losses. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, but including mortgage loans, held primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we dispose of or securitize mortgage loans or MBS in a manner that was treated as dealer activity for U.S. federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales or securitization structures, even though


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the transactions might otherwise be beneficial to us. Alternatively, in order to avoid the prohibited transactions tax, we may choose to implement certain transactions through a TRS.
Although we expect to avoid the prohibited transactions tax by conducting the sale of property that may be characterized as dealer property through a TRS, such TRS will be subject to federal, state and local corporate income tax and may incur a significant tax liability as a result of those sales conducted through the TRS. Moreover, no assurance can be given that the IRS will respect the transaction by which property that may be characterized as dealer property is contributed to the TRS; if such transaction is not respected, then we may be treated as having engaged in a prohibited transaction, and our net income therefrom would be subject to a 100% tax.
Our Operating Partnership has made a mark-to-market election under Section 475(f) of the Code. If the IRS challenges our application of that election, it may jeopardize our REIT qualification.
Our Operating Partnership and certain other subsidiaries have made elections under Section 475(f) of the Code to mark their securities to market. There are limited authorities under Section 475(f) of the Code as to what constitutes a trader for U.S. federal income tax purposes. Under other sections of the Code, the status of a trader in securities depends on all of the facts and circumstances, including the nature of the income derived from the taxpayer's activities, the frequency, extent and regularity of the taxpayer's securities transactions, and the taxpayer's investment intent. There can be no assurance that these subsidiaries will continue to qualify as a trader in securities eligible to make the mark-to-market election. We have not received, nor are we seeking, an opinion from counsel or a ruling from the IRS regarding our or our subsidiaries' qualification as a trader. If the qualification for, or our application of, the mark-to-market election were successfully challenged by the IRS, in whole or in part, it could, depending on the circumstances, result in retroactive (or prospective) changes in the amount or timing of gross we recognize. Furthermore, the law is unclear as to the treatment of mark-to-market gains and losses under the various REIT tax rules, including, among others, the prohibited transaction and qualified liability hedging rules. While there is limited analogous authority, we treat any mark-to-market gains as qualifying income for purposes of the 75% gross income test to the extent that the gain is recognized with respect to a qualifying real estate asset, based on an opinion of Hunton Andrews Kurth LLP substantially to the effect that any such gains recognized with respect to assets that would produce qualifying income for purposes of the 75% and/or 95% gross income test, as applicable, if they were actually sold should be treated as qualifying income to the same extent for purposes of the 75% and/or 95% gross income test, as applicable, and any such gains should not be subject to the prohibited transaction tax. If the IRS were to successfully treat our mark-to-market gains as subject to the prohibited transaction tax or to successfully challenge the treatment or timing of recognition of our mark-to-market gains or losses with respect to our qualified liability hedges, we could owe material federal income or penalty tax or, in some circumstances, even fail to qualify as a REIT. Finally, mark-to-market gains and losses could cause volatility in the amount of our taxable income, which, in turn, could cause us to distribute more dividends to our stockholders than would otherwise be desirable from a business perspective.
The interest apportionment rules may affect our ability to comply with the REIT asset and gross income tests.
Most of the distressed mortgage loans that we have acquired were acquired by us at a discount from their outstanding principal amount, because our pricing was generally based on the value of the underlying real estate that secures those mortgage loans. Treasury Regulation Section 1.856-5(c) (the "interest apportionment regulation") provides that if a mortgage is secured by both real property and other property, a REIT is required to apportion its annual interest income to the real property security based on a fraction, the numerator of which is the value of the real property securing the loan, determined when the REIT commits to acquire the loan, and the denominator of which is the highest "principal amount" of the loan during the year. If a mortgage is secured by both real property and personal property and the value of the personal property does not exceed 15% of the aggregate value of the property securing the mortgage, the mortgage is treated as secured solely by real property for this purpose. Revenue Procedure 2014-51 interprets the "principal amount" of the loan to be the face amount of the loan, despite the Code requiring taxpayers to treat any market discount, that is the difference between the purchase price of the loan and its face amount, for all purposes (other than certain withholding and information reporting purposes) as interest rather than principal.
The interest apportionment regulation applies only if the debt in question is secured both by real property and personal property. We believe that most of the mortgage loans that we acquire at a discount under the circumstances contemplated by Revenue Procedure 2014-51 are secured only by real property (including mortgage loans secured by both real property and personal property where the value of the personal property does not exceed 15% of the aggregate value of the property securing the mortgage). Accordingly, we believe that the interest apportionment regulation generally does not apply to our loans.
Nevertheless, if the IRS were to assert successfully that such mortgage loans were secured by property other than real estate, that the interest apportionment regulation applied for purposes of our REIT testing, and that the position taken in Revenue Procedure 2014-51 should be applied to our portfolio, then depending upon the value of the real property securing our


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loans and their face amount, and the sources of our gross income generally, we might not be able to meet the REIT 75% gross income test, and possibly the asset tests applicable to REITs. If we did not meet these tests, we could potentially either lose our REIT status or be required to pay a tax penalty to the IRS. With respect to the REIT 75% asset test, Revenue Procedure 2014-51 provides a safe harbor under which the IRS will not challenge a REIT's treatment of a loan as being a real estate asset in an amount equal to the lesser of (1) the greater of (a) the current value of the real property securing the loan or (b) the fair market value of the real property securing the loan determined as of the date the REIT committed to acquire the loan or (2) the fair market value of the loan on the date of the relevant quarterly REIT asset testing date. This safe harbor, if it applied to us, would help us comply with the REIT asset tests following the acquisition of distressed debt if the value of the real property securing the loan were to subsequently decline. If we did not meet one or more of the REIT asset tests, then we could potentially either lose our REIT status or be required to pay a tax penalty to the IRS.
Our investments in residential transition loans, or "RTLs," will require us to make estimates about the fair value of land improvements that may be challenged by the IRS.
We invest in RTLs, which generally are short term loans secured by a mortgage on a residential property where the proceeds of the loan will be used, in part, to renovate the property. The interest from RTLs will be qualifying income for purposes of the REIT income tests, provided that the loan value of the real property securing the RTL is equal to or greater than the highest outstanding principal amount of the loan during any taxable year. Under the REIT provisions, where improvements will be constructed with the proceeds of the loan, the loan value of the real property is the fair value of the land and existing real property improvements plus the reasonably estimated cost of the improvements or developments (other than personal property) that will secure the loan and that are to be constructed from the proceeds of the loan. There can be no assurance that the IRS would not challenge our estimate of the loan value of the real property.
The failure of a mezzanine loan or similar debt to qualify as a real estate asset could adversely affect our ability to qualify as a REIT.
We may invest in mezzanine loans or similar debt. The IRS has provided a safe harbor for mezzanine loans but not rules of substantive law. Pursuant to the safe harbor, if a mezzanine loan meets certain requirements, it will be treated by the IRS as a real estate asset for purposes of the REIT asset tests, and interest derived from the mezzanine loan will be treated as qualifying income for purposes of the REIT 75% gross income test. We may acquire mezzanine loans or similar debt that meet most but do not meet all of the requirements of this safe harbor, and we may treat such loans as real estate assets for purposes of the REIT asset and income tests. In the event that we own a mezzanine loan or similar debt that does not meet the safe harbor, the IRS could challenge such loan's treatment as a real estate asset for purposes of the REIT asset and income tests and, if such a challenge were sustained, we could fail to qualify as a REIT.
Our qualification as a REIT and exemption from U.S. federal income tax with respect to certain assets may be dependent on the accuracy of legal opinions or advice rendered or given or statements by the issuers of assets that we acquire, and the inaccuracy of any such opinions, advice or statements may adversely affect our REIT qualification and result in significant corporate-level tax.
When purchasing securities, we may rely on opinions or advice of counsel for the issuer of such securities, or statements made in related offering documents, for purposes of determining whether such securities represent debt or equity securities for U.S. federal income tax purposes, the value of such securities, and also to what extent those securities constitute qualified real estate assets for purposes of the REIT asset tests and produce income which qualifies under the REIT 75% gross income test. The inaccuracy of any such opinions, advice or statements may adversely affect our REIT qualification and result in significant corporate-level tax.
If we failed in a prior year to satisfy the "qualifying income exception" under the rules for publicly traded partnerships, our income for such years could be subject to an entity-level tax, and the value of our shares could be adversely affected.
We believe, for our taxable years prior to January 1, 2019, we were organized and had operated so that we qualified to be treated as a partnership for U.S. federal income tax purposes based on the "qualifying income exception" within the meaning of Section 7704(d) of the Code. If we failed to satisfy the "qualifying income exception" for any of our prior taxable years, we would be treated as a corporation for such years for U.S. federal income tax purposes. In that event, we would be required to pay U.S. federal, state and local income tax at regular corporate rates for all of the affected years, together with interest and penalties, which would likely result in a material expense for us.
Item 1B. Unresolved Staff Comments
None.


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Item 2. Properties
We do not own any properties. Our principal offices are located in leased space at 53 Forest Avenue, Old Greenwich, CT 06870. The offices of our Manager and Ellington are at the same location. As part of our management agreement, our Manager is responsible for providing offices necessary for all operations, and accordingly, all lease responsibilities belong to our Manager.
Item 3. Legal Proceedings
Neither we nor Ellington nor its affiliates (including our Manager) are currently subject to any legal proceedings that we or our Manager consider material. Nevertheless, we and Ellington and its affiliates operate in highly regulated markets that currently are under regulatory scrutiny, and over the years, Ellington and its affiliates have received, and we expect in the future that we and they may receive, inquiries and requests for documents and information from various federal, state and foreign regulators.
We and Ellington cannot provide any assurance that, whether the result of regulatory inquiries or otherwise, neither we nor Ellington nor its affiliates will become subject to investigations, enforcement actions, fines, penalties or the assertion of private litigation claims or that, if any such events were to occur, they would not materially adversely affect us. For a discussion of these and other related risks, see "Part I, Item 1A. Risk Factors—We, Ellington, or its affiliates may be subject to regulatory inquiries and proceedings, or other legal proceedings" of this Annual Report on Form 10-K for the year ended December 31, 2019.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common shares have been listed on the NYSE under the symbol "EFC" since October 8, 2010.
Holders of Our Common Stock
Based upon a review of a securities position listing as of March 6, 2020, we had an aggregate of 132 holders of record and holders of our common stock who are nominees for an undetermined number of beneficial owners.
Unregistered Sales of Equity Securities
Pursuant to our 2017 Plan, on December 13, 2019, we granted 22,885 OP LTIP Units to certain of our partially dedicated employees. The OP LTIP Units are subject to forfeiture restrictions that will lapse with respect to 12,818 of the OP LTIP Units on December 13, 2020 and 10,067 of the OP LTIP Units on December 13, 2021. Once vested, the OP LTIP Units may be converted at the election of the holder, or at any time at our election, into OP Units on a one-for-one basis. Subject to certain conditions, the OP Units are redeemable by the holder for an equivalent number of shares of our common stock or, at our election, for the cash value of such shares of our common stock. Such grants were exempt from the registration requirements of the Securities Act based on the exemption provided in Section 4(a)(2) of the Securities Act.
Item 6. Selected Financial Data
We are a smaller reporting company as defined in Rule 12b-2 under the Exchange Act. As a result, pursuant to Item 301 (c) of Regulation S-K, we are not required to provide the information required by this Item.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Executive Summary
We invest in a diverse array of real-estate-related and other financial assets, including residential and commercial mortgage loans, residential mortgage-backed securities, or "RMBS," commercial mortgage-backed securities, or "CMBS," consumer loans and asset-backed securities, or "ABS," including ABS backed by consumer loans, collateralized loan obligations, or "CLOs," non-mortgage- and mortgage-related derivatives, equity investments in loan origination companies, and other strategic investments. We are externally managed and advised by our Manager, an affiliate of Ellington. Ellington is a registered investment adviser with a 25-year history of investing in the credit markets.


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We conduct all of our operations and business activities through the Operating Partnership. As of December 31, 2019, we have an ownership interest of approximately 98.4% in the Operating Partnership. The remaining ownership interest of approximately 1.6% in the Operating Partnership represents the interests in the Operating Partnership that are owned by an affiliate of our Manager, our directors, and certain current and former Ellington employees and their related parties, and is reflected in our financial statements as a non-controlling interest.
Our primary objective is to generate attractive, risk-adjusted total returns for our stockholders. We seek to attain this objective by utilizing an opportunistic strategy to make investments, without restriction as to ratings, structure, or position in the capital structure, that we believe compensate us appropriately for the risks associated with them rather than targeting a specific yield. Our evaluation of the potential risk-adjusted return of any potential investment typically involves weighing the potential returns of such investment under a variety of economic scenarios against the perceived likelihood of the various scenarios. Potential investments subject to greater risk (such as those with lower credit ratings and/or those with a lower position in the capital structure) will generally require a higher potential return to be attractive in comparison to investment alternatives with lower potential return and a lower degree of risk. However, at any particular point in time, depending on how we perceive the market's pricing of risk both generally and across sectors, we may favor higher-risk assets or we may favor lower-risk assets, or a combination of the two, in the interests of portfolio diversification or other considerations.
As detailed in Note 2 of the notes to our consolidated financial statements, effective January 1, 2019, as a result of our prospective change in accounting, the naming conventions for repurchase agreements and reverse repurchase agreements were changed. Assets sold under agreements to be repurchased at an agreed-upon price and date, which were formerly referred to as "reverse repurchase agreements," are now referred to as "repurchase agreements," or "repos." Assets purchased under agreements to resell at an agreed-upon price and date, which were formerly referred to as "repurchase agreements," are now referred to as "reverse repurchase agreements," or "reverse repos." For purposes of this Management's Discussion and Analysis of Financial Condition and Results of Operations, we will use the naming conventions that took effect on January 1, 2019 in connection with our change in accounting.
Additionally, due to the prospective application of a change in accounting as required under ASC 946-10-25-2, we have determined that the presentation of our consolidated financial statements for periods beginning after December 31, 2018 are not comparable to the consolidated financial statements previously prepared for prior periods for which we applied ASC 946, Financial Services—Investment Companies ("ASC 946"). As a result, we have not provided comparisons or discussion of period-over-period fluctuations of certain components of our financial condition and results of operations that we believe are not directly comparable.
Through December 31, 2019, our credit portfolio, which includes all of our investments other than RMBS for which the principal and interest payments are guaranteed by a U.S. government agency or a U.S. government-sponsored entity, or "Agency RMBS," has been the primary driver of our risk and return, and we expect that this will continue in the near- to medium-term. For more information on our targeted assets, see "—Our Targeted Asset Classes" below. We believe that Ellington's capabilities allow our Manager to identify attractive assets in these classes, value these assets, monitor and forecast the performance of these assets, and opportunistically hedge our risk with respect to these assets.
We continue to maintain a highly leveraged portfolio of Agency RMBS to take advantage of opportunities in that market sector, to help maintain our exclusion from registration as an investment company under the Investment Company Act, and to help qualify as well as maintain our qualification as a REIT. Unless we acquire very substantial amounts of whole mortgage loans or there are changes to the rules and regulations applicable to us under the Investment Company Act, we expect that we will always maintain some amount of Agency RMBS.
The strategies that we employ are intended to capitalize on opportunities in the current market environment. Subject to qualifying and maintaining our qualification as a REIT, we intend to adjust our strategies to changing market conditions by shifting our asset allocations across various asset classes as credit and liquidity trends evolve over time. We believe that this flexibility, combined with Ellington's experience, will help us generate more consistent returns on our capital throughout changing market cycles.
Subject to qualifying and maintaining our qualification as a REIT, we opportunistically hedge our credit risk, interest rate risk, and foreign currency risk; however, at any point in time we may choose not to hedge all or a portion of these risks, and we will generally not hedge those risks that we believe are appropriate for us to take at such time, or that we believe would be impractical or prohibitively expensive to hedge.
We also use leverage in our credit strategy, albeit significantly less leverage than that used in our Agency RMBS strategy. Through December 31, 2019, we financed the vast majority of our Agency RMBS assets, and a portion of our credit assets, through repos, which we account for as collateralized borrowings. We expect to continue to finance the vast majority of our Agency RMBS through the use of repos. In addition to financing assets through repos, we also enter into other secured


54


borrowing transactions, which are accounted for as collateralized borrowings, to finance certain of our loan assets. We have also obtained, through the securitization markets, term financing for certain of our non-qualified mortgage, or "non-QM," loans, certain of our consumer loans, and certain of our leveraged corporate loans. Additionally, we have issued unsecured long-term debt.
As of December 31, 2019, outstanding borrowings under repos and Total other secured borrowings (which include Other secured borrowings and Other secured borrowings, at fair value, as presented on our Consolidated Balance Sheet) were $3.2 billion, of which approximately 58%, or $1.9 billion, relates to our Agency RMBS holdings. The remaining outstanding borrowings relate to our credit portfolio.
As of December 31, 2019, we also had $86.0 million outstanding of unsecured long-term debt, maturing in September of 2022, or the "Senior Notes." The Senior Notes bear interest at a rate of 5.50%, subject to adjustment based on changes, if any, in the ratings of the Senior Notes. The indenture governing the Senior Notes contains a number of covenants, including several financial covenants. The Senior Notes were issued in connection with an exchange of our previously issued unsecured long-term debt (the "Old Senior Notes") on February 13, 2019 (the "Note Exchange"), in connection with our intended election to be taxed as a REIT. At the time of the Note Exchange, the Senior Notes were rated A by Egan-Jones Rating Company1. See Note 11 of the notes to our consolidated financial statements as of December 31, 2019 for further detail on the Senior Notes and the Note Exchange.
As of December 31, 2019, our book value per share of common stock, calculated using Total Stockholders' Equity less the aggregate liquidation preference of outstanding preferred stock, was $18.48. Our debt-to-equity ratio was 3.8:1 as of December 31, 2019. Our debt-to-equity ratio does not account for liabilities other than debt financings and does not include debt associated with securitization transactions accounted for as sales. Our recourse debt-to-equity ratio was 2.6:1 as of December 31, 2019.
During the year ended December 31, 2019 we repurchased 50,825 shares of our common stock at an average price per share of $15.39 and a total cost of $0.8 million. In addition to making discretionary repurchases, we from time to time use 10b5-1 plans to increase the number of trading days available to implement these repurchases.
On July 22, 2019, we completed a follow-on offering of 3,500,000 shares of our common stock, which generated net proceeds, after underwriters' discount and offering costs, of $60.7 million. On July 25, 2019, we issued an additional 525,000 shares of our common stock in connection with the exercise of the underwriters' option granted in the initial offering. The exercise of the underwriters' option resulted in net proceeds to us of an additional $9.1 million, after underwriters' discount and offering costs.
On October 22, 2019, we issued 4,600,000 shares of 6.750% Series A Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, $0.001 par value per share ("Series A Preferred Stock"), of which 600,000 shares were issued pursuant to the exercise of the underwriters' over-allotment option. The issuance and sale of the 4,600,000 shares of Series A Preferred Stock resulted in total net proceeds to us of approximately $111.0 million, after underwriters' discount and offering costs. At the time of issuance, the Series A Preferred Stock was rated BBB+ by Egan-Jones Rating Company1.
On November 21, 2019, we completed a follow-on offering of 4,200,000 shares of our common stock, which generated net proceeds, after underwriters' discount and offering costs, of $75.3 million. On December 3, 2019, we issued an additional 630,000 shares of our common stock in connection with the exercise of the underwriters' option granted in the initial offering. The exercise of the underwriters' option resulted in net proceeds to us of an additional $11.2 million, after underwriters' discount and offering costs.
On January 24, 2020, we completed a follow-on offering of 5,290,000 shares of our common stock, of which 690,000 shares were issued pursuant to the exercise of the underwriters' option. The issuance and sale of 5,290,000 common shares generated net proceeds, after underwriters' discount and offering costs, of $95.3 million.
We will elect to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, or "the Code," upon the filing of our tax return for the taxable year ended December 31, 2019. Provided that we maintain our qualification as a REIT, we generally will not be subject to U.S. federal, state, and local income tax on our REIT taxable income that is currently distributed to our stockholders. Any taxes paid by a domestic taxable REIT subsidiary, or "TRS," will reduce the cash available for distribution to our stockholders. REITs are subject to a number of organizational and operational requirements, including a requirement that they currently distribute at least 90% of their annual REIT taxable income excluding net capital gains.
1A rating is not a recommendation to buy, sell or hold securities. Ratings may be subject to revision or withdrawal at any time by the assigning rating organization. Each rating should be evaluated independently of any other rating.


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On February 28, 2019, we filed a certificate of conversion with the Secretary of State of the State of Delaware (the "Secretary of State") to convert from a Delaware limited liability company to a Delaware corporation (the "Conversion") and change our name to Ellington Financial Inc. (the "Corporation"). The Conversion became effective on March 1, 2019, and upon effectiveness, each of our existing common shares representing limited liability company interests, no par value, converted into one issued and outstanding, fully paid and nonassessable share of common stock, $0.001 par value per share, of the Corporation.
Our Targeted Asset Classes
Our targeted asset classes currently include investments in the U.S. and Europe (as applicable) in the categories listed below. Subject to qualifying and maintaining our qualification as a REIT, we expect to continue to invest in these targeted asset classes. Also, we expect to hold certain of our targeted assets through one or more TRSs. As a result, a portion of the income from such assets will be subject to U.S. federal corporate income tax.


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Asset Class
 
Principal Assets
 
Agency RMBS
.
Whole pool pass-through certificates;
 
.
Partial pool pass-through certificates;
 
.
Agency collateralized mortgage obligations, or "CMOs," including interest only securities, or "IOs," principal only securities, or "POs," inverse interest only securities, or "IIOs"; and
 
 
 
 
 
CLOs
.
Retained tranches from CLO securitizations, including participating in the accumulation of the underlying assets for such securitization by providing capital to the vehicle accumulating assets; and
 
 
 
.
Other CLO debt and equity tranches.
 
 
 
 
 
CMBS and Commercial Mortgage Loans
.
CMBS; and
 
.
Commercial mortgage loans and other commercial real estate debt.
 
 
 
 
 
Consumer Loans and ABS
.
Consumer loans;
 
.
ABS, including ABS backed by consumer loans; and
 
.
Retained tranches from securitizations to which we have contributed assets.
 
 
 
 
 
Mortgage-Related Derivatives
.
To-Be-Announced mortgage pass-through certificates, or "TBAs";
 
.
Credit default swaps, or "CDS," on individual RMBS, on the ABX, CMBX and PrimeX indices and on other mortgage-related indices; and
 
.
Other mortgage-related derivatives.
 
 
 
 
 
Non-Agency RMBS
.
RMBS backed by prime jumbo, Alt-A, manufactured housing, and subprime mortgages;
 
.
RMBS backed by fixed rate mortgages, Adjustable rate mortgages, or "ARMs," Option-ARMs, and Hybrid ARMs;
 
.
RMBS backed by first lien and second lien mortgages;
 
.
Investment grade and non-investment grade securities;
 
.
Senior and subordinated securities;
 
.
IOs, POs, IIOs, and inverse floaters;
 
.
Collateralized debt obligations, or "CDOs";
 
.
RMBS backed by European residential mortgages, or "European RMBS"; and
 
.
Retained tranches from securitizations in which we have participated.
 
 
 
 
 
Residential Mortgage Loans
.
Residential non-performing mortgage loans, or "NPLs";
 
.
Re-performing loans, or "RPLs," which generally are loans that were modified and/or formerly NPLs where the borrower has resumed making payments in some form or amount;
 
.
Residential "transition loans," such as residential bridge loans and residential "fix-and-flip" loans;
 
.
Non-QM loans; and
 
.
Retained tranches from securitizations to which we have contributed assets.
 
 
 
 
 
Other
.
Real estate, including commercial and residential real property;
 
.
Strategic debt and/or equity investments in loan originators and mortgage-related entities;
 
.
Corporate debt and equity securities and corporate loans;
 
.
Mortgage servicing rights, or "MSRs";
 
.
Credit risk transfer securities, or "CRTs"; and
 
.
Other non-mortgage-related derivatives.


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Agency RMBS
Our Agency RMBS assets consist primarily of whole pool (and to a lesser extent, partial pool) pass-through certificates, the principal and interest of which are guaranteed by a federally chartered corporation, such as the Federal National Mortgage Association, or "Fannie Mae," the Federal Home Loan Mortgage Corporation, or "Freddie Mac," or the Government National Mortgage Association, within the U.S. Department of Housing and Urban Development, or "Ginnie Mae," and which are backed by ARMs, Hybrid ARMs, or fixed-rate mortgages. In addition to investing in pass-through certificates which are backed by traditional mortgages, we have also invested in Agency RMBS backed by reverse mortgages. Reverse mortgages are mortgage loans for which neither principal nor interest is due until the borrower dies, the home is sold, or other trigger events occur. Mortgage pass-through certificates are securities representing undivided interests in pools of mortgage loans secured by real property where payments of both interest and principal, plus prepaid principal, on the securities are made monthly to holders of the security, in effect "passing through" monthly payments made by the individual borrowers on the mortgage loans that underlie the securities, net of fees paid to the issuer/guarantor and servicers of the securities. Whole pool pass-through certificates are mortgage pass-through certificates that represent the entire ownership of (as opposed to merely a partial undivided interest in) a pool of mortgage loans.
Our Agency RMBS assets are typically concentrated in specified pools. Specified pools are fixed-rate Agency pools consisting of mortgages with special characteristics, such as mortgages with low loan balances, mortgages backed by investor properties, mortgages originated through the government-sponsored "Making Homes Affordable" refinancing programs, and mortgages with various other characteristics. Our Agency strategy also includes RMBS that are backed by ARMs or Hybrid ARMs and reverse mortgages, and CMOs, including IOs, POs, and IIOs.
CLOs
CLOs are a form of asset-backed security collateralized by syndicated corporate loans. We have retained, and may retain in the future, tranches from CLO securitizations for which we have participated in the accumulation of the underlying assets, typically by providing capital to a vehicle accumulating assets for such CLO securitization. Such vehicles may enter into warehouse financing facilities in order to facilitate such accumulation. Securitizations can effectively provide us with long-term, locked-in financing on the related collateral pool, with an effective cost of funds well below the expected yield on the collateral pool. Our CLO holdings may include both debt and equity interests.
CMBS
We acquire CMBS, which are securities collateralized by mortgage loans on commercial properties. The majority of CMBS issued are fixed rate securities backed by fixed rate loans made to multiple borrowers on a variety of property types, though single-borrower CMBS and floating rate CMBS have also been issued.
The majority of CMBS utilize senior/subordinate structures, similar to those found in non-Agency RMBS. Subordination levels vary so as to provide for one or more AAA credit ratings on the most senior classes, with less senior securities rated investment grade and non-investment grade, including a first loss component which is typically unrated. This first loss component is commonly referred to as the "B-piece," which is the most subordinated (and therefore highest yielding and riskiest) tranche of a CMBS securitization. Much of our focus within the CMBS sector has been on B-pieces.
Commercial Mortgage Loans and Other Commercial Real Estate Debt
We acquire commercial mortgage loans, which are loans secured by liens on commercial properties, including hotel, industrial, multi-family, office and retail properties. Loans may be fixed or floating rate and will generally range from two to ten years. We may acquire both first lien loans and subordinated loans. Commercial real estate debt typically limits the borrower's right to freely prepay for a period of time through provisions such as prepayment fees, lockout, yield maintenance, or defeasance provisions. Some of the commercial mortgage loans that we acquire may be non-performing, underperforming, or otherwise distressed; these loans are typically acquired at a discount both to their unpaid principal balances and to the value of the underlying real estate.
We also participate in the origination of "bridge" loans, which have shorter terms and higher interest rates than more traditional commercial mortgage loans. Bridge loans are typically secured by properties in transition, where the borrower is in the process of either re-developing or stabilizing operations at the property. Properties securing these loans may include multi-family, retail, office, industrial, and other commercial property types.
Within both our loan acquisition and loan origination strategies, we generally focus on smaller balance loans and/or loan packages that are less-competitively-bid. These loans typically have balances that are less than $20 million, and are secured by real estate and, in some cases, a personal guarantee from the borrower.


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Consumer Loans and ABS
We acquire U.S. consumer whole loans and ABS, including ABS backed by U.S. consumer loans. Our U.S. consumer loan portfolio primarily consists of unsecured loans, but also includes secured auto loans. We are currently purchasing newly originated consumer loans under flow agreements with originators, and we continue to evaluate new opportunities. We seek to purchase newly originated consumer loans from originators that have demonstrated disciplined underwriting with a significant focus on regulatory compliance and sound lending practices.
TBAs and Other Mortgage-Related Derivatives
In addition to investing in specific pools of Agency RMBS, subject to our satisfying the requirements for qualification as a REIT, we utilize TBA transactions, whereby we agree to purchase or sell, for future delivery, Agency RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular Agency RMBS to be delivered is not identified until shortly before the TBA settlement date. TBAs are liquid and have quoted market prices and represent the most actively traded class of mortgage-backed securities, or "MBS." TBA trading is based on the assumption that mortgage pools that are eligible to be delivered at TBA settlement are fungible and thus the specific mortgage pools to be delivered do not need to be explicitly identified at the time a trade is initiated.
We generally engage in TBA transactions for purposes of managing certain risks associated with our investment strategies. Other than with respect to TBA transactions entered into by our TRSs, most of our TBA transactions are treated for tax purposes as hedging transactions used to hedge indebtedness incurred to acquire or carry real estate assets, or "qualifying liability hedges." The principal risks that we use TBAs to mitigate are interest rate and yield spread risks. For example, we may hedge the interest rate and/or yield spread risk inherent in our long Agency RMBS by taking short positions in TBAs that are similar in character. Alternatively, we may opportunistically engage in TBA transactions because we find them attractive in their own right, from a relative value perspective or otherwise. For accounting purposes, in accordance with generally accepted accounting principles in the United States of America, or "U.S. GAAP," we classify TBA transactions as derivatives.
We also take long and short positions in various other mortgage-related derivative instruments, including mortgage-related credit default swaps. A credit default swap is a credit derivative contract in which one party (the protection buyer) pays an ongoing periodic premium (and often an upfront payment as well) to another party (the protection seller) in return for compensation for default (or similar credit event) by a reference entity. In this case, the reference entity can be an individual MBS or an index of several MBS, such as an ABX, PrimeX, or CMBX index. Payments from the protection seller to the protection buyer typically occur if a credit event takes place. A credit event can be triggered by, among other things, the reference entity's failure to pay its principal obligations or a severe ratings downgrade of the reference entity.
Non-Agency RMBS
We acquire non-Agency RMBS backed by prime jumbo, Alt-A, manufactured housing, and subprime residential mortgage loans. Our non-Agency RMBS holdings can include investment-grade and non-investment grade classes, including non-rated classes.
Non-Agency RMBS are generally debt obligations issued by private originators of, or investors in, residential mortgage loans. Non-Agency RMBS generally are issued as CMOs and are backed by pools of whole mortgage loans or by mortgage pass-through certificates. Non-Agency RMBS generally are securitized in senior/subordinated structures, or in excess spread/over-collateralization structures. In senior/subordinated structures, the subordinated tranches generally absorb all losses on the underlying mortgage loans before any losses are borne by the senior tranches. In excess spread/over-collateralization structures, losses are first absorbed by any existing over-collateralization, then borne by subordinated tranches and excess spread, which represents the difference between the interest payments received on the mortgage loans backing the RMBS and the interest due on the RMBS debt tranches, and finally by senior tranches and any remaining excess spread.
We also have acquired, and may acquire in the future, European RMBS, including retained tranches from European RMBS securitizations in which we have participated.
Residential Mortgage Loans
Our residential mortgage loans include newly originated non-QM loans, residential transition loans, as well as legacy residential NPLs and RPLs. A non-QM loan is not necessarily high-risk, or subprime, but is instead a loan that does not conform to the complex Qualified Mortgage, or "QM," rules of the Consumer Financial Protection Bureau. For example, many non-QM loans are made to creditworthy borrowers who cannot provide traditional documentation for income, such as borrowers who are self-employed. There is also demand from certain creditworthy borrowers for loans above the QM 43% debt-to-income ratio limit that still meet all ability-to-repay standards. We hold an equity investment in a non-QM originator,


59


and to date we have purchased the vast majority of our non-QM loans from this originator, although we could potentially purchase a greater share of non-QM loans from other sources in the future.
The residential transition loans that we originate or purchase include: (i) "fix and flip" loans, which are made to real estate investors for the purpose of acquiring residential homes, making value-add improvements to such homes, and reselling the newly rehabilitated homes for a potential profit, and (ii) loans made to real estate investors for a "business purpose," such as purchasing a rental investment property, financing or refinancing a fully rehabilitated home awaiting sale, or securing short-term financing pending qualification for longer-term lower-rate financing. Our residential transition loans are always secured by non-owner occupied properties, and are typically structured as fixed-rate, interest-only loans with terms to maturity between 6 and 24 months. Our underwriting guidelines focus on both the "as is" and "as repaired" property values, borrower experience as a real estate investor, and asset verification.
We remain active in the market for residential NPLs and RPLs. The market for large residential NPL and RPL pools has remained highly concentrated, with the great majority having traded to only a handful of large players who typically securitize the residential NPLs and RPLs that they purchase. As a result, we have continued to focus our acquisitions on smaller, less-competitively-bid, and more attractively-priced mixed legacy pools sourced from motivated sellers.
Other Investment Assets
Our other investment assets include real estate, including residential and commercial real property, strategic debt and/or equity investments in loan originators, corporate debt and equity securities, corporate loans, which can include litigation finance loans, CRTs, and other non-mortgage-related derivatives. We do not typically purchase real property directly; rather, our real estate ownership usually results from foreclosure activity with respect to our acquired residential and commercial loans. We have made investments in loan originators and other related entities in the form of debt and/or equity and, to date, our investments have represented non-controlling interests. We have also entered into flow agreements with certain of the loan originators in which we have invested. We have not yet acquired mortgage servicing rights directly, but we may do so in the future.
Hedging Instruments
Interest Rate Hedging
We opportunistically hedge our interest rate risk by using various hedging strategies, subject to qualifying and maintaining our qualification as a REIT. The interest rate hedging instruments that we use and may use in the future include, without limitation:
TBAs;
interest rate swaps (including floating-to-fixed, fixed-to-floating, floating-to-floating, or more complex swaps such as floating-to-inverse floating, callable or non-callable);
CMOs;
U.S. Treasury securities;
swaptions, caps, floors, and other derivatives on interest rates;
futures and forward contracts; and
options on any of the foregoing.
Because fluctuations in short-term interest rates may expose us to fluctuations in the spread between the interest we earn on our investments and the interest we pay on our borrowings, we may seek to manage such exposure by entering into short positions in interest rate swaps. An interest rate swap is an agreement to exchange interest rate cash flows, calculated on a notional principal amount, at specified payment dates during the life of the agreement. Typically, one party pays a fixed interest rate and receives a floating interest rate and the other party pays a floating interest rate and receives a fixed interest rate. Each party's payment obligation is computed using a different interest rate. In an interest rate swap, the notional principal is generally not exchanged.
Credit Risk Hedging
We enter into credit-hedging positions in order to protect against adverse credit events with respect to our credit investments, subject to qualifying and maintaining our qualification as a REIT. Our credit hedging portfolio can vary significantly from period to period, and can encompass a wide variety of financial instruments, including corporate debt or equity-related instruments, RMBS- or CMBS-related instruments, or instruments involving other markets. Our hedging


60


instruments can include both "single-name" instruments (i.e., instruments referencing one underlying entity or security) and hedging instruments referencing indices.
Currently, our credit hedges consist primarily of financial instruments tied to corporate credit, such as CDS on corporate bond indices, short positions in and CDS on corporate bonds; and positions involving exchange traded funds, or "ETFs," of corporate bonds. Our credit hedges also currently include CDS tied to individual MBS or an index of several MBS, such as CDS on CMBS indices, or "CMBX."
Foreign Currency Hedging
To the extent that we hold instruments denominated in currencies other than U.S. dollars, we may enter into transactions to offset the potential adverse effects of changes in currency exchange rates, subject to qualifying and maintaining our qualification as a REIT. In particular, we may use currency forward contracts and other currency-related derivatives to mitigate this risk.
Trends and Recent Market Developments
Market Overview
After raising the target range for the federal funds rate four times in 2018, the U.S. Federal Reserve, or "Federal Reserve," elected to maintain the range of 2.25%–2.50% during the first half of 2019, before lowering the range by 25 basis points at each of its July, September, and October meetings, to the current range of 1.50%–1.75%. These were the first reductions since 2008 and were in response to uncertainties around global growth and trade negotiations. At its final meeting of the year, in December 2019, the Federal Reserve elected to leave the target range unchanged.
In March 2019, the Federal Reserve announced that over the following six months it would gradually end the tapering of its U.S. Treasury security reinvestments. According to the plan, beginning in May, the monthly tapering of U.S. Treasury security reinvestments would decrease to $15 billion, from $30 billion, and the tapering would end altogether at the end of September. Additionally, the tapering of Agency RMBS would continue at $20 billion per month, but beginning in October, monthly paydowns from Agency RMBS up to the $20 billion monthly cap would be reinvested in U.S. Treasury securities. Then, in July, the Federal Reserve announced that it would end the tapering of its U.S. Treasury security reinvestments on August 1, 2019, two months earlier than previously planned. It also announced that it would reinvest principal payments from Agency RMBS into U.S. Treasury securities, up to $20 billion per month, and that it would reinvest principal payments in excess of $20 billion into Agency RMBS. The Federal Reserve confirmed this plan at its December meeting.
During the week of September 16, 2019, interest rates on overnight repo spiked to unusually high levels. In response, the Federal Reserve conducted overnight and term repo operations to provide liquidity to the repo market, and repo rates normalized as a result. To help prevent future spikes in overnight repo rates, the Federal Reserve began buying short-term U.S. Treasury bills in October, and committed to continue purchasing them at least into the second quarter of 2020. The Federal Reserve also committed to continue these repo operations through January 2020 to address any year-end liquidity issues. Repo markets remained relatively stable in the fourth quarter of 2019, allaying fears of year-end volatility.
LIBOR rates, which drive many of our financing costs, steadily declined during 2019 before increasing modestly in December. For the year, one-month LIBOR decreased 74 basis points to 1.76% at year end, and three-month LIBOR fell 90 basis points to 1.91%, a 15 basis point positive spread, as compared to a 30 basis point positive spread at the end of 2018. However, at several points during 2019, in anticipation of near-term interest rate cuts by the Federal Reserve, the spread between one- and three-month LIBOR inverted.
Over the course of 2019, interest rates declined across the U.S. Treasury yield curve, with the two-year U.S. Treasury yield decreasing 92 basis points to finish the year at 1.57%, and the ten-year U.S. Treasury yield declining 76 basis points to 1.92%. During one week in the third quarter, the spread between the two-year U.S. Treasury yield and ten-year U.S. Treasury yield inverted, which had not happened since June 2007. As of the end of the third quarter, the entire two-month through five-year segment of the U.S. Treasury yield curve was inverted. During the fourth quarter, the yield curve normalized, and the spread between the two-year and ten-year U.S. Treasury yields was 35 basis points at year end, its steepest level in more than 18 months.
Mortgage rates declined sharply during the first eight months of the year, before increasing moderately going into year end. The Freddie Mac survey 30-year mortgage rate declined 106 basis points between December 31, 2018 and September 5, 2019, before increasing 25 basis points to end the year at 3.74%. With falling mortgage rates, Agency RMBS prepayment rates surged, increasing from 6.6% in January to 21.2% in October, before retracing to 17.0% in December.


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U.S. real GDP increased at an estimated annualized rate of 3.1% in the first quarter, 2.0% in the second quarter, 2.1% in the third quarter, and 2.1% in the fourth quarter. Total unemployment declined throughout the year, falling to 3.5% as of year-end 2019, as compared to 3.9% as of year-end 2018.
Each of the Bloomberg Barclays US MBS Index ("BB MBS Index"), Bloomberg Barclays US Corporate Bond Index ("BB IG Index"), and Bloomberg Barclays US Corporate High Yield Bond Index ("BB HY Index") generated positive returns for each quarter of 2019; and for the full year, each generated excess returns (on a duration-adjusted basis) over the Bloomberg Barclays US Treasury Index ("BB UST Index"). During 2019, the BB MBS Index generated a positive return of 6.35% and an excess return of 0.61%; the BB IG Index generated a positive return of 14.5% and an excess return of 6.76%; and the BB HY Index generated a positive return of 14.3% and an excess return of 9.3%.
Changing market sentiment around central bank policies, trade negotiations, global growth prospects, and geopolitical tensions drove market fluctuations during 2019, but over the course of the year most asset classes performed well, as interest rates ratcheted tighter and the yield curve remained flat, and at times, inverted.
During the first quarter of the year, the market weakness of December 2018 reversed course, and most fixed income and equity assets performed well. Dovish messaging from the Federal Reserve soothed the stock and bond markets and sparked a market rally; domestic equity indexes rose, yield spreads on most credit assets and many Agency assets tightened, and market volatility declined. Interest rates were range-bound for the first two months of the year before dropping considerably in March. At March 31, 2019 the yield on the ten-year U.S. Treasury note had declined to 2.41%, down 83 basis points from early November 2018. Meanwhile, the yield curve continued to flatten, with a portion of the curve even inverting for a week in March, again stoking fears of a full yield curve inversion, and whether that might signal a looming recession. The Federal Reserve appeared to end its rate hiking cycle and also announced a slowdown of its balance sheet runoff in March; in Europe, the European Central Bank ("ECB") introduced new stimulus measures in response to slowing growth, including a recession in Italy.
Moving into the second quarter, volatility remained low, and equities and many credit assets continued to perform well in April. Meanwhile, declining interest rates continued to drive increases in actual and projected prepayments, which in turn led to modest widening of Agency RMBS yield spreads and increases in pay-ups on specified pools, trends that would continue through most of 2019. Volatility returned to the markets in May, however, as global trade tensions escalated. By the end of May, the Merrill Lynch Option Volatility Estimate Index, or "MOVE Index," which had just reached an all-time low in March, spiked to its highest level in more than two years. Meanwhile, domestic equities sold off, yield spreads on most fixed income assets widened, and interest rates plummeted. Over the course of the month, the S&P 500 declined 6% while the yield on the ten-year U.S. Treasury fell 38 basis points. Both the BB IG Index and BB HY Index underperformed relative to the BB UST Index, while the BB MBS Index had its worst performance relative to U.S. Treasuries since November 2016. In June, interest rate futures markets implied a near-certain probability of a rate cut in July, which spurred a broad rally across most asset classes. Long-term U.S. Treasury yields continued their precipitous decline, with the ten-year yield dropping below 2% for the first time since November 2016. In Europe, the ECB signaled that it was ready to launch another round of stimulus, and the total amount of negative-yielding sovereign bonds reached $13 trillion globally.
In July, the market was optimistic about U.S./China trade negotiations, and anticipating an interest rate cut by the Federal Reserve, domestic equities hit record highs. On July 31, the Federal Reserve indeed cut short term rates by 25 basis points, and announced an end to its U.S. Treasury security portfolio runoff two months early. Sentiment flipped in August, however, and significant market volatility returned, as messaging from the Federal Reserve shifted hawkish, concerns over global growth intensified, and U.S. trade negotiations with China grew tense following China's devaluation of its currency. During the month, the MOVE Index hit a 3.5-year high, and the VIX volatility index spiked to its highest level since the beginning of the year. Meanwhile, domestic equities fell, interest rates plummeted, various parts of the yield curve inverted, and yield spreads on many fixed income assets fluctuated. Over the course of the month, the S&P 500 declined by 1.8% while the yield on the ten-year U.S. Treasury fell by 52 basis points, finishing the month below the yield on the two-year U.S. Treasury.
The Federal Reserve responded to the increased volatility by pledging more monetary stimulus should the global slowdown damage the U.S. economy, while several central banks around the globe also responded by cutting interest rates. Moving into September, volatility subsided; the VIX and MOVE indexes declined, domestic equities recovered, and U.S. Treasury yields rose. The ECB cut its short-term rate in September, its first cut since 2016, and announced a quantitative easing program. Later in the month, the Federal Reserve cut its short term rate again, though the decision was not unanimous, clouding the outlook for future reductions. Domestic equity indexes posted positive returns for the month, and medium-term and long-term U.S. Treasury yields rose.
Markets remained steady in the fourth quarter. Trade concerns eased with the announcement that the U.S. and China had reached agreement on "Phase One" of a trade deal in principle, and with the signing of the U.S.–Mexico–Canada Agreement.


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Meanwhile, accommodative monetary policy continued globally with a third rate cut from the Federal Reserve, the ECB restarting asset purchases, and additional policy support in China. Domestic equity indexes set new record highs and volatility was low as the VIX hit its low point for the year in November, and the ten-year traded in a 41-basis point range for the quarter, as compared to a range of 133 basis points during the year's first three quarters. Interest rates drifted up modestly, slowing prepayments in November and December and supporting agency yield spreads, and the yield curve steepened moderately going into year end.
Over the course of 2019, market optimism over global stimulus, including three interest rate cuts by the Federal Reserve, and progress on trade negotiations seemed to prevail over various macroeconomic concerns including slowing global growth, the Federal Reserve signaling an end to interest rate cuts, geopolitical tensions, and an upcoming U.S. presidential election. Coming off of a weak December in 2018, virtually all investment classes performed well over 2019. Domestic equities had one of the best years of the decade, with the NASDAQ up 35%, the S&P up 29%, and the Dow Jones Industrial Average up 22%. The BB IG Index and BB HY Index each generated returns over 14% and significant excess returns to the BB UST Index. Safer assets rallied as well, with the BB MBS Index generating positive absolute and excess returns to the BB UST Index, despite falling mortgage rates and significant increases in prepayments; gold prices appreciating 18%; and the yield on the ten-year U.S. Treasury note reaching a 3-year low in September, before finishing the year below 2%.
Portfolio Overview and Outlook
During the first half of 2019, in connection with our REIT conversion, we rotated a portion of our capital from non-REIT-qualifying assets to REIT-qualifying assets. As a result of these efforts, the Agency RMBS portfolio grew significantly, while the composition of the overall credit portfolio shifted somewhat, highlighted by net purchases of non-QM loans, residential transition loans, and small balance commercial mortgage loans; and net sales of secondary CLOs and UK non-conforming RMBS. Our total long credit portfolio, including real estate owned, or "REO," but excluding hedges and other derivative positions, increased 4.0% to $1.539 billion as of June 30, 2019, from $1.480 billion as of December 31, 2018. Excluding non-retained tranches of our consolidated non-QM securitization trusts, our total long credit portfolio declined 9.8% to $1.069 billion as of June 30, 2019, from $1.185 billion as of December 31, 2018, mainly due to the completion of our third non-QM securitization in June. Over the same period, our long Agency RMBS portfolio increased 37.3% to $1.339 billion as of June 30, 2019, from $975.4 million as of December 31, 2018.
During the second half of 2019, we closed two follow-on common equity offerings, in July and November, as well as our inaugural preferred equity offering, in October; as we deployed the proceeds from these offerings, the size of both of our credit and Agency portfolios increased significantly. Our total long credit portfolio, including REO but excluding hedges and other derivative positions, increased 31.8% to $2.028 billion as of December 31, 2019, from $1.539 billion as of June 30, 2019. Excluding non-retained tranches of our consolidated non-QM securitization trusts, our total long credit portfolio increased 35.1% to $1.444 billion as of December 31, 2019, from $1.069 billion as of June 30, 2019. Similar to the first half of the year, we continued to grow the non-QM, residential transition, and small balance commercial mortgage loan portfolios, capitalizing on our proprietary loan pipelines. We also opportunistically increased the size of our secondary CLO and CMBS portfolios significantly, as well as adding to our consumer loan holdings. Additionally, we increased our long Agency RMBS portfolio by 44.7% to $1.937 billion as of December 31, 2019, from $1.339 billion as of June 30, 2019. The larger Agency portfolio was a combination of an investment opportunity that we capitalized on when Agency yield spreads widened in August, as well as a result of rotating capital to REIT-qualifying assets.


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Credit Summary (1) 
 
 
December 31, 2019
 
As of December 31, 2018
($ in thousands)
 
Fair Value
 
% of Total Long Credit Portfolio
 
Fair Value
 
% of Total Long Credit Portfolio
Dollar Denominated:
 
 
 
 
 
 
 
 
CLOs(2)
 
$
172,802

 
8.5
%
 
$
123,893

 
8.4
%
CMBS
 
124,693

 
6.2
%
 
18,426

 
1.2
%
Commercial Mortgage Loans and REO(3)(4)
 
320,926

 
15.8
%
 
245,536

 
16.6
%
Consumer Loans and ABS Backed by Consumer Loans(2)
 
238,193

 
11.7
%
 
209,922

 
14.2
%
Corporate Debt and Equity and Corporate Loans
 
20,987

 
1.0
%
 
6,179

 
0.4
%
Debt and Equity Investments in Loan Origination Entities
 
41,393

 
2.1
%
 
37,067

 
2.5
%
Non-Agency RMBS
 
113,342

 
5.6
%
 
153,214

 
10.4
%
Residential Mortgage Loans and REO(3)
 
933,870

 
46.1
%
 
498,126

 
33.7
%
Non-Dollar Denominated:
 
 
 
 
 
 
 
 
CLOs(2)
 
5,722

 
0.3
%
 

 
%
CMBS
 
175

 
%
 
15,482

 
1.0
%
Consumer Loans and ABS Backed by Consumer Loans
 
549

 
%
 
884

 
0.1
%
Corporate Debt and Equity
 
30

 
%
 
10,810

 
0.7
%
RMBS(5)
 
55,156

 
2.7
%
 
160,342

 
10.8
%
Total Long Credit
 
$
2,027,838

 
100.0
%
 
$
1,479,881

 
100.0
%
(1)
This information does not include U.S. Treasury securities, interest rate swaps, TBA positions, or other hedge positions.
(2)
Includes equity investments in securitization-related vehicles.
(3)
As discussed in Note 2 of the notes to consolidated financial statements for the year ended December 31, 2019, as of December 31, 2019, REO is not considered a financial instrument and as a result is included at the lower of cost or fair value. As of December 31, 2018, REO was considered a financial instrument and is included at fair value.
(4)
Includes investments in unconsolidated entities holding small balance commercial mortgage loans and REO.
(5)
Includes an investment in an unconsolidated entity holding European RMBS.
Steady net interest income from our credit portfolio was the primary driver of our strong results in 2019. We had excellent performance in several of our loan-related strategies, including small-balance commercial mortgage loans, residential transition loans, consumer loans, and the non-QM mortgage business. We also had strong results from CMBS, non-Agency RMBS, and secondary CLOs.
In contrast, for most of 2019 CLO equity underperformed high yield corporate indices, which led to losses in our portfolio. Also, while our UK non-conforming RMBS portfolio generated gains for the year, our Euro-denominated RMBS portfolio generated losses. Additionally, the interest rate hedges in our credit portfolio—which consisted primarily of interest rate swaps—generated net losses as interest rates declined. Our credit hedges, which consisted primarily of derivative positions on high yield corporate credit and CMBX, also generated losses. We had net gains on our foreign currency hedges, which more than offset net losses on our foreign currency-related transactions and remeasurement.


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Agency RMBS Summary
 
 
December 31, 2019
 
December 31, 2018
($ in thousands)
 
Fair Value
 
% of Long Agency Portfolio
 
Fair Value
 
% of Long Agency Portfolio
Long Agency RMBS:
 
 
 
 
 
 
 
 
Fixed Rate
 
$
1,758,882

 
90.8
%
 
$
884,870

 
90.7
%
Floating Rate
 
10,002

 
0.5
%
 
5,496

 
0.6
%
Reverse Mortgages
 
132,800

 
6.9
%
 
55,475

 
5.7
%
IOs
 
35,279

 
1.8
%
 
29,516

 
3.0
%
Total Long Agency RMBS
 
1,936,963

 
100.0
%
 
975,357

 
100.0
%
Despite fluctuations in interest rates and yield spreads, increasing prepayment rates, and at times an inverted yield curve, our Agency RMBS portfolio had excellent performance in 2019. Pay-ups on our specified pools increased during most of the year, and along with declining interest rates, helped generate net realized and unrealized gains on our portfolio. Pay-ups are price premiums for specified pools relative to their TBA counterparts, and reflect the prepayment protection that specified pools provide. The decline in mortgage rates and associated increase in actual and projected prepayments during the year drove the expansion of pay-ups. Average pay-ups on our specified pools increased to 1.36% as of December 31, 2019, as compared to 0.64% as of December 31, 2018.
During the year we continued to hedge interest rate risk in our Agency strategy, primarily through the use of interest rate swaps, short positions in TBAs, U.S. Treasury securities, and futures. In our interest rate hedging portfolio, the relative proportion, based on 10-year equivalents, of short positions in TBAs increased slightly year over year relative to other hedging instruments. Ten-year equivalents for a group of positions represent the amount of 10-year U.S. Treasury securities that would be expected to experience a similar change in market value under a standard parallel move in interest rates. The decline in interest rates during the year generated net realized and unrealized losses on our interest rate hedges on our Agency portfolio.
As of December 31, 2019 and 2018, the weighted average net pass-through rate on our fixed-rate specified pools was 4.0% and 4.2%, respectively. Portfolio turnover for our Agency strategy, as measured by sales and excluding paydowns, was approximately 74% for the year.
We expect to continue to target specified pools that, taking into account their particular composition and based on our prepayment projections, should: (1) generate attractive yields relative to other Agency RMBS and U.S. Treasury securities, (2) have less prepayment sensitivity to government policy shocks, and/or (3) create opportunities for trading gains once the market recognizes their value, which for newer pools may come only after several months, when actual prepayment experience can be observed. We believe that our research team, proprietary prepayment models, and extensive databases remain essential tools in our implementation of this strategy.
The following table summarizes the prepayment rates for our portfolio of fixed-rate specified pools (excluding those backed by reverse mortgages) for the three-month periods ended December 31, 2019, September 30, 2019, June 30, 2019, March 31, 2019, and December 31, 2018.
 
 
Three-Month Period Ended
 
 
December 31, 2019
 
September 30, 2019
 
June 30, 2019
 
March 31, 2019
 
December 31, 2018
Three-Month Constant Prepayment Rates(1)
 
19.9%
 
15.7%
 
12.8%
 
7.8%
 
7.5%
(1)
Excludes Agency fixed-rate RMBS without any prepayment history.


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The following table provides details about the composition of our portfolio of fixed-rate specified pools (excluding those backed by reverse mortgages) as of December 31, 2019 and 2018:
 
 
 
 
December 31, 2019
 
December 31, 2018
 
 
Coupon
 
Current Principal
 
Fair Value
 
Weighted
Average Loan
Age (Months)
 
Current Principal
 
Fair Value
 
Weighted
Average Loan
Age (Months)
 
 
 
 
(In thousands)
 
 
 
(In thousands)
 
 
Fixed-rate Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-year fixed-rate mortgages:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2.50

 
$
125,526

 
$
127,080

 
146

 
$

 
$

 

 
 
3.00

 
68,037

 
70,097

 
62

 
13,242

 
13,237

 
38

 
 
3.50

 
109,362

 
113,943

 
44

 
50,938

 
51,630

 
41

 
 
4.00

 
5,453

 
5,764

 
58

 
6,614

 
6,720

 
64

 
 
4.50

 
6,258

 
6,522

 
113

 
2,177

 
2,265

 
93

Total 15-year fixed-rate mortgages
 
 
 
314,636

 
323,406

 
90

 
72,971

 
73,852

 
44

20-year fixed-rate mortgages:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
4.00

 

 

 

 
1,478

 
1,526

 
62

 
 
4.50

 
804

 
877

 
73

 
976

 
1,021

 
61

Total 20-year fixed-rate mortgages
 
 
 
804

 
877

 
73

 
2,454

 
2,547

 
62

30-year fixed-rate mortgages:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2.50

 
13,991

 
13,867

 
3

 
524

 
495

 
62

 
 
3.00

 
39,161

 
40,200

 
18

 
6,087

 
5,973

 
56

 
 
3.28

 
106

 
108

 
90

 
109

 
106

 
78

 
 
3.50

 
279,624

 
291,575

 
24

 
146,664

 
147,204

 
28

 
 
3.75

 
2,297

 
2,393

 
31

 
2,508

 
2,537

 
17

 
 
4.00

 
482,388

 
507,707

 
28

 
310,389

 
318,520

 
29

 
 
4.50

 
280,885

 
299,042

 
21

 
190,413

 
198,214

 
25

 
 
5.00

 
235,034

 
252,500

 
18

 
95,089

 
100,092

 
24

 
 
5.50

 
21,041

 
22,618

 
21

 
28,507

 
30,335

 
15

 
 
6.00

 
4,235

 
4,589

 
42

 
4,647

 
4,995

 
32

Total 30-year fixed-rate mortgages
 
 
 
1,358,762

 
1,434,599

 
23

 
784,937

 
808,471

 
27

Total fixed-rate Agency RMBS
 
 
 
$
1,674,202

 
$
1,758,882

 
36

 
$
860,362

 
$
884,870

 
29

Our net Agency premium as a percentage of the fair value of our specified pool holdings is one metric that we use to measure the overall prepayment risk of our specified pool portfolio. Net Agency premium represents the total premium (excess of market value over outstanding principal balance) on our specified pool holdings less the total premium on related net short TBA positions. The lower our net Agency premium, the less we believe that our specified pool portfolio is exposed to market-wide increases in Agency RMBS prepayments. Our net Agency premium as a percentage of fair value of our specified pool holdings was approximately 2.6% and 1.8% as of December 31, 2019 and 2018, respectively. These figures take into account the net short TBA positions that we use to hedge our specified pool holdings, which had a notional value of $1.093 billion and a fair value of $1.139 billion as of December 31, 2019, as compared to a notional value of $460.1 million and a fair value of $470.7 million as of December 31, 2018. Excluding these TBA hedging positions, our Agency premium as a percentage of fair value was approximately 5.0% and 2.9% as of December 31, 2019 and 2018, respectively. Our Agency premium percentage and net Agency premium percentage may fluctuate from period to period based on a variety of factors, including market factors such as interest rates and mortgage rates, and, in the case of our net Agency premium percentage, based on the degree to which


66


we hedge prepayment risk with short TBA positions. We believe that our focus on purchasing pools with specific prepayment characteristics provides a measure of protection against prepayments.
Financing
The following table details our borrowings outstanding and debt-to-equity ratios as of December 31, 2019 and 2018:
 
 
As of
($ in thousands)
 
December 31, 2019
 
December 31, 2018
Recourse(1) Borrowings:
 
 
 
 
Repurchase Agreements
 
$
2,150,282

 
$
1,498,849

Other Secured Borrowings
 
47,814

 
13,150

Senior Notes, at par
 
86,000

 
86,000

Total Recourse Borrowings
 
$
2,284,096

 
$
1,597,999

Debt-to-Equity Ratio Based on Total Recourse Borrowings(1)
 
2.6:1

 
2.7:1

Debt-to-Equity Ratio Based on Total Recourse Borrowings Excluding U.S. Treasury Securities
 
2.6:1

 
2.7:1

Non-Recourse(2) Borrowings:
 
 
 
 
Repurchase Agreements
 
$
295,018

 
$

Other Secured Borrowings
 
102,520

 
100,950

Other Secured Borrowings, at fair value(3)
 
594,396

 
297,948

Total Recourse and Non-Recourse Borrowings
 
$
3,276,030

 
$
1,996,897

Debt-to-Equity Ratio Based on Total Recourse and Non-Recourse Borrowings
 
3.8:1

 
3.4:1

Debt-to-Equity Ratio Based on Total Recourse and Non-Recourse Borrowings Excluding U.S. Treasury Securities
 
3.8:1

 
3.4:1

(1)
As of December 31, 2019, excludes borrowings at certain unconsolidated entities that are recourse to us. Including such borrowings, our debt-to-equity ratio based on total recourse borrowings is 2.7:1 as of December 31, 2019.
(2)
All of our non-recourse borrowings are secured by collateral. In the event of default under a non-recourse borrowing, the lender has a claim against the collateral but not any of the Operating Partnership's other assets. In the event of default under a recourse borrowing, the lender's claim is not limited to the collateral (if any).
(3)
Relates to our non-QM loan securitizations, where we have elected the fair value option on the related debt.
Our debt-to-equity ratio including repos, Total other secured borrowings, and our Senior Notes, but excluding repos on U.S. Treasury securities, was 3.8:1 and 3.4:1, as of December 31, 2019 and 2018, respectively. Our recourse debt-to-equity ratio decreased slightly over the course of the year, to 2.6:1 as of December 31, 2019 from 2.7:1 as of December 31, 2018. Our debt-to-equity ratio may fluctuate period over period based on portfolio management decisions, market conditions, capital markets activities, and the timing of security purchase and sale transactions.
Our financing costs include interest expense related to our repo borrowings, Total other secured borrowings, and Senior Notes. The interest rates on our repo borrowings and Other secured borrowings are based on, or correlated with, LIBOR. As of December 31, 2019, our weighted average borrowing rate declined to 2.67% from 3.39% as of December 31, 2018. The weighted average borrowing rate at year end 2019 was lower due to (i) an increase in the proportion of our borrowings on Agency RMBS, which typically have lower borrowing costs than our credit investments, (ii) lower short-term LIBOR rates year over year, and (ii) tighter financing spreads compared to LIBOR in several sectors. For the year ended December 31, 2019, however, our average cost of funds increased to 3.18%, compared to 2.81% for the year ended December 31, 2018. The year-over-year increase was primarily due to (i) higher average rates on our repo and Other secured borrowings, (ii) wider spreads on Agency borrowings, and (iii) a higher proportion of our credit-related borrowings consisting of borrowings used to finance loan assets, which typically have higher borrowing costs than securities.


67


Critical Accounting Policies
We adopted ASC 946 upon commencement of operations in August 2007, and applied U.S. GAAP for investment companies. In connection with our internal restructuring and our intention to qualify as a REIT for the year ended December 31, 2019, we have determined that, effective January 1, 2019, we no longer qualified for investment company accounting in accordance with ASC 946-10-25, and have prospectively discontinued its use. We elected the fair value option for, and therefore we will continue to measure at fair value, those of our assets and liabilities for which such election is permitted, as provided for under ASC 825, Financial Instruments ("ASC 825").
Our consolidated financial statements include the accounts of Ellington Financial Inc., its Operating Partnership, its subsidiaries, and variable interest entities, or "VIEs," for which the Company is deemed to be the primary beneficiary. All intercompany balances and transactions have been eliminated. Certain of our critical accounting policies require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe that all of the decisions and assessments upon which our consolidated financial statements are based were reasonable at the time made based upon information available to us at that time. We rely on the experience of our Manager and Ellington and analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. See Note 2 of the notes to our consolidated financial statements for a complete discussion of our significant accounting policies. We have identified our most critical accounting policies to be the following:
Valuation: For financial instruments that are traded in an "active market," the best measure of fair value is the quoted market price. However, many of our financial instruments are not traded in an active market. Therefore, management generally uses third-party valuations when available. If third-party valuations are not available, management uses other valuation techniques, such as the discounted cash flow methodology. Summary descriptions, for various categories of financial instruments, of the valuation methodologies management uses in determining fair value of our financial instruments are detailed in Note 2 of the notes to our consolidated financial statements. Management utilizes such methodologies to assign a good faith fair value (the estimated price that, in an orderly transaction at the valuation date, would be received to sell an asset, or paid to transfer a liability, as the case may be) to each such financial instrument.
See the notes to our consolidated financial statements for more information on valuation techniques used by management in the valuation of our assets and liabilities.
Purchases and Sales of Investments and Investment Income: Purchase and sales transactions are generally recorded on trade date. Realized and unrealized gains and losses are calculated based on identified cost. We generally amortize premiums and accrete discounts on our fixed-income investments using the effective interest method.
See the notes to our consolidated financial statements for more information on the assumptions and methods that we use to amortize purchase premiums and accrete purchase discounts.
Recent Accounting Pronouncements
Refer to the notes to our consolidated financial statements for a description of relevant recent accounting pronouncements.


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Financial Condition
The following table summarizes our investment portfolio(1) as of December 31, 2019.
(In thousands)
 
Fair Value
Long:
 
 
Credit:
 
 
Dollar Denominated:
 
 
CLO(2)
 
$
172,802

CMBS
 
124,693

Commercial Mortgage Loans and REO(3)(4)
 
320,926

Consumer Loans and ABS backed by Consumer Loans(2)
 
238,193

Corporate Debt and Equity and Corporate Loans
 
20,987

Equity Investments in Loan Origination Entities
 
41,393

Non-Agency RMBS
 
113,342

Residential Mortgage Loans and REO(3)
 
933,870

Non-Dollar Denominated:
 
 
CLO(2)
 
5,722

CMBS
 
175

Consumer Loans and ABS backed by Consumer Loans
 
549

Corporate Debt and Equity
 
30

RMBS(5)
 
55,156

Agency:
 
 
Fixed-Rate Specified Pools
 
1,758,882

Floating-Rate Specified Pools
 
10,002

IOs
 
35,279

Reverse Mortgage Pools
 
132,800

Total Long
 
$
3,964,801

Short:
 
 
Credit:
 
 
Dollar Denominated:
 
 
Corporate Debt and Equity
 
$
(471
)
Government Debt:
 
 
Dollar Denominated
 
(62,994
)
Non-Dollar Denominated
 
(9,944
)
Total Short
 
$
(73,409
)
(1)
For more detailed information about the investments in our portfolio, please see the notes to consolidated financial statements for the year ended December 31, 2019.
(2)
Includes equity investments in securitization-related vehicles.
(3)
REO is not eligible to elect the fair value option as described in Note 2 of the notes to consolidated financial statements for the year ended December 31, 2019, and, as a result, is included at the lower of cost or fair value.
(4)
Includes investments in unconsolidated entities holding small balance commercial mortgage loans and REO.
(5)
Includes an investment in an unconsolidated entity holding European RMBS.


69


The following table summarizes our investment portfolio(1) as of December 31, 2018.
(In thousands)
 
Fair Value
Long:
 
 
Credit:
 
 
Dollar Denominated:
 
 
CLO(2)
 
$
123,893

CMBS
 
18,426

Commercial Mortgage Loans and REO(3)
 
245,536

Consumer Loans and ABS Backed by Consumer Loans(2)
 
209,922

Corporate Debt and Equity
 
15,316

Debt and Equity Investments in Loan Origination Entities
 
37,067

Non-Agency RMBS
 
153,214

Residential Mortgage Loans and REO
 
498,126

Non-Dollar Denominated:
 
 
CMBS
 
15,482

Consumer Loans and ABS Backed by Consumer Loans
 
884

Corporate Debt and Equity
 
10,810

RMBS(4)
 
160,342

Agency:
 
 
Fixed-Rate Specified Pools
 
884,870

Floating-Rate Specified Pools
 
5,496

IOs
 
29,516

Reverse Mortgage Pools
 
55,475

TBAs
 
474,860

Government:
 
 
Dollar Denominated
 
76

Total Long
 
2,939,311

Reverse repos
 
 
Dollar Denominated
 
41,530

Non-Dollar Denominated
 
19,744

Total Repurchase Agreements
 
61,274

Short:
 
 
Credit:
 

Dollar Denominated:
 
 
Corporate Debt and Equity
 
(23,462
)
Agency:
 
 
TBAs
 
(772,964
)
Government:
 
 
Dollar Denominated
 
(34,817
)
Non-Dollar Denominated
 
(19,334
)
Total Short
 
(850,577
)
Net Total
 
$
2,150,008

(1)
For more detailed information about the investments in our portfolio, please refer to the Consolidated Condensed Schedule of Investments contained in our consolidated financial statements for the year ended December 31, 2018.
(2)
Includes equity investment in a securitization-related vehicle.
(3)
Includes equity investment in a limited liability company holding small balance commercial mortgage loans.
(4)
Includes RMBS secured by non-performing loans and REO, and an investment in an entity holding a securitization call right.


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The following table summarizes our financial derivatives portfolio(1)(2) as of December 31, 2019.
 
 
Notional
 
Net
Fair Value
(In thousands)
 
Long
 
Short
 
Net
 
Mortgage-Related Derivatives:
 
 
 
 
 
 
 
 
CDS on MBS and MBS Indices
 
$
1,039

 
$
(70,656
)
 
$
(69,617
)
 
$
4,062

Total Net Mortgage-Related Derivatives
 
1,039

 
(70,656
)
 
(69,617
)
 
4,062

Corporate-Related Derivatives:
 
 
 
 
 
 
 
 
CDS on Corporate Bonds and Corporate Bond Indices
 
131,137

 
(262,885
)
 
(131,748
)
 
(10,616
)
Total Return Swaps on Corporate Bond Indices and Corporate Debt(3)
 
7,359

 
(17,560
)
 
(10,201
)
 
(589
)
Total Net Corporate-Related Derivatives
 
138,496

 
(280,445
)
 
(141,949
)
 
(11,205
)
Interest Rate-Related Derivatives:
 
 
 
 
 
 
 
 
TBAs
 
40,100

 
(1,093,730
)
 
(1,053,630
)
 
(416
)
Interest Rate Swaps
 
305,723

 
(732,961
)
 
(427,238
)
 
(3,251
)
U.S. Treasury Futures(4)
 

 
(16,000
)
 
(16,000
)
 
148

Eurodollar Futures(5)
 

 
(14,000
)
 
(14,000
)
 
(45
)
Total Interest Rate-Related Derivatives
 
 
 
 
 
 
 
(3,564
)
Other Derivatives:
 
 
 
 
 
 
 
 
Foreign Currency Forwards(6)
 

 
(26,211
)
 
(26,211
)
 
(126
)
Total Net Other Derivatives
 
 
 
 
 
 
 
(126
)
Net Total
 
 
 
 
 
 
 
$
(10,833
)
(1)
For more detailed information about the financial derivatives in our portfolio, please refer to Note 8 of the notes to consolidated financial statements for the year ended December 31, 2019.
(2)
In the table above, fair value of certain derivative transactions are shown on a net basis. The accompanying financial statements separate derivative transactions as either assets or liabilities. As of December 31, 2019, derivative assets and derivative liabilities were $16.8 million and $(27.6) million, respectively, for a net fair value of $(10.8) million, as reflected in "Net Total" above.
(3)
Notional value represents the face amount of the underlying asset.
(4)
Notional value represents the total face amount of U.S. Treasury securities underlying all contracts held. As of December 31, 2019, a total of 160 short U.S. Treasury futures contracts were held.
(5)
Every $1,000,000 in notional value represents one contract.
(6)
Short notional value represents U.S. Dollars to be received by us at the maturity of the forward contract.


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The following table summarizes our financial derivatives portfolio(1)(2) as of December 31, 2018.
 
 
Notional
 
Net
Fair Value
(In thousands)
 
Long
 
Short
 
Net
 
Mortgage-Related Derivatives:
 
 
 
 
 
 
 
 
CDS on MBS and MBS Indices
 
$
15,527

 
$
(59,393
)
 
$
(43,866
)
 
$
7,439

Total Net Mortgage-Related Derivatives
 
15,527

 
(59,393
)
 
(43,866
)
 
7,439

Corporate-Related Derivatives:
 
 
 
 
 
 
 
 
CDS on Corporate Bonds and Corporate Bond Indices
 
83,060

 
(316,383
)
 
(233,323
)
 
(11,597
)
Total Return Swaps on Corporate Equities(3)
 

 
(17,740
)
 
(17,740
)
 
1

Total Return Swaps on Corporate Bond Indices(4)
 

 
(11,230
)
 
(11,230
)
 
(6
)
Total Net Corporate-Related Derivatives
 
83,060

 
(345,353
)
 
(262,293
)
 
(11,602
)
Interest Rate-Related Derivatives:
 
 
 
 
 
 
 
 
Interest Rate Swaps
 
143,007

 
(425,413
)
 
(282,406
)
 
3,831

U.S. Treasury Futures(5)
 

 
(151,600
)
 
(151,600
)
 

Eurodollar Futures(6)
 

 
(98,000
)
 
(98,000
)
 
(53
)
Total Interest Rate-Related Derivatives
 
 
 
 
 
 
 
3,778

Other Derivatives:
 
 
 
 
 
 
 
 
Foreign Currency Forwards(7)
 

 
(17,299
)
 
(17,299
)
 
(114
)
Foreign Currency Futures(8)
 

 
(47,931
)
 
(47,931
)
 
(302
)
Other(9)
 
n/a

 
n/a

 
n/a

 
(4
)
Total Net Other Derivatives
 
 
 
 
 
 
 
(420
)
Net Total
 
 
 
 
 
 
 
$
(805
)
(1)
For more detailed information about the financial derivatives in our portfolio, please refer to the Consolidated Condensed Schedule of Investments as of December 31, 2018 contained in our consolidated financial statements.
(2)
In the table above, fair value of certain derivative transactions are shown on a net basis. The accompanying financial statements separate derivative transactions as either assets or liabilities. As of December 31, 2018, derivative assets and derivative liabilities were $20.0 million and $(20.8) million, respectively, for a net fair value of $(0.8) million, as reflected in "Net Total" above.
(3)
Notional value represents number of underlying shares multiplied by the closing price of the underlying security.
(4)
Notional value represents the number of underlying index units multiplied by the reference price.
(5)
Notional value represents the total face amount of U.S. Treasury securities underlying all contracts held. As of December 31, 2018, a total of 1,516 short U.S. Treasury futures contracts were held.
(6)
Every $1,000,000 in notional value represents one contract.
(7)
Short notional value represents U.S. Dollars to be received by us at the maturity of the forward contract.
(8)
Notional value represents the total face amount of currency futures underlying all contracts held. As of December 31, 2018, a total of 411 short foreign currency futures contracts were held.
(9)
As of December 31, 2018, includes interest rate caps and interest rate "basis" swaps whereby we pay one floating rate and receive a different floating rate.
As of December 31, 2019, our Consolidated Balance Sheet reflected total assets of $4.3 billion and total liabilities of $3.5 billion. Our investments in securities, loans, and unconsolidated entities, financial derivatives, and real estate owned included in total assets were $4.0 billion as of December 31, 2019. Our investments in securities sold short and financial derivatives included in total liabilities were $101.0 million as of December 31, 2019. As of December 31, 2019, investments in securities sold short consisted principally of short positions in sovereign bonds and U.S. Treasury securities, which we primarily use to hedge the risk of rising interest rates and foreign currency risk.
As of December 31, 2018, our Consolidated Statement of Assets, Liabilities, and Equity reflected total assets of $4.0 billion and total liabilities of $3.4 billion. Our investments, financial derivatives, and repurchase agreements included in total assets were $3.0 billion as of December 31, 2018. Our investments sold short and financial derivatives included in total liabilities were $871.4 million as of December 31, 2018. As of December 31, 2018 investments in securities sold short consisted principally of short positions in TBAs, which we primarily use to hedge the risk of rising interest rates on our investment portfolio.
As of December 31, 2019, as a result of our prospective change of accounting, TBAs are classified as financial derivatives, rather than investments, as was the case as of December 31, 2018. Typically, we hold a net short position in TBAs. The amounts of net short TBAs, as well as of other hedging instruments, may fluctuate according to the size of our investment portfolio as well as according to how we view market dynamics as favoring the use of one hedging instrument or another. As of December 31, 2019 and 2018, we had a net short notional TBA position of $1.1 billion and $293.7 million, respectively.


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For a more detailed discussion of our investment portfolio, see "—Trends and Recent Market Developments—Portfolio Overview and Outlook" above.
We use mortgage-related credit derivatives primarily to hedge credit risk in certain credit strategies, although we also take net long positions in certain CDS on RMBS and CMBS indices. Our CDS on individual RMBS represent "single-name" positions whereby we have synthetically purchased credit protection on specific non-Agency RMBS bonds. As there is no longer an active market for CDS on individual RMBS, our portfolio in this sector continues to run off. We also use CDS on corporate bond indices, options thereon, and various other instruments as a means to hedge credit risk. As market conditions change, especially as the pricing of various credit hedging instruments changes in relation to our outlook on future credit performance, we continuously re-evaluate both the extent to which we hedge credit risk and the particular mix of instruments that we use to hedge credit risk.
We may hold long and/or short positions in corporate bonds or equities. Our long and short positions in corporate bonds or equities may serve as outright investments or portfolio hedges.
We use a variety of instruments to hedge interest rate risk in our portfolio, including non-derivative instruments such as U.S. Treasury securities and sovereign debt instruments, and derivative instruments such as interest rate swaps, TBAs, Eurodollar and U.S. Treasury futures, and options on the foregoing. The mix of instruments that we use to hedge interest rate risk may change materially from one period to the next.
We have also entered into foreign currency forward and futures contracts in order to hedge risks associated with foreign currency fluctuations.
We have entered into repos to finance many of our assets. As of December 31, 2019 indebtedness outstanding on our repos was approximately $2.4 billion. As of December 31, 2019, our assets financed with repos consisted of Agency RMBS of $1.9 billion and credit assets of $830.3 million. As of December 31, 2019, outstanding indebtedness under repos was $1.9 billion for Agency RMBS and $580.8 million for credit assets. As of December 31, 2018, indebtedness outstanding on our repos was approximately $1.5 billion. As of December 31, 2018, our assets financed with repos consisted of Agency RMBS of $972.7 million, credit assets of $815.1 million, and U.S. Treasury securities of $0.3 million. As of December 31, 2018 outstanding indebtedness under repos was $917.3 million for Agency RMBS, $581.3 million for credit assets, and $0.3 million for U.S. Treasury securities.
Our repos bear interest at rates that have historically moved in close relationship to LIBOR. We account for our repos as collateralized borrowings. In addition to our repos, as of December 31, 2019 we had Total other secured borrowings of $744.7 million, used to finance $843.4 million of non-QM loans and REO and consumer loans and ABS backed by consumer loans. This compares to Total other secured borrowings of $412.0 million as of December 31, 2018, used to finance $483.5 million of non-QM and consumer loans. In addition to our secured borrowings, we had $86.0 million of Senior Notes outstanding as of December 31, 2019 and $86.0 million of Old Senior Notes outstanding as of December 31, 2018.
As of December 31, 2019 and 2018 our debt-to-equity ratio was 3.8:1 and 3.4:1, respectively. Our recourse debt-to-equity ratio was 2.6:1 as of December 31, 2019 as compared to 2.7:1 as of December 31, 2018. See the discussion in "—Liquidity and Capital Resources" below for further information on our borrowings.
Equity
As of December 31, 2019, our equity increased by approximately $273.5 million to $868.7 million from $595.2 million as of January 1, 2019. This increase principally consisted of net proceeds from the issuance of common stock of $156.3 million, net proceeds from the issuance of preferred stock of $111.0 million, net income for the year ended December 31, 2019 of $63.2 million, and contributions from our non-controlling interests of approximately $27.7 million. These increases were partially offset by dividends of $61.3 million, distributions to non-controlling interests of approximately $23.1 million, and payments to repurchase shares of common stock of $0.8 million. Stockholders' equity, which excludes the non-controlling interests related to the minority interest in the Operating Partnership as well as the minority interests of our joint venture partners, was $829.3 million as of December 31, 2019.


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Results of Operations for the Years Ended December 31, 2019 and 2018
The following table summarizes our results of operations for the year ended December 31, 2019:
(In thousands except per share amounts)
 
Year Ended
December 31, 2019
Interest Income (Expense)
 
 
Interest income
 
$
159,901

Interest expense
 
(78,479
)
Net interest income
 
81,422

Other Income (Loss)
 
 
Realized and unrealized gains (losses) on securities and loans, net
 
41,693

Realized and unrealized gains (losses) on financial derivatives, net
 
(36,250
)
Realized and unrealized gains (losses) on real estate owned, net
 
1,048

Other, net
 
5,350

Total other income (loss)
 
11,841

Expenses
 
 
Base management fee to affiliate (Net of fee rebates of $1,967)
 
7,988

Incentive fee to affiliate
 
116

Other investment related expenses
 
17,777

Other operating expenses
 
12,856

Total expenses
 
38,737

Net Income (Loss) before Income Tax Expense (Benefit) and Earnings from Investments in Unconsolidated Entities
 
54,526

Income tax expense (benefit)
 
1,558

Earnings from investments in unconsolidated entities
 
10,209

Net Income (Loss)
 
63,177

Net income (loss) attributable to non-controlling interests
 
5,244

Dividends on preferred stock
 
1,466

Net Income (Loss) Attributable to Common Stockholders
 
$
56,467

Net Income (Loss) Per Common Share
 
$
1.76



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The following table summarizes our results of operations for the year ended December 31, 2018:
(In thousands except per share amounts)
 
Year Ended
December 31, 2018
Investment Income
 
 
Interest income
 
$
131,027

Other income
 
4,014

Total investment income
 
135,041

Expenses
 
 
Base management fee to affiliate (Net of fee rebates of $1,380)
 
7,573

Incentive fee to affiliate
 
715

Interest expense
 
56,707

Other investment related expenses
 
16,954

Other operating expenses
 
9,967

Total expenses
 
91,916

Net Investment Income
 
43,125

Net realized and change in net unrealized gain (loss) on investments
 
(526
)
Net realized and change in net unrealized gain (loss) on other secured borrowings
 
758

Net realized and change in net unrealized gain (loss) on financial derivatives, excluding currency hedges
 
4,454

Net realized and change in net unrealized gain (loss) on financial derivatives—currency hedges
 
5,040

Net foreign currency gain (loss)
 
(2,940
)
Net Increase (Decrease) in Equity Resulting from Operations
 
49,911

Less: Net Increase (Decrease) in Equity Resulting from Operations Attributable to Non-controlling Interests
 
3,235

Net Increase (Decrease) in Shareholders' Equity Resulting from Operations
 
$
46,676

Net Increase (Decrease) in Shareholders' Equity Resulting from Operations per share
 
$
1.52

Core Earnings
In connection with our conversion to a REIT (the "REIT Conversion"), we have included the calculation of Core Earnings. Prior to the REIT Conversion, we did not calculate Core Earnings. We calculate Core Earnings as U.S. GAAP net income (loss) as adjusted for: (i) realized and unrealized gain (loss) on securities and loans, REO, financial derivatives (excluding periodic settlements on interest rate swaps), other secured borrowings, at fair value, and foreign currency transactions; (ii) incentive fee to affiliate; (iii) Catch-up Premium Amortization Adjustment (as defined below); (iv) non-cash equity compensation expense; (v) miscellaneous non-recurring expenses; (vi) provision for income taxes; and (vii) certain other income or loss items that are of a non-recurring nature. For certain investments in unconsolidated entities, we include the relevant components of net operating income in Core Earnings. The Catch-up Premium Amortization Adjustment is a quarterly adjustment to premium amortization triggered by changes in actual and projected prepayments on our Agency RMBS (accompanied by a corresponding offsetting adjustment to realized and unrealized gains and losses). The adjustment is calculated as of the beginning of each quarter based on our then-current assumptions about cashflows and prepayments, and can vary significantly from quarter to quarter.
Core Earnings is a supplemental non-GAAP financial measure. We believe that the presentation of Core Earnings provides a consistent measure of operating performance by excluding the impact of gains and losses and other adjustments listed above from operating results. We believe that Core Earnings provides information useful to investors because it is a metric that we use to assess our performance and to evaluate the effective net yield provided by our portfolio. In addition, we believe that presenting Core Earnings enables our investors to measure, evaluate, and compare our operating performance to that of our peers. However, because Core Earnings is an incomplete measure of our financial results and differs from net income (loss) computed in accordance with U.S. GAAP, it should be considered as supplementary to, and not as a substitute for, net income (loss) computed in accordance with U.S. GAAP.


75


The following table reconciles, for the year ended December 31, 2019, Core Earnings to the line on the our Consolidated Statement of Operations entitled Net Income (Loss), which we believe is the most directly comparable U.S. GAAP measure.
(In thousands, except per share amounts)
 
Year Ended
December 31, 2019
Net income (loss)
 
$
63,177

Income tax expense (benefit)
 
1,558

Net income (loss) before income tax expense
 
64,735

Adjustments:
 
 
Realized (gains) losses on securities and loans, net
 
12,785

Realized (gains) losses on financial derivatives, net
 
30,912

Realized (gains) losses on real estate owned, net
 
(2,327
)
Unrealized (gains) losses on securities and loans, net
 
(54,478
)
Unrealized (gains) losses on financial derivatives, net
 
5,338

Unrealized (gains) losses on real estate owned, net
 
1,279

Other realized and unrealized (gains) losses, net(1)
 
829

Net realized gains (losses) on periodic settlements of interest rate swaps
 
1,695

Net unrealized gains (losses) on accrued periodic settlements of interest rate swaps
 
(764
)
Incentive fee to affiliate
 
116

Non-cash equity compensation expense
 
475

Negative (positive) component of interest income represented by Catch-up Premium Amortization Adjustment
 
4,660

Debt issuance costs related to Other secured borrowings, at fair value
 
3,536

Miscellaneous non-recurring expenses(2)
 
1,333

(Earnings) losses from investments in unconsolidated entities(3)
 
(5,561
)
Total Core Earnings
 
64,563

Dividends on preferred stock
 
1,466

Core Earnings attributable to non-controlling interests
 
4,883

Core Earnings Attributable to Common Stockholders
 
$
58,214

Core Earnings Attributable to Common Stockholders, per share
 
$
1.82

(1)
Includes realized and unrealized gains (losses) on foreign currency and unrealized gain (loss) on other secured borrowings, at fair value, included in Other, net, on the Consolidated Statement of Operations.
(2)
Miscellaneous non-recurring expenses consist mostly of professional fees related to the REIT Conversion.
(3)
Adjustment represents, for certain investments in unconsolidated entities, the net realized and unrealized gains and losses of the underlying investments of such entities.
Results of Operations for the Years Ended December 31, 2019 and 2018
Net Income (Loss) Attributable to Common Stockholders
For the year ended December 31, 2019 we had net income (loss) attributable to common stockholders of $56.5 million. We had interest income of $159.9 million, interest expense of $78.5 million, total other income (loss) of $11.8 million, earnings from investments in unconsolidated entities of $10.2 million, income tax expense of $1.6 million, total operating expenses of $38.7 million, net income attributable to non-controlling interests of $5.2 million, and dividends on preferred stock of $1.5 million.
Summary of Net Increase in Shareholders' Equity from Operations
For the year ended December 31, 2018 we had a net increase in shareholders' equity resulting from operations of $46.7 million. We had interest income of $131.0 million, other income of $4.0 million, net realized and unrealized gains of $6.8 million, and total expenses of $91.9 million, less net increase (decrease) in equity resulting from operations attributable to non-controlling interests of $3.2 million.


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Interest Income
Interest income was $159.9 million for the year ended December 31, 2019, as compared to $131.0 million for the year ended December 31, 2018. Interest income for both periods included coupon payments received and accrued on our holdings, the net accretion and amortization of purchase discounts and premiums on those holdings, and interest on our cash balances, including those balances held by our counterparties as collateral.
For the year ended December 31, 2019, interest income from our credit portfolio was $120.3 million, as compared to $91.6 million for the year ended December 31, 2018. This period-over-period increase was primarily due to the larger size of the credit portfolio for the year ended December 31, 2019, as well as higher average asset yields on this portfolio.
For the year ended December 31, 2019, interest income from our Agency RMBS was $37.4 million, as compared to $31.1 million for the year ended December 31, 2018. This year-over-year increase was primarily due to the larger size of the Agency portfolio for the year ended December 31, 2019, partially offset by lower average asset yields on this portfolio.
The following table details our interest income, average holdings of yield-bearing assets, and weighted average yield based on amortized cost for the years ended December 31, 2019 and 2018:
 
Credit(1)
 
Agency(1)
 
Total(1)
(In thousands)
Interest Income
 
Average Holdings
 
Yield
 
Interest Income
 
Average Holdings
 
Yield
 
Interest Income
 
Average Holdings
 
Yield
Year ended
December 31, 2019
$
120,342

 
$
1,415,358

 
8.50
%
 
$
37,372

 
$
1,331,654

 
2.81
%
 
$
157,714

 
$
2,747,012

 
5.74
%
Year ended
December 31, 2018
$
91,624

 
$
1,139,460

 
8.04
%
 
$
31,115

 
$
960,090

 
3.24
%
 
$
122,739

 
$
2,099,550

 
5.85
%
(1)
Amounts exclude interest income on cash and cash equivalents (including when posted as margin) and long positions in U.S. Treasury securities. Also excludes long holdings of corporate securities that represent components of certain relative value trading strategies.
Some of the variability in our interest income and portfolio yields is due to the Catch-up Premium Amortization Adjustment. For the year ended December 31, 2019, we had a negative Catch-up Premium Amortization Adjustment of approximately $(4.7) million, which decreased our interest income. Excluding the Catch-up Premium Amortization Adjustment, the weighted average yield of our Agency portfolio and our total portfolio was 3.16% and 5.91%, respectively, for the year ended December 31, 2019. By comparison, for the year ended December 31, 2018 the Catch-up Premium Amortization Adjustment decreased interest income by approximately $(0.1) million, which slightly decreased our interest income. Excluding the Catch-up Premium Amortization Adjustment, the weighted average yield of our Agency portfolio and our total portfolio was 3.26% and 5.85%, respectively for the year ended December 31, 2018.
Interest Expense
Interest expense primarily includes interest on funds borrowed under repos and Total other secured borrowings, interest on our Senior Notes, coupon interest on securities sold short, the related net accretion and amortization of purchase discounts and premiums on those short holdings, and interest on our counterparties' cash collateral held by us. Our total interest expense increased to $78.5 million for the year ended December 31, 2019, as compared to $56.7 million for the year ended December 31, 2018. The year-over-year increase was primarily due to (i) an increase in our total borrowings, in connection with the growth of our portfolio, (ii) higher average rates on our repo and Other secured borrowings, and (iii) a higher proportion of our credit-related borrowings consisting of borrowings used to finance loan assets, which typically have higher borrowing costs than securities.


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The table below summarizes the components of interest expense for the years ended December 31, 2019 and 2018.
 
 
For the Year Ended
(In thousands)
 
December 31, 2019
 
December 31, 2018
Repos and Total other secured borrowings
 
$
72,702

 
46,280

Senior Notes (1)
 
4,968

 
4,778

Securities sold short (2)
 
746

 
5,116

Other (3)
 
63

 
533

Total
 
$
78,479

 
56,707

(1)
Amount includes the related amortization of debt issuance costs. For the year ended December 31, 2019, amount includes interest expense on the Senior Notes and the Old Senior Notes. For the year ended December 31, 2018, amount includes interest expense on the Old Senior Notes.
(2)
Amount includes the related net accretion and amortization of purchase discounts and premiums.
(3)
Primarily includes interest expense on our counterparties' cash collateral held by us, and reverse repos with negative interest rates, which can occur when we borrow certain bonds that we have sold short.
The following table summarizes our aggregate secured borrowings, which, other than Other secured borrowings, at fair value, carry interest rates that are based on, or correlated with, LIBOR, including repos and Total other secured borrowings, for the years ended December 31, 2019 and 2018.
 
 
For the Year Ended
 
 
December 31, 2019
 
December 31, 2018
Collateral for Secured Borrowing
 
Average
Borrowings
 
Interest Expense
 
Average
Cost of
Funds
 
Average
Borrowings
 
Interest Expense
 
Average
Cost of
Funds
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Credit(1)
 
$
1,041,209

 
$
41,932

 
4.03
%
 
$
747,283

 
$
27,317

 
3.66
%
Agency RMBS
 
1,241,957

 
30,703

 
2.47
%
 
882,388

 
18,593

 
2.11
%
Subtotal(1)
 
2,283,166

 
72,635

 
3.18
%
 
1,629,671

 
45,910

 
2.82
%
U.S. Treasury Securities
 
2,771

 
67

 
2.40
%
 
18,349

 
370

 
2.02
%
Total
 
$
2,285,937

 
$
72,702

 
3.18
%
 
$
1,648,020

 
$
46,280

 
2.81
%
Average One-Month LIBOR
 
 
 
 
 
2.22
%
 
 
 
 
 
2.02
%
Average Six-Month LIBOR
 
 
 
 
 
2.32
%
 
 
 
 
 
2.49
%
(1)
Excludes U.S. Treasury Securities.
Among other instruments, we use interest rate swaps to hedge against the risk of rising interest rates. If we were to include as a component of our cost of funds the amortization of upfront payments and the actual and accrued periodic payments on our interest rate swaps used to hedge our assets, our total average cost of funds would decrease to 3.11% for the year ended December 31, 2019 and to 2.73% for the year ended December 31, 2018. Excluding the Catch-up Premium Amortization Adjustment, our net interest margin, defined as the yield on our portfolio of yield-bearing targeted assets less our cost of funds (including amortization of upfront payments and actual and accrued periodic payments on interest rate swaps as described above), was 2.80% and 3.12% for the years ended December 31, 2019 and 2018, respectively. These metrics do not include costs associated with other instruments that we use to hedge interest rate risk, such as TBAs and futures.
Base Management Fees
For the year ended December 31, 2019, the gross base management fee, which is based on total equity at the end of each quarter, was $10.0 million, and our Manager credited us with rebates on our base management fee of $2.0 million, resulting in a net base management fee of $8.0 million. For the year ended December 31, 2018, the gross base management fee was $9.0 million, and our Manager credited us with rebates on our base management fee of $1.4 million, resulting in a net base management fee of $7.6 million. For each period, the base management fee rebates related to those of our CLO investments for which Ellington or one of its affiliates earned CLO management fees. The year-over-year increase in the net base management fee was primarily due to our larger capital base in the second half of 2019 partially offset by the year-over-year increase in the fee rebate from our Manager.
Incentive Fees
In addition to the base management fee, our Manager is also entitled to a quarterly incentive fee if our performance (as measured by adjusted net income, as defined in the management agreement) over the relevant rolling four quarter calculation


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period exceeds a defined return hurdle for the period. Incentive fee incurred for the years ended December 31, 2019 and 2018 was $0.1 million and $0.7 million, respectively. Because our operating results can vary materially from one period to another, incentive fee expense can be highly variable.
Other Investment Related Expenses
Other investment related expenses consist of servicing fees on our mortgage and consumer loans, as well as various other expenses and fees directly related to our financial assets and certain financial liabilities carried at fair value. For the years ended December 31, 2019 and 2018 other investment related expenses were $17.8 million and $17.0 million, respectively. The increase in other investment related expenses was primarily due to an increase in debt issuance costs related to Other secured borrowings, at fair value, given that we completed two non-QM securitizations during 2019 as compared to just one in 2018, and to a lesser extent, an increase in servicing expenses on our larger loan portfolios. These increases were partially offset by a decrease in dividend expense on common stock sold short.
Other Operating Expenses
Other operating expenses consist of professional fees, compensation expense related to our dedicated or partially dedicated personnel, and various other operating expenses necessary to run our business. Other operating expenses exclude management and incentive fees, interest expense, and other investment related expenses. Other operating expenses were $12.9 million for the year ended December 31, 2019 as compared to $10.0 million for the year ended December 31, 2018. The increase in other operating expenses for the year ended December 31, 2019 was primarily due to an increase in professional fees related to our REIT Conversion and an increase in compensation expense.
Other Income (Loss)
Other income (loss) consists of net realized and unrealized gains (losses) on securities and loans, financial derivatives, and real estate owned. Other, net, another component of Other income (loss), includes rental income and income related to loan origination, as well as realized gains (losses) on foreign currency transactions and unrealized gains (losses) on foreign currency remeasurement and Other Secured Borrowings, at fair value. For the year ended December 31, 2019, other income was $11.8 million, consisting primarily of net realized and unrealized gains of $41.7 million on our securities and loans, gains included in Other, net of $5.4 million, and net realized and unrealized gains of $1.0 million on our real estate owned, partially offset by net realized and unrealized losses of $(36.3) million on our financial derivatives. Net realized and unrealized gains of $41.7 million on our securities and loans primarily resulted from net realized and unrealized gains on Agency RMBS, residential mortgage loans, and non-Agency RMBS and CMBS, partially offset by net realized and unrealized losses on CLOs, consumer loans, and corporate debt and equity. Net realized and unrealized losses of $(36.3) million on our financial derivatives was primarily related to net realized and unrealized losses on interest rate swaps, TBAs, futures, CDS on corporate bond indices, and CDS on asset-backed indices, partially offset by net realized and unrealized gains on forwards.
Net Realized and Unrealized Gains (Losses) on Investments
During the year ended December 31, 2018, we had net realized and unrealized losses on investments of $(0.5) million. Included in these investments are short positions in TBAs, U.S. Treasury securities, and sovereign securities, used primarily to hedge interest rate and/or prepayment risk with respect to our other investment holdings.
Net realized and unrealized losses on investments of $(0.5) million for the year ended December 31, 2018 resulted principally from net realized and unrealized losses on Agency RMBS, U.S. CLOs, and European RMBS, partially offset by net realized and unrealized gains on TBAs, CMBS, listed and non-listed equity investments, and European non-performing loans.
Net Realized and Unrealized Gains and (Losses) on Financial Derivatives
During the year ended December 31, 2018, we had net realized and unrealized gains on our financial derivatives of $9.5 million. Our financial derivatives consisted of interest rate derivatives, used primarily to hedge interest rate risk, and of credit derivatives and total return swaps, both used primarily to hedge credit risk, but also for non-hedging purposes. Our derivatives also included foreign currency forwards and futures, used to hedge foreign currency risk. Our interest rate derivatives were primarily in the form of net short positions in interest rate swaps, Eurodollar futures, and U.S. Treasury Note futures.
Net realized and unrealized gains of $9.5 million on our financial derivatives for the year ended December 31, 2018 resulted primarily from net gains on our total return swaps, interest rate swaps, and CDS on corporate bond indices, partially offset by net realized and unrealized losses on credit default swaps on asset-backed indices. Net realized and unrealized gains on our foreign currency hedges more than offset the net foreign exchange transaction and translation losses. Translation and transaction net losses were incurred in connection with our non-dollar denominated European assets.


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Liquidity and Capital Resources
Liquidity refers to our ability to meet our cash needs, including repaying our borrowings, funding and maintaining positions in our targeted assets, making distributions in the form of dividends, and other general business needs. Our short-term (one year or less) and long-term liquidity requirements include acquisition costs for assets we acquire, payment of our base management fee and incentive fee, compliance with margin requirements under our repos, reverse repos, and financial derivative contracts, repayment of repo borrowings and other secured borrowings to the extent we are unable or unwilling to extend such borrowings, payment of our general operating expenses, payment of interest payments on our Senior Notes, and payment of our dividends. Our capital resources primarily include cash on hand, cash flow from our investments (including principal and interest payments received on our investments and proceeds from the sale of investments), borrowings under repos and other secured borrowings, and proceeds from equity and debt offerings. We expect that these sources of funds will be sufficient to meet our short-term and long-term liquidity needs.
The following summarizes our borrowings under repos by remaining maturity:
(In thousands)
 
December 31, 2019
Remaining Days to Maturity
 
Outstanding Borrowings
 
% of Total
30 Days or Less
 
$
528,545

 
21.6
%
31 - 60 Days
 
848,878

 
34.7
%
61 - 90 Days
 
733,575

 
30.0
%
91 - 120 Days
 
10,270

 
0.4
%
121 - 150 Days
 
7,460

 
0.3
%
151 - 180 Days
 
34,580

 
1.4
%
181 - 360 Days
 
186,661

 
7.7
%
> 360 Days
 
95,331

 
3.9
%
 
 
$
2,445,300

 
100.0
%
Repos involving underlying investments that we sold prior to December 31, 2019, for settlement following December 31, 2019, are shown using their original maturity dates even though such repos may be expected to be terminated early upon settlement of the sale of the underlying investment. 
The amounts borrowed under our repo agreements are generally subject to the application of "haircuts." A haircut is the percentage discount that a repo lender applies to the market value of an asset serving as collateral for a repo borrowing, for the purpose of determining whether such repo borrowing is adequately collateralized. As of December 31, 2019, the weighted average contractual haircut applicable to the assets that serve as collateral for our outstanding repo borrowings (excluding repo borrowings related to U.S. Treasury securities) was 29.3% with respect to credit assets, 5.0% with respect to Agency RMBS assets, and 12.3% overall. As of December 31, 2018 these respective weighted average contractual haircuts were 28.5%, 5.4%, and 15.9%.
We expect to continue to borrow funds in the form of repos as well as other similar types of financings. The terms of our repo borrowings are predominantly governed by master repurchase agreements, which generally conform to the terms in the standard master repurchase agreement as published by the Securities Industry and Financial Markets Association as to repayment and margin requirements. In addition, each lender may require that we include supplemental terms and conditions to the standard master repurchase agreement. Typical supplemental terms and conditions include the addition of or changes to provisions relating to margin calls, net asset value requirements, cross default provisions, certain key person events, changes in corporate structure, and requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction. These provisions may differ for each of our repo lenders.
As of December 31, 2019, we had $2.4 billion of borrowings outstanding under our repos. As of December 31, 2019, the remaining terms on our repos ranged from 2 days to 882 days, with a weighted average remaining term of 91 days. Our repo borrowings were with a total of 28 counterparties as of December 31, 2019. As of December 31, 2019, our repos had a weighted average borrowing rate of 2.37%. As of December 31, 2019, our repos had interest rates ranging from 0.15% to 5.20%. Investments transferred as collateral under repos had an aggregate fair value of $2.8 billion as of December 31, 2019.
As of December 31, 2018, we had $1.5 billion of borrowings outstanding under our repos. As of December 31, 2018, the remaining terms on our repos ranged from 2 days to 871 days, with a weighted average remaining term of 121 days. Our repo borrowings were with a total of 23 counterparties as of December 31, 2018. As of December 31, 2018, our repos, excluding


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those on U.S. Treasury securities, had a weighted average borrowing rate of 3.13%. As of December 31, 2018, our repos had interest rates ranging from 0.23% to 6.07%. Investments transferred as collateral under repos had an aggregate fair value of $1.8 billion as of December 31, 2018.
The interest rates of our repos have historically moved in close relationship to short-term LIBOR rates, and in some cases are explicitly indexed to short-term LIBOR rates and reset accordingly. It is expected that amounts due upon maturity of our repos will be funded primarily through the roll/re-initiation of repos and, if we are unable or unwilling to roll/re-initiate our repos, through free cash and proceeds from the sale of securities.
The following table details total outstanding borrowings, average outstanding borrowings, and the maximum outstanding borrowings at any month end for each quarter under repos for the past twelve quarters:
Quarter Ended
 
Borrowings Outstanding at
Quarter End
 
Average
Borrowings Outstanding
 
Maximum Borrowings Outstanding at Any Month End
 
 
(In thousands)
December 31, 2019(1)
 
$
2,445,300

 
$
2,119,394

 
$
2,445,300

September 30, 2019
 
2,056,422

 
1,796,310

 
2,056,422

June 30, 2019
 
1,715,506

 
1,769,909

 
1,962,866

March 31, 2019
 
1,550,016

 
1,471,592

 
1,550,016

December 31, 2018
 
1,498,849

 
1,509,819

 
1,595,118

September 30, 2018
 
1,636,039

 
1,534,490

 
1,672,077

June 30, 2018
 
1,421,506

 
1,398,813

 
1,471,052

March 31, 2018
 
1,330,943

 
1,269,297

 
1,330,943

December 31, 2017(2)
 
1,209,315

 
1,050,018

 
1,209,315

September 30, 2017
 
1,029,810

 
1,078,165

 
1,133,586

June 30, 2017
 
1,119,238

 
1,121,884

 
1,213,525

March 31, 2017
 
1,086,271

 
1,083,251

 
1,157,648

(1)
At the end of 2019 we increased the size of both our Credit and Agency portfolios which we subsequently financed through repos.
(2)
At the end of 2017 we increased the size of our Credit portfolio by purchasing certain more liquid, lower-risk securities which we subsequently financed through repos.
In addition to our borrowings under repos, we have entered into various other types of transactions to finance certain of our non-QM loans and REO and consumer loans and ABS backed by consumer loans; these transactions are accounted for as collateralized borrowings. As of December 31, 2019 we had outstanding borrowings related to such transactions in the amount of $744.7 million, which is reflected under the captions "Other secured borrowings" and "Other secured borrowings, at fair value" on the Consolidated Balance Sheet. As of December 31, 2019, the fair value of non-QM loans and REO and consumer loans and ABS backed by consumer loans collateralizing our Total other secured borrowings was $843.4 million. As of December 31, 2018 we had outstanding borrowings related to such transactions in the amount of $412.0 million, which is reflected under the captions "Other secured borrowings" and "Other secured borrowings, at fair value" on the Consolidated Statement of Assets, Liabilities, and Equity. As of December 31, 2018, the fair value of non-QM and consumer loans collateralizing our Total other secured borrowings was $483.5 million. See Note 11 in the notes to our consolidated financial statements as of December 31, 2019 and Note 7 in the notes to our consolidated financial statements as of December 31, 2018 for further information on our other secured borrowings.
As of December 31, 2019, we had $86.0 million outstanding of Senior Notes, maturing in September 2022 and bearing interest at a rate of 5.50%, subject to adjustment based on changes, if any, in the ratings of the Senior Notes. These Senior Notes were issued on February 13, 2019 in connection with the Note Exchange. As of December 31, 2018, we had $86.0 million outstanding of Old Senior Notes, which had an interest rate of 5.25%. See Note 11 in the notes to our consolidated financial statements as of December 31, 2019 and Note 7 in the notes to our consolidated financial statements as of December 31, 2018 for further detail on the Senior Notes and the Old Senior Notes.
As of December 31, 2019, we had an aggregate amount at risk under our repos with 28 counterparties of approximately $348.4 million, and as of December 31, 2018, we had an aggregate amount at risk under our repos with 23 counterparties of approximately $306.4 million. Amounts at risk represent the excess, if any, for each counterparty of the fair value of collateral held by such counterparty over the amounts outstanding under repos. If the amounts outstanding under repos with a particular counterparty are greater than the collateral held by the counterparty, there is no amount at risk for the particular counterparty.


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Amount at risk as of December 31, 2019 and December 31, 2018 does not include approximately $5.1 million and $2.6 million, respectively, of net accrued interest receivable, which is defined as accrued interest on securities held as collateral less interest payable on cash borrowed.
Our derivatives are predominantly subject to bilateral collateral arrangements or clearing in accordance with the Dodd-Frank Act. We may be required to deliver or receive cash or securities as collateral upon entering into derivative transactions. Changes in the relative value of derivative transactions may require us or the counterparty to post or receive additional collateral. Entering into derivative contracts involves market risk in excess of amounts recorded on our balance sheet. In the case of cleared derivatives, the clearinghouse becomes our counterparty and the future commission merchant acts as an intermediary between us and the clearinghouse with respect to all facets of the related transaction, including the posting and receipt of required collateral.
As of December 31, 2019, we had an aggregate amount at risk under our derivative contracts, excluding TBAs, with 10 counterparties of approximately $26.4 million. We also had $14.2 million of initial margin for cleared over-the-counter, or "OTC," derivatives posted to central clearinghouses as of that date. As of December 31, 2018, we had an aggregate amount at risk under our derivatives contracts, excluding TBAs, with 12 counterparties of approximately $25.2 million. We also had $8.3 million of initial margin for cleared OTC derivatives posted to central clearinghouses as of that date. Amounts at risk under our derivatives contracts represent the excess, if any, for each counterparty of the fair value of our derivative contracts plus our collateral held directly by the counterparty less the counterparty's collateral held by us. If a particular counterparty's collateral held by us is greater than the aggregate fair value of the financial derivatives plus our collateral held directly by the counterparty, there is no amount at risk for the particular counterparty.
We purchase and sell TBAs and Agency pass-through certificates on a when-issued or delayed delivery basis. The delayed delivery for these securities means that these transactions are more prone to market fluctuations between the trade date and the ultimate settlement date, and therefore are more vulnerable, especially in the absence of margining arrangements with respect to these transactions, to increasing amounts at risk with the applicable counterparties. As of December 31, 2019, in connection with our forward settling TBA and Agency pass-through certificates, we had an aggregate amount at risk with nine counterparties of approximately $4.2 million. As of December 31, 2018, in connection with our forward settling TBA and Agency pass-through certificates, we had an aggregate amount at risk with five counterparties of approximately $1.7 million. Amounts at risk in connection with our forward settling TBA and Agency pass-through certificates represent the excess, if any, for each counterparty of the net fair value of the forward settling transactions plus our collateral held directly by the counterparty less the counterparty's collateral held by us. If a particular counterparty's collateral held by us is greater than the aggregate fair value of the forward settling transactions plus our collateral held directly by the counterparty, there is no amount at risk for the particular counterparty.
We held cash and cash equivalents of approximately $72.3 million and $44.7 million as of December 31, 2019 and 2018, respectively.
On June 13, 2018, our Board of Directors approved the adoption of a share repurchase program under which we are authorized to repurchase up to 1.55 million shares of common stock. The program, which is open-ended in duration, allows us to make repurchases from time to time on the open market or in negotiated transactions, including under 10b5-1 plans. Repurchases are at our discretion, subject to applicable law, share availability, price and our financial performance, among other considerations. In addition to making discretionary repurchases, we from time to time use 10b5-1 plans to increase the number of trading days available to implement these repurchases.
During the year ended December 31, 2019, we repurchased 50,825 shares at an average price per share of $15.39 and a total cost of $0.8 million. From inception of the current repurchase plan through March 6, 2020, we repurchased 411,915 shares at an average price per share of $15.34 and a total cost of $6.3 million, and have authorization to repurchase an additional 1,138,085 common shares.
On April 3, 2019, we commenced an "at-the-market" offering program, or "ATM program," by entering into equity distribution agreements with third party sales agents under which we are authorized to offer and sell shares of common stock from time to time with a maximum aggregate gross offering price of up to $150 million. Through January 21, 2020 we did not issue any shares of common stock under the ATM program. Effective January 21, 2020, we terminated the ATM program.
On July 22, 2019, we completed a follow-on offering of 3,500,000 shares of our common stock, which generated net proceeds, after underwriters' discount and offering costs, of $60.7 million. On July 25, 2019, we issued an additional 525,000 shares of our common stock in connection with the exercise of the underwriters' option granted in the initial offering. The exercise of the underwriters' option resulted in net proceeds to us of an additional $9.1 million, after underwriters' discount and offering costs.


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On October 22, 2019, we issued 4,600,000 shares of 6.750% Series A Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, $0.001 par value per share ("Series A Preferred Stock"), of which 600,000 shares were issued pursuant to the exercise of the underwriters' over-allotment option. Holders of the Series A Preferred Stock will be entitled to receive cumulative cash dividends (i) from and including the original issue date to, but excluding, October 30, 2024, at a fixed rate equal to 6.750% per annum of the $25.00 per share liquidation preference and (ii) from and including October 30, 2024, at a floating rate equal to three-month LIBOR plus a spread of 5.196% per annum of the $25.00 per share liquidation preference. The Series A Preferred Stock is not redeemable by us prior to October 30, 2024, except under circumstances where it is necessary to allow us to qualify and maintain our qualification as a REIT for U.S. federal income tax purposes and except in certain instances upon the occurrence of a change of control. The issuance and sale of the 4,600,000 shares of Series A Preferred Stock resulted in total net proceeds to us of approximately $111.0 million, after underwriters' discount and offering costs.
On November 21, 2019, we completed a follow-on offering of 4,200,000 shares of our common stock, which generated net proceeds, after underwriters' discount and offering costs, of $75.3 million. On December 3, 2019, we issued an additional 630,000 shares of our common stock in connection with the exercise of the underwriters' option granted in the initial offering. The exercise of the underwriters' option resulted in net proceeds to us of an additional $11.2 million, after underwriters' discount and offering costs.
On January 24, 2020, we completed a follow-on offering of 5,290,000 shares of our common stock, of which 690,000 shares were issued pursuant to the exercise of the underwriters' option. The issuance and sale of 5,290,000 common shares generated net proceeds, after underwriters' discount and offering costs, of $95.3 million.
We may declare dividends based on, among other things, our earnings, our financial condition, the REIT qualification requirements of the Internal Revenue Code of 1986, as amended, our working capital needs and new opportunities. The declaration of dividends to our stockholders and the amount of such dividends are at the discretion of our Board of Directors.
The following table sets forth the dividend distributions authorized by the Board of Directors payable to common shareholders and holders of Convertible Non-controlling Interest Units (as defined in Note 2 of the notes to consolidated financial statements as of December 31, 2019) for the periods indicated below:
Year Ended December 31, 2019
Declaration Date
 
Dividend Per Share
 
Dividend Amount
 
Record Date
 
Payment Date
 
 
 
 
(In thousands)
 
 
 
 
February 14, 2019
 
$
0.41

 
$
12,496

 
March 1, 2019
 
March 15, 2019
March 11, 2019
 
0.14

 
4,267

 
March 29, 2019
 
April 25, 2019
April 5, 2019
 
0.14

 
4,267

 
April 30, 2019
 
May 28, 2019
May 7, 2019
 
0.14

 
4,267

 
May 31, 2109
 
June 25, 2019
June 7, 2019
 
0.14

 
4,267

 
June 28, 2019
 
July 25, 2019
July 8, 2019
 
0.14

 
4,831

 
July 31, 2019
 
August 26, 2019
August 7, 2019
 
0.14

 
4,831

 
August 30, 2019
 
September 25, 2019
September 9, 2019
 
0.14

 
4,833

 
September 30, 2019
 
October 25, 2019
October 7, 2019
 
0.14

 
4,833

 
October 31, 2019
 
November 25, 2019
November 7, 2019
 
0.14

 
5,421

 
November 29, 2019
 
December 26, 2019
December 6, 2019
 
0.14

 
5,512

 
December 31, 2019
 
January 27, 2020
Year Ended December 31, 2018
Declaration Date
 
Dividend Per Share
 
Dividend Amount
 
Record Date
 
Payment Date
 
 
 
 
(In thousands)
 
 
 
 
February 6, 2018
 
$
0.41

 
$
12,850

 
March 1, 2018
 
March 15, 2018
May 2, 2018
 
0.41

 
12,650

 
June 1, 2018
 
June 15, 2018
August 1, 2018
 
0.41

 
12,651

 
August 31, 2018
 
September 17, 2018
October 31, 2018
 
0.41

 
12,584

 
November 30, 2018
 
December 17, 2018


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On January 8, 2020, our Board of Directors declared a dividend in the amount of $0.15 per common share payable on February 25, 2020 to stockholders of record as of January 31, 2020; on February 7, 2020, our Board of Directors declared a dividend in the amount of $0.15 per common share payable on March 25, 2020 to stockholders of record as of February 28, 2020; and on March 6, 2020, our Board of Directors declared a dividend in the amount of $0.15 per common share payable on April 27, 2020 to stockholders of record as of March 31, 2020.
On December 13, 2019, our Board of Directors declared a dividend in the amount of $0.45938 per preferred share payable on January 30, 2020 to stockholder of record as of December 31, 2019.
For the year ended December 31, 2019, our operating activities provided net cash in the amount of $79.2 million and our investing activities used net cash in the amount of $1.665 billion. Our repo activity used to finance many of our investments (including repayments of amounts borrowed under our repos) provided net cash of $1.171 billion. We received $348.3 million in proceeds from the issuance of Total other secured borrowings and we used $124.0 million for principal payments on Total other secured borrowings. Thus our operating and investing activities, when combined with our repo financings and Other secured borrowings (net of repayments), used net cash of $189.5 million for the year ended December 31, 2019. We received proceeds from the issuance of common and preferred stock, net of offering costs paid, of $267.4 million and contributions from non-controlling interests provided cash of $27.7 million. We used $54.3 million to pay dividends, $23.1 million for distributions to non-controlling interests (our joint venture partners), and $0.8 million to repurchase common stock. As a result there was an increase in our cash holdings of $27.4 million, from $45.1 million as of December 31, 2018 to $72.5 million as of December 31, 2019.
For the year ended December 31, 2018, our operating activities used net cash in the amount of $494.2 million, and our reverse repo activity used to finance many of our investments (including repayments of amounts borrowed under our reverse repo agreements) provided net cash of $409.7 million. We received $201.9 million in proceeds from the issuance of Total other secured borrowings, net of certain expenses related to these issuances, and we used $43.8 million for principal payments on Other secured borrowings. Thus our operating activities, when combined with our reverse repo financings, Total other secured borrowings (net of repayments and certain expenses related to the issuance of debt), provided net cash of $73.6 million for the year ended December 31, 2018. In addition, contributions from non-controlling interests provided cash of $21.5 million. We used $50.7 million to pay dividends, $23.9 million for distributions to non-controlling interests (our joint venture partners), and $23.1 million to repurchase common shares. As a result there was a decrease in our cash holdings of $2.6 million, from $47.7 million as of December 31, 2017 to $45.1 million as of December 31, 2018.
Based on our current portfolio, amount of free cash on hand, debt-to-equity ratio, and current and anticipated availability of credit, we believe that our capital resources will be sufficient to enable us to meet anticipated short-term and long-term liquidity requirements. However, the unexpected inability to finance our Agency RMBS portfolio would create a serious short-term strain on our liquidity and would require us to liquidate much of that portfolio, which in turn would require us to restructure our portfolio to maintain our exclusion from registration as an investment company under the Investment Company Act and to qualify and maintain our qualification as a REIT. Steep declines in the values of our credit assets financed using repos, or in the values of our derivative contracts, would result in margin calls that would significantly reduce our free cash position. Furthermore, a substantial increase in prepayment rates on our assets financed by repos could cause a temporary liquidity shortfall, because we are generally required to post margin on such assets in proportion to the amount of the announced principal paydowns before the actual receipt of the cash from such principal paydowns. If our cash resources are at any time insufficient to satisfy our liquidity requirements, we may have to sell assets or issue additional debt or equity securities.
Although we may from time to time enter into financing arrangements that limit our leverage, our investment guidelines do not limit the amount of leverage that we may use, and we believe that the appropriate leverage for the particular assets we hold depends on the credit quality and risk of those assets, as well as the general availability and terms of stable and reliable financing for those assets.
Contractual Obligations and Commitments
We are a party to a management agreement with our Manager. Pursuant to that agreement, our Manager is entitled to receive a base management fee, an incentive fee, reimbursement of certain expenses and, in certain circumstances, a termination fee. Such fees and expenses do not have fixed and determinable payments. For a description of the management agreement provisions, see Note 13 of the notes to our consolidated financial statements as of December 31, 2019.
We have numerous contractual obligations and commitments related to our outstanding borrowings (see Note 11 of the notes to our consolidated financial statements as of December 31, 2019) and related to our financial derivatives (see Note 8 of the notes to our consolidated financial statements as of December 31, 2019).


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See Note 21 of the notes to our consolidated financial statements as of December 31, 2019 for further detail on our other contractual obligations and commitments.
Off-Balance Sheet Arrangements
As of December 31, 2019, we did not have any material relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment to provide funding to any such entities that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or resources that would be material to an investor in our securities. As such, we are not materially exposed to any market, credit, liquidity, or financing risk that could arise if we had engaged in such relationships. See Note 6 and Note 10 of the notes to our consolidated financial statements as of December 31, 2019 for further detail about a multi-seller consumer loan securitization transaction we entered into in August 2016.
At December 31, 2019 we have not entered into any repurchase agreements for which delivery of the borrowed funds is not scheduled until after period end.
Inflation
Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The primary components of our market risk at December 31, 2019 are related to credit risk, prepayment risk, and interest rate risk. We seek to actively manage these and other risks and to acquire and hold assets that we believe justify bearing those risks, and to maintain capital levels consistent with those risks.
Credit Risk
We are subject to credit risk in connection with many of our assets, especially non-Agency RMBS, CMBS, residential and commercial mortgage loans, corporate debt investments including CLOs and investments in securitization warehouses, and consumer loans.
Credit losses on real estate loans can occur for many reasons, including, but not limited to, poor origination practices, fraud, faulty appraisals, documentation errors, poor underwriting, legal errors, poor servicing practices, weak economic conditions, decline in the value of homes, businesses or commercial properties, special hazards, earthquakes and other natural events, over-leveraging of the borrower on a property, reduction in market rents and occupancies and poor property management services, changes in legal protections for lenders, reduction in personal income, job loss, and personal events such as divorce or health problems. Property values are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional, and local economic conditions (which may be adversely affected by industry slowdowns and other factors), local real estate conditions (such as an oversupply of housing), changes or continued weakness in specific industry segments, construction quality, age and design, demographic factors, and retroactive changes to building or similar codes.
The ability of borrowers to repay consumer loans may be adversely affected by numerous borrower-specific factors, including unemployment, divorce, major medical expenses or personal bankruptcy. General factors, including an economic downturn, high energy costs or acts of God or terrorism, pandemics such as novel coronavirus (COVID-19), may also affect the financial stability of borrowers and impair their ability or willingness to repay their loans. Whenever any of our consumer loans defaults, we are at risk of loss to the extent of any deficiency between the liquidation value of the collateral, if any, securing the loan, and the principal and accrued interest of the loan. Many of our consumer loans are unsecured, or are secured by collateral (such as an automobile) that depreciates rapidly; as a result, these loans may be at greater risk of loss than residential real estate loans.
Our corporate investments, especially our lower-rated or unrated CLO investments, corporate equity, and our investments in loan originators, have significant risk of loss, and our efforts to protect these investments may involve substantial costs and may not be successful. We also will be subject to significant uncertainty as to when and in what manner and for what value the corporate debt in which we directly or indirectly invest will eventually be satisfied (e.g., through liquidation of the obligor's


85


assets, an exchange offer or plan of reorganization involving the debt securities or a payment of some amount in satisfaction of the obligation). In addition, these investments could involve loans to companies that are more likely to experience bankruptcy or similar financial distress, such as companies that are thinly capitalized, employ a high degree of financial leverage, are in highly competitive or risky businesses, are in a start-up phase, or are experiencing losses.
Similarly, we are exposed to the risk of potential credit losses on the other assets in our credit portfolio.
For many of our investments, the two primary components of credit risk are default risk and severity risk.
Default Risk
Default risk is the risk that a borrower fails to make scheduled principal and interest payments on a mortgage loan or other debt obligation. We may attempt to mitigate our default risk by, among other things, opportunistically entering into credit default swaps and total return swaps. These instruments can reference various MBS indices, corporate bond indices, or corporate entities. We often rely on third-party servicers to mitigate our default risk, but such third-party servicers may have little or no economic incentive to mitigate loan default rates.
Severity Risk
Severity risk is the risk of loss upon a borrower default on a mortgage loan or other secured or unsecured debt obligation. Severity risk includes the risk of loss of value of the property or other asset, if any, securing the mortgage loan or debt obligation, as well as the risk of loss associated with taking over the property or other asset, if any, including foreclosure costs. We often rely on third-party servicers to mitigate our severity risk, but such third-party servicers may have little or no economic incentive to mitigate loan loss severities. In the case of mortgage loans, such mitigation efforts may include loan modification programs and prompt foreclosure and property liquidation following a default. Many of our consumer loans are unsecured, or are secured by collateral (such as an automobile) that depreciates rapidly; as a result, these loans may be at greater risk of loss than residential real estate loans. Pursuing any remaining deficiency following a default on a consumer loan is often difficult or impractical, especially when the borrower has a low credit score, making further substantial collection efforts unwarranted. In addition, repossessing personal property securing a consumer loan can present additional challenges, including locating and taking physical possession of the collateral. We rely on servicers who service these consumer loans, to, among other things, collect principal and interest payments on the loans and perform loss mitigation services, and these servicers may not perform in a manner that promotes our interests. In the case of corporate debt, if a company declares bankruptcy, the bankruptcy process has a number of significant inherent risks. Many events in a bankruptcy proceeding are the product of contested matters and adversarial proceedings and are beyond the control of the creditors. A bankruptcy filing by a company whose debt we have purchased may adversely and permanently affect such company. If the proceeding results in liquidation, the liquidation value of the company may have deteriorated significantly from what we believed to be the case at the time of our initial investment. The duration of a bankruptcy proceeding is also difficult to predict, and our return on investment can be adversely affected by delays until a plan of reorganization or liquidation ultimately becomes effective. A bankruptcy court may also re-characterize our debt investment as equity, and subordinate all or a portion of our claim to that of other creditors. This could occur even if our investment had initially been structured as senior debt.
Prepayment Risk
Prepayment risk is the risk of change, whether an increase or a decrease, in the rate at which principal is returned in respect of fixed-income assets in our portfolio, including both through voluntary prepayments and through liquidations due to defaults and foreclosures. Most significantly, our portfolio is exposed to the risk of changes in prepayment rates of mortgage loans, including the mortgage loans underlying our RMBS, and changes in prepayment rates of certain of our consumer loan holdings. This rate of prepayment is affected by a variety of factors, including the prevailing level of interest rates as well as economic, demographic, tax, social, legal, and other factors. Changes in prepayment rates will have varying effects on the different types of securities in our portfolio, and we attempt to take these effects into account in making asset management decisions. Additionally, increases in prepayment rates may cause us to experience losses on our interest only securities and inverse interest only securities, as those securities are extremely sensitive to prepayment rates. Prepayment rates, besides being subject to interest rates and borrower behavior, are also substantially affected by government policy and regulation. For example, the government sponsored HARP program, which was designed to encourage mortgage refinancings, was a steady contributor to Agency RMBS prepayment speeds from its inception in 2009 until its expiration at the end of 2018. Mortgage rates declined significantly during 2019 and remain very low by historical standards, and as a result, prepayments continue to represent a meaningful risk, especially with respect to our Agency RMBS.
Interest Rate Risk
Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors beyond our control. We are subject to interest rate risk in


86


connection with most of our assets and liabilities. For some securities in our portfolio, the coupon interest rates on, and therefore also the values of, such securities are highly sensitive to interest rate movements, such as inverse floating rate RMBS, which benefit from falling interest rates. Our repurchase agreements generally carry interest rates that are determined by reference to LIBOR or similar short-term benchmark rates for those same periods. Whenever one of our fixed-rate repo borrowings matures, it will generally be replaced with a new fixed-rate repo borrowing based on market interest rates prevailing at such time. Subject to qualifying and maintaining our qualification as a REIT and our exclusion from registration under the Investment Company Act, we opportunistically hedge our interest rate risk by entering into interest rate swaps, TBAs, U.S. Treasury securities, Eurodollar futures, U.S. Treasury futures, and other instruments. In general, such hedging instruments are used to mitigate the interest rate risk arising from the mismatch between the duration of our financed assets and the duration of the liabilities used to finance such assets. The majority of this mismatch currently relates to our Agency RMBS.
The following sensitivity analysis table shows the estimated impact on the value of our portfolio segregated by certain identified categories as of December 31, 2019, assuming a static portfolio and immediate and parallel shifts in interest rates from current levels as indicated below.
(In thousands)
 
Estimated Change for a Decrease in Interest Rates by
 
Estimated Change for an Increase in Interest Rates by
 
 
50 Basis Points
 
100 Basis Points
 
50 Basis Points
 
100 Basis Points
Category of Instruments
 
Market Value
 
% of Total Equity
 
Market Value
 
% of Total Equity
 
Market Value
 
% of Total Equity
 
Market Value
 
% of Total Equity
Agency RMBS
 
$
10,591

 
1.22
 %
 
$
18,486

 
2.13
 %
 
$
(13,287
)
 
(1.53
)%
 
$
(29,271
)
 
(3.37
)%
Non-Agency RMBS, CMBS, ABS and Loans
 
8,131

 
0.94
 %
 
16,685

 
1.92
 %
 
(7,709
)
 
(0.89
)%
 
(14,995
)
 
(1.73
)%
U.S. Treasury Securities, and Interest Rate Swaps, Options, and Futures
 
(13,597
)
 
(1.57
)%
 
(27,786
)
 
(3.2
)%
 
13,006

 
1.50
 %
 
25,422

 
2.93
 %
Mortgage-Related Derivatives
 
9

 
 %
 
20

 
 %
 
(7
)
 
 %
 
(13
)
 
 %
Corporate Securities and Derivatives on Corporate Securities
 
(7
)
 
 %
 
(14
)
 
 %
 
7

 
 %
 
13

 
 %
Repurchase Agreements, Reverse Repurchase Agreements, and Senior Notes
 
(2,582
)
 
(0.30
)%
 
(5,139
)
 
(0.59
)%
 
2,606

 
0.30
 %
 
5,236

 
0.60
 %
Total
 
$
2,545

 
0.29
 %
 
$
2,252

 
0.26
 %
 
$
(5,384
)
 
(0.62
)%
 
$
(13,608
)
 
(1.57
)%
The preceding analysis does not show sensitivity to changes in interest rates for instruments for which we believe that the effect of a change in interest rates is not material to the value of the overall portfolio and/or cannot be accurately estimated. In particular, this analysis excludes certain of our holdings of corporate securities and derivatives on corporate securities, and reflects only sensitivity to U.S. interest rates.
Our analysis of interest rate risk is derived from Ellington's proprietary models as well as third-party information and analytics. Many assumptions have been made in connection with the calculations set forth in the table above and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. For example, for each hypothetical immediate shift in interest rates, assumptions have been made as to the response of mortgage prepayment rates, the shape of the yield curve, and market volatilities of interest rates; each of the foregoing factors can significantly and adversely affect the fair value of our interest rate-sensitive instruments.
The above analysis utilizes assumptions and estimates based on management's judgment and experience, and relies on financial models, which are inherently imperfect; in fact, different models can produce different results for the same securities. While the table above reflects the estimated impacts of immediate parallel interest rate increases and decreases on specific categories of instruments in our portfolio, we actively trade many of the instruments in our portfolio, and therefore our current or future portfolios may have risks that differ significantly from those of our December 31, 2019 portfolio estimated above. Moreover, the impact of changing interest rates on fair value can change significantly when interest rates change by a greater amount than the hypothetical shifts assumed above. Furthermore, our portfolio is subject to many risks other than interest rate risks, and these additional risks may or may not be correlated with changes in interest rates. For all of the foregoing reasons and others, the table above is for illustrative purposes only and actual changes in interest rates would likely cause changes in the actual fair value of our portfolio that would differ from those presented above, and such differences might be significant and adverse. See "Business—Special Note Regarding Forward-Looking Statements."


87


Item 8. Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2019 AND FOR THE YEAR ENDED DECEMBER 31, 2019
 
 
Report of Independent Registered Public Accounting Firm
 
89
Consolidated Balance Sheet
 
91
Consolidated Statement of Operations
 
92
Consolidated Statement of Changes in Equity
 
93
Consolidated Statement of Cash Flows
 
94
Notes to Consolidated Financial Statements
 
97
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2018 AND FOR THE YEAR ENDED DECEMBER 31, 2018
 
 
Report of Independent Registered Public Accounting Firm
 
149
 
150
 
151
 
164
 
166
 
167
Notes to Consolidated Financial Statements
 
169


88


Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Ellington Financial Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheet of Ellington Financial Inc. and its subsidiaries (the "Company") as of December 31, 2019, and the related consolidated statements of operations, of changes in equity and of cash flows for the year then ended, including the related notes (collectively referred to as the "consolidated financial statements"). We also have audited the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control—Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company's consolidated financial statements and on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audit of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.


89


Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 /s/ PricewaterhouseCoopers LLP
New York, New York
March 13, 2020
We have served as the Company's auditor since 2007.


90


ELLINGTON FINANCIAL INC.
CONSOLIDATED BALANCE SHEET

 
December 31, 2019
(In thousands, except share amounts)
Expressed in U.S. Dollars
Assets
 
Cash and cash equivalents(1)
$
72,302

Restricted cash(1)
175

Securities, at fair value(1)
2,449,941

Loans, at fair value(1)
1,412,426

Investments in unconsolidated entities, at fair value(1)
71,850

Real estate owned(1)
30,584

Financial derivatives—assets, at fair value
16,788

Reverse repurchase agreements
73,639

Due from brokers(1)
79,829

Investment related receivables(1)
123,120

Other assets(1)
7,563

Total Assets
$
4,338,217

Liabilities
 
Securities sold short, at fair value
$
73,409

Repurchase agreements(1)
2,445,300

Financial derivatives—liabilities, at fair value
27,621

Due to brokers
2,197

Investment related payables(1)
66,133

Other secured borrowings(1)
150,334

Other secured borrowings, at fair value(1)
594,396

Senior notes, net
85,298

Base management fee payable to affiliate
2,663

Incentive fee payable to affiliate
116

Dividends payable
6,978

Interest payable(1)
7,320

Accrued expenses and other liabilities(1)
7,753

Total Liabilities
3,469,518

Commitments and contingencies (Note 21)

Equity
 
Preferred stock, par value $0.001 per share, 100,000,000 shares authorized;
6.750% Series A Fixed-to-Floating Rate Cumulative Redeemable; 4,600,000 shares issued and outstanding ($115,000 liquidation preference)
111,034

Common stock, par value $0.001 per share, 100,000,000 shares authorized;
38,647,943 shares issued and outstanding
39

Additional paid-in-capital
821,747

Retained earnings (accumulated deficit)
(103,555
)
Total Stockholders' Equity
829,265

Non-controlling interests(1)
39,434

Total Equity
868,699

Total Liabilities and Equity
$
4,338,217

(1)
Ellington Financial Inc.'s Consolidated Balance Sheet includes assets and liabilities of variable interest entities it has consolidated. See Note 9 for additional details on Ellington Financial Inc.'s consolidated variable interest entities.

See Notes to Consolidated Financial Statements
91


ELLINGTON FINANCIAL INC.
CONSOLIDATED STATEMENT OF OPERATIONS

 
Year Ended
December 31, 2019
(In thousands, except per share amounts)
Expressed in U.S. Dollars
Net Interest Income
 
Interest income
$
159,901

Interest expense
(78,479
)
Total net interest income
81,422

Other Income (Loss)
 
Realized gains (losses) on securities and loans, net
(12,785
)
Realized gains (losses) on financial derivatives, net
(30,912
)
Realized gains (losses) on real estate owned, net
2,327

Unrealized gains (losses) on securities and loans, net
54,478

Unrealized gains (losses) on financial derivatives, net
(5,338
)
Unrealized gains (losses) on real estate owned, net
(1,279
)
Other, net
5,350

Total other income (loss)
11,841

Expenses
 
Base management fee to affiliate (Net of fee rebates of $1,967)(1)
7,988

Incentive fee to affiliate
116

Investment related expenses:
 
Servicing expense
8,632

Debt issuance costs related to Other secured borrowings, at fair value
3,536

Other
5,609

Professional fees
4,853

Compensation expense
3,649

Other expenses
4,354

Total expenses
38,737

Net Income (Loss) before Income Tax Expense (Benefit) and Earnings from Investments in Unconsolidated Entities
54,526

Income tax expense (benefit)
1,558

Earnings from investments in unconsolidated entities
10,209

Net Income (Loss)
63,177

Net income (loss) attributable to non-controlling interests
5,244

Dividends on preferred stock
1,466

Net Income (Loss) Attributable to Common Stockholders
$
56,467

Net Income (Loss) per Share of Common Stock:
 
Basic and Diluted
$
1.76

(1)
See Note 13 for further details on management fee rebates.

See Notes to Consolidated Financial Statements
92


ELLINGTON FINANCIAL INC.
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

 
 
 
Common Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings/(Accumulated Deficit)
 
Total Stockholders' Equity
 
Non-controlling Interest
 
Total Equity
 
Preferred Stock
 
Shares
 
Par Value
 
 
 
 
 
(In thousands, except share amounts)
 
 
 
 
Expressed in U.S. Dollars
BALANCE, January 1, 2019
$

 
29,796,601

 
$

 
$
665,356

 
$
(101,523
)
 
$
563,833

 
$
31,337

 
$
595,170

Share conversion(1)
 
 

 
30

 
(30
)
 

 

 

 

Net income (loss)
 
 
 
 
 
 
 
 
57,933

 
57,933

 
5,244

 
63,177

Net proceeds from the issuance of common stock(2)
 
 
8,855,000

 
9

 
156,319

 

 
156,328

 


 
156,328

Net proceeds from the issuance of preferred stock(2)
111,034

 
 
 
 
 

 

 
111,034

 


 
111,034

Contributions from non-controlling interests
 
 
 
 
 
 
 
 
 
 
 
 
27,650

 
27,650

Common dividends(3)
 
 
 
 
 
 
 
 
(58,499
)
 
(58,499
)
 
(1,325
)
 
(59,824
)
Preferred dividends(4)
 
 
 
 
 
 
 
 
(1,466
)
 
(1,466
)
 
 
 
(1,466
)
Distributions to non-controlling interests
 
 
 
 
 
 
 
 
 
 
 
 
(23,063
)
 
(23,063
)
Conversion of non-controlling interest units to shares of common stock
 
 
47,167

 

 
812

 
 
 
812

 
(812
)
 

Adjustment to non-controlling interests
 
 
 
 
 
 
(392
)
 
 
 
(392
)
 
392

 

Repurchase of shares of common stock
 
 
(50,825
)
 

 
(782
)
 

 
(782
)
 

 
(782
)
Share-based long term incentive plan unit awards
 
 
 
 
 
 
464

 
 
 
464

 
11

 
475

BALANCE, December 31, 2019
$
111,034

 
38,647,943

 
$
39

 
$
821,747

 
$
(103,555
)
 
$
829,265

 
$
39,434

 
$
868,699

(1)
See Note 1 for further details on the share conversion.
(2)
Net of underwriters' discounts and offering costs.
(3)
For the year ended December 31, 2019, dividends totaling $1.81 per share of common stock and convertible unit outstanding, were declared.
(4)
For the year ended December 31, 2019, dividends totaling $0.45938 per share of preferred stock were declared.

See Notes to Consolidated Financial Statements
93


ELLINGTON FINANCIAL INC.
CONSOLIDATED STATEMENT OF CASH FLOWS

 
Year Ended
December 31, 2019
(In thousands)
Expressed in U.S. Dollars
Cash Flows from Operating Activities:
 
Net income (loss)
$
63,177

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
Amortization of premiums and accretion of discounts, net
48,132

Realized (gains) losses on securities and loans, net
12,785

Realized (gains) losses on financial derivatives, net
30,912

Realized (gains) losses on real estate owned, net
(2,327
)
Unrealized (gains) losses on securities and loans, net
(54,478
)
Unrealized (gains) losses on financial derivatives, net
5,338

Unrealized (gains) losses on real estate owned, net
1,279

Unrealized (gains) losses other, net
645

Realized (gains) losses other, net—foreign currency transaction
2,392

Unrealized (gains) losses other, net—foreign currency translation
(3,310
)
Amortization of deferred debt issuance costs
263

Share-based long term incentive plan unit expense
475

Interest income related to consolidated securitization trust(1)
(16,034
)
Interest expense related to consolidated securitization trust(1)
15,136

Debt issuance costs related to Other secured borrowings, at fair value(1)
1,381

(Earnings) losses from investments in unconsolidated entities
(10,209
)
Changes in operating asset and liabilities:
 
(Increase) decrease in interest and principal receivable
(15,449
)
(Increase) decrease in other assets
(3,663
)
Increase (decrease) in base management fee payable to affiliate
919

Increase (decrease) in incentive fee payable to affiliate
116

Increase (decrease) in interest payable
161

Increase (decrease) in accrued expenses and other liabilities
1,607

Net cash provided by (used in) operating activities
$
79,248

 
 

See Notes to Consolidated Financial Statements
94


ELLINGTON FINANCIAL INC.
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
 
 
 
 
 
Year Ended
December 31, 2019
(In thousands)
Expressed in U.S. Dollars
Cash Flows from Investing Activities:
 
Purchase of securities
$
(3,057,372
)
Purchase of loans
(1,040,006
)
Capital improvements of real estate owned
(240
)
Proceeds from disposition of securities
1,838,182

Proceeds from disposition of loans
28,878

Contributions to investments in unconsolidated entities
(42,124
)
Distributions from investments in unconsolidated entities
49,758

Proceeds from disposition of real estate owned
24,059

Proceeds from principal payments of securities
275,221

Proceeds from principal payments of loans
304,953

Proceeds from securities sold short
645,553

Repurchase of securities sold short
(650,576
)
Payments on financial derivatives
(90,057
)
Proceeds from financial derivatives
58,578

Payments made on reverse repurchase agreements
(7,050,581
)
Proceeds from reverse repurchase agreements
7,038,216

Due from brokers, net
6,483

Due to brokers, net
(3,458
)
Net cash provided by (used in) investing activities
(1,664,533
)
Cash Flows from Financing Activities:
 
Net proceeds from the issuance of common stock(2)
156,742

Net proceeds from the issuance of preferred stock(2)
111,378

Offering costs paid
(712
)
Repurchase of common stock
(782
)
Dividends paid
(54,312
)
Contributions from non-controlling interests
27,650

Distributions to non-controlling interests
(23,063
)
Proceeds from issuance of Other secured borrowings
97,642

Principal payments on Other secured borrowings
(61,408
)
Borrowings under repurchase agreements
9,047,746

Repayments of repurchase agreements
(7,862,227
)
Proceeds from issuance of Other secured borrowings, at fair value
250,666

Repayment of Other secured borrowings, at fair value
(62,608
)
Due from brokers, net
(13,676
)
Due to brokers, net
(355
)
Net cash provided by (used in) financing activities
1,612,681

Net Increase (Decrease) in Cash, Cash Equivalents, and Restricted Cash
27,396

Cash, Cash Equivalents, and Restricted Cash, Beginning of Period
45,081

Cash, Cash Equivalents, and Restricted Cash, End of Period
$
72,477

 
 

See Notes to Consolidated Financial Statements
95


ELLINGTON FINANCIAL INC.
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
 
 
 
 
 
Year Ended
December 31, 2019
(In thousands)
Expressed in U.S. Dollars
Supplemental disclosure of cash flow information:
 
Interest paid
$
78,754

Income tax paid
189

Dividends payable
6,978

Share-based long term incentive plan unit awards (non-cash)
475

Purchase of investments (non-cash)
(2,975
)
Distributions from investments in unconsolidated entities (non-cash)
2,975

Transfers from mortgage loans to real estate owned (non-cash)
22,577

Proceeds from principal payments of investments (non-cash)
119,683

Proceeds received from Other secured borrowings, at fair value (non-cash)
227,428

Principal payments on Other secured borrowings, at fair value (non-cash)
(119,683
)
Repayments of repurchase agreements (non-cash)
(226,945
)
Repayment of senior notes (non-cash)
(86,000
)
Issuance of senior notes (non-cash)
86,000

(1)
Related to residential mortgage loan securitization transactions. See Note 10 for further details.
(2)
Net of underwriters' discounts.

See Notes to Consolidated Financial Statements
96


ELLINGTON FINANCIAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
1. Organization and Investment Objective
Ellington Financial Inc., formerly known as Ellington Financial LLC, was originally formed as a Delaware limited liability company on July 9, 2007 and commenced operations on August 17, 2007. On February 28, 2019, Ellington Financial LLC filed a certificate of conversion with the Secretary of State of the State of Delaware (the "Secretary") to convert from a Delaware limited liability company to a Delaware corporation (the "Conversion") and change its name to Ellington Financial Inc. The Conversion became effective on March 1, 2019, and upon effectiveness, each of Ellington Financial LLC's existing common shares representing limited liability company interests, no par value, converted into one issued and outstanding, fully paid and nonassessable share of common stock, $0.001 par value per share, of Ellington Financial Inc. In connection with the Conversion, Ellington Financial Inc.'s Board of Directors (the "Board of Directors") approved Ellington Financial Inc.'s Certificate of Incorporation (which was also filed with the Secretary) and Bylaws.
Ellington Financial Operating Partnership LLC (the "Operating Partnership"), a 98.4% owned consolidated subsidiary of Ellington Financial Inc., was formed as a Delaware limited liability company on December 14, 2012 and commenced operations on January 1, 2013. All of Ellington Financial Inc.'s operations and business activities are conducted through the Operating Partnership. Ellington Financial Inc., the Operating Partnership, and their consolidated subsidiaries are hereafter collectively referred to as the "Company." All intercompany accounts are eliminated in consolidation.
The Company conducts its operations to qualify and be taxed as a real estate investment trust, or "REIT," under the Internal Revenue Code of 1986, as amended (the "Code"), and has elected to be taxed as a corporation effective January 1, 2019. The Company will elect to be taxed as a REIT for U.S. federal income tax purposes upon the filing of its tax return for the taxable ending December 31, 2019, which is expected to be filed in 2020. In anticipation of the Company's intended election to be taxed as a REIT under the Code beginning with its 2019 taxable year (the "REIT Election"), the Company implemented an internal restructuring as of December 31, 2018. As part of this restructuring, the Company moved certain of its non-REIT-qualifying investments and financial derivatives to taxable REIT subsidiaries or, "TRSs," and disposed of certain of its investments in non-REIT-qualifying investments and financial derivatives.
The Company invests in a diverse array of financial assets, including residential and commercial mortgage loans, residential mortgage-backed securities, or "RMBS," commercial mortgage-backed securities, or "CMBS," consumer loans and asset-backed securities, or "ABS," including ABS backed by consumer loans, collateralized loan obligations, or "CLOs," non-mortgage- and mortgage-related derivatives, equity investments in loan origination companies, and other strategic investments.
Ellington Financial Management LLC (the "Manager") is an SEC-registered investment adviser that serves as the Manager to the Company pursuant to the terms of its Seventh Amended and Restated Management Agreement (the "Management Agreement"), which was approved by the Board of Directors effective March 13, 2018. The Manager is an affiliate of Ellington Management Group, L.L.C. ("Ellington"), an investment management firm that is registered as both an investment adviser and a commodity pool operator. In accordance with the terms of the Management Agreement, the Manager implements the investment strategy and manages the business and operations on a day-to-day basis for the Company and performs certain services for the Company, subject to oversight by the Board of Directors.
2. Significant Accounting Policies
(A) Basis of Presentation: The Company's consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America, or "U.S. GAAP," and Regulation S-X. The consolidated financial statements include the accounts of the Company, the Operating Partnership, its subsidiaries, and variable interest entities, or "VIEs," for which the Company is deemed to be the primary beneficiary. All intercompany balances and transactions have been eliminated. The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and those differences could be material.
The Company adopted ASC 946, Financial Services—Investment Companies ("ASC 946") upon its commencement of operations in August 2007, and applied U.S. GAAP for investment companies. In connection with the Company's internal restructuring and the Company's intention to qualify as a REIT for the year ended December 31, 2019, the Company determined that, effective January 1, 2019, it no longer qualified for investment company accounting in accordance with ASC 946-10-25, and has prospectively discontinued its use. The Company elected the fair value option, or "FVO," for, and therefore the Company will continue to measure at fair value, those of its assets and liabilities it had previously measured at fair value


97


and for which such election is permitted, as provided for under ASC 825, Financial Instruments ("ASC 825"). Due to the prospective application of a change in accounting as required under ASC 946-10-25-2, the Company determined that the presentation of its consolidated financial statements for periods beginning after December 31, 2018 are not comparable to the consolidated financial statements previously prepared for prior periods for which the Company applied ASC 946. As a result, the Company has provided separate consolidated financial statements for applicable prior periods in Item 8 of this Annual Report on Form 10-K.
Reclassification and Presentation
Effective January 1, 2019, the Company prospectively discontinued its application of ASC 946. Upon its change in status, the following significant changes and elections were made:
Investments in securities are now accounted for in accordance with ASC 320, Investments—Debt and Equity Securities ("ASC 320");
The Company elected the FVO as provided for under ASC 825-10-25-4 for all eligible financial instruments for which the Company had previously measured at fair value, including investments in securities, loans, financial derivatives, and certain of the Company's secured borrowings. As a result, all changes in the fair value of such financial instruments will continue to be recorded in earnings on the Company's Consolidated Statement of Operations;
Real estate owned, or "REO," is not eligible for the FVO election. As a result, REO is carried at the lower of cost or fair value. The Company's cost basis in any REO that was previously measured at fair value under ASC 946 was adjusted on January 1, 2019 to equal the fair value of such investment as of December 31, 2018;
The Company elected not to designate its financial derivatives as hedging instruments in accordance with ASC 815, Derivatives and Hedging ("ASC 815"). As a result, all changes in the fair value of financial derivatives will continue to be recorded in earnings on the Company's Consolidated Statement of Operations;
Forward settling to-be-announced mortgage-backed-securities, or "TBAs," are no longer classified as investments. TBAs will be classified as financial derivatives, with the difference between the forward contract price and the market value of the TBA position as of the reporting date included in Unrealized gains (losses) on financial derivatives, net, on the Consolidated Statement of Operations; and
The Company is required to account for certain of its equity investments under ASC 323-10, Investments—Equity Method and Joint Ventures ("ASC 323-10"). The Company has elected the FVO for such equity investments and changes in fair value will be reported in Earnings from investments in unconsolidated entities, on the Consolidated Statement of Operations.
The discontinuation of the Company's application of ASC 946 prospectively changed the presentation of the Company's consolidated financial statements. The most significant changes are:
The Consolidated Statement of Assets, Liabilities, and Equity has been changed to a Consolidated Balance Sheet;
The Consolidated Condensed Schedule of Investments has been removed;
The Consolidated Statement of Operations is no longer presented in the format required under ASC 946. The Company will present the Consolidated Statement of Operations as required under U.S. GAAP for operating companies. A Consolidated Statement of Other Comprehensive Income (Loss) will be presented, if and when applicable;
The Consolidated Statement of Cash Flows has been changed, and now includes a section for investing activities;
Certain footnotes have been changed to reflect conformity with applicable U.S. GAAP for operating companies;
The Company re-evaluated its interests in all entities to determine whether they are variable interests, and re-evaluated its investments, including it investments in partially owned entities, to determine if they are VIEs, as required under ASC 810, Consolidation ("ASC 810"). The Company also re-evaluated consolidation considerations for all of its investments in VIEs and partially owned entities, as required under ASC 810. Applicable disclosures related to VIEs have been included in these notes to consolidated financial statements;
Securities/loans sold under agreements to be repurchased at an agreed-upon price and date, which were formerly referred to as "reverse repurchase agreements," are now referred to as "repurchase agreements";
Securities/loans purchased under agreements to resell at an agreed-upon price and date, which were formerly referred to as "repurchase agreements," are now referred to as "reverse repurchase agreements"; and
The financial highlights disclosures, which are not required under U.S. GAAP for operating companies, have been removed.


98


(B) Valuation: The Company applies ASC 820-10, Fair Value Measurement ("ASC 820") to its holdings of financial instruments. ASC 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the observability of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
Level 1—inputs to the valuation methodology are observable and reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Currently, the types of financial instruments the Company generally includes in this category are listed equities and exchange-traded derivatives;
Level 2—inputs to the valuation methodology other than quoted prices included in Level 1 are observable for the asset or liability, either directly or indirectly. Currently, the types of financial instruments that the Company generally includes in this category are RMBS for which the principal and interest payments are guaranteed by a U.S. government agency or a U.S. government-sponsored entity, or "Agency RMBS," U.S. Treasury securities and sovereign debt, certain non-Agency RMBS, CMBS, CLOs, corporate debt, and actively traded derivatives such as interest rate swaps, foreign currency forwards, and other over-the-counter derivatives; and
Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement. The types of financial instruments that the Company generally includes in this category are certain RMBS, CMBS, CLOs, ABS, credit default swaps, or "CDS," on individual ABS, and total return swaps on distressed corporate debt, in each case where there is less price transparency. Also included in this category are residential and commercial mortgage loans, consumer loans, and private corporate debt and equity investments.
For certain financial instruments, the various inputs that management uses to measure fair value may fall into different levels of the fair value hierarchy. For each such financial instrument, the determination of which category within the fair value hierarchy is appropriate is based on the lowest level of input that is significant to the fair value measurement. ASC 820 prioritizes the various inputs that management uses to measure fair value, with the highest priority given to inputs that are observable and reflect quoted prices (unadjusted) for identical assets or liabilities in active markets (Level 1), and the lowest priority given to inputs that are unobservable and significant to the fair value measurement (Level 3). The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. The Company may use valuation techniques consistent with the market and income approaches to measure the fair value of its financial instruments. The market approach uses third-party valuations and information obtained from market transactions involving identical or similar financial instruments. The income approach uses projections of the future economic benefit of an instrument to determine its fair value, such as in the discounted cash flow methodology. The inputs or methodology used for valuing financial instruments are not necessarily an indication of the risk associated with investing in these financial instruments. The leveling of each financial instrument is reassessed at the end of each period. Transfers between levels of the fair value hierarchy are assumed to occur at the end of the reporting period.
Summary Valuation Techniques
For financial instruments that are traded in an "active market," the best measure of fair value is the quoted market price. However, many of the Company's financial instruments are not traded in an active market. Therefore, management generally uses third-party valuations when available. If third-party valuations are not available, management uses other valuation techniques, such as the discounted cash flow methodology. The following are summary descriptions, for various categories of financial instruments, of the valuation methodologies management uses in determining fair value of the Company's financial instruments in such categories. Management utilizes such methodologies to assign a fair value (the estimated price that, in an orderly transaction at the valuation date, would be received to sell an asset, or paid to transfer a liability, as the case may be) to each such financial instrument.
For mortgage-backed securities, or "MBS," TBAs, CLOs, and corporate debt and equity, management seeks to obtain at least one third-party valuation, and often obtains multiple valuations when available. Management has been able to obtain third-party valuations on the vast majority of these instruments and expects to continue to solicit third-party valuations in the future. Management generally values each financial instrument at the average of third-party valuations received and not rejected as described below. Third-party valuations are not binding, management may adjust the valuations it receives (e.g., downward adjustments for odd lots), and management may challenge or reject a valuation when, based on its validation criteria, management determines that such valuation is unreasonable or erroneous. Furthermore, based on its validation criteria, management may determine that the average of the third-party valuations received for a given financial instrument does not result in what management believes to be the fair value of such instrument, and in such circumstances management may override this average with its own good faith valuation. The validation criteria may take into account output from management's own models, recent trading activity in the same or similar instruments, and valuations received from third parties. The use of proprietary models requires the use of a significant amount of judgment and the application of various assumptions including, but not limited to, assumptions concerning future prepayment rates and default rates. Given their


99


relatively high level of price transparency, Agency RMBS pass-throughs are typically classified as Level 2. Non-Agency RMBS, CMBS, Agency interest only and inverse interest only RMBS, CLOs, and corporate bonds are generally classified as either Level 2 or Level 3 based on analysis of available market data and/or third-party valuations. The Company's investments in distressed corporate debt can be in the form of loans as well as total return swaps on loans. These investments, as well as related non-listed equity investments, are generally designated as Level 3 assets. Valuations for total return swaps are typically based on prices of the underlying loans received from third-party pricing services. Private equity investments are generally classified as Level 3. Furthermore, the methodology used by the third-party valuation providers is reviewed at least annually by management, so as to ascertain whether such providers are utilizing observable market data to determine the valuations that they provide.
For residential and commercial mortgage loans and consumer loans, management determines fair value by taking into account both external pricing data, which includes third-party valuations, and internal pricing models. Management has obtained third-party valuations on the majority of these investments and expects to continue to solicit third-party valuations in the future. In determining fair value for non-performing mortgage loans, management evaluates third-party valuations, if applicable, as well as management's estimates of the value of the underlying real estate, using information including general economic data, broker price opinions, or "BPOs," recent sales, property appraisals, and bids. In determining fair value for performing mortgage loans and consumer loans, management evaluates third-party valuations, if applicable, as well as discounted cash flows of the loans based on market assumptions. Cash flow assumptions typically include projected default and prepayment rates and loss severities, and may include adjustments based on appraisals and BPOs. Mortgage and consumer loans are classified as Level 3.
The Company has securitized certain mortgage loans that are not deemed "qualified mortgage," or "QM," loans under the rules of the Consumer Financial Protection Bureau, or "non-QM loans." The Company's securitized non-QM loans are held as part of a collateralized financing entity, or "CFE." A CFE is a VIE that holds financial assets, issues beneficial interests in those assets, and has no more than nominal equity, and for which the issued beneficial interests have contractual recourse only to the related assets of the CFE. ASC 810 allows the Company to elect to measure both the financial assets and financial liabilities of the CFE using the more observable of the fair value of the financial assets and the fair value of the financial liabilities of the CFE. The Company has elected the FVO for initial and subsequent recognition of the debt issued by its consolidated securitization trusts and has determined that each consolidated securitization trust meets the definition of a CFE; see Note 10 "Securitization TransactionsResidential Mortgage Loan Securitizations" for further discussion on the Company's securitization trusts. The Company has determined the inputs to the fair value measurement of the financial liabilities of each of its CFEs to be more observable than those of the financial assets and, as a result, has used the fair value of the financial liabilities of each of the CFEs to measure the fair value of the financial assets of each of the CFEs. The fair value of the debt issued by each CFE is typically valued using discounted cash flows and other market data. The securitized non-QM loans, which are assets of the CFEs, are included in Loans, at fair value, on the Company's Consolidated Balance Sheet. The debt issued by the CFEs is included in Other secured borrowings, at fair value, on the Company's Consolidated Balance Sheet. Unrealized gains (losses) from changes in fair value of Other secured borrowings, at fair value, are included in Other, net, on the Company's Consolidated Statement of Operations. The securitized non-QM loans and the debt issued by the Company's CFEs are both classified as Level 3.
For financial derivatives with greater price transparency, such as CDS on asset-backed indices, CDS on corporate indices, certain options on the foregoing, and total return swaps on publicly traded equities or indices, market-standard pricing sources are used to obtain valuations; these financial derivatives are generally classified as Level 2. Interest rate swaps, swaptions, and foreign currency forwards are typically valued based on internal models that use observable market data, including applicable interest rates and foreign currency rates in effect as of the measurement date; the model-generated valuations are then typically compared to counterparty valuations for reasonableness. These financial derivatives are also generally classified as Level 2. Financial derivatives with less price transparency, such as CDS on individual ABS, are generally valued based on internal models, and are classified as Level 3. In the case of CDS on individual ABS, the valuation process typically starts with an estimation of the value of the underlying ABS. In valuing its financial derivatives, the Company also considers the creditworthiness of both the Company and its counterparties, along with collateral provisions contained in each financial derivative agreement.
Investments in private operating entities, such as loan originators, are valued based on available metrics, such as relevant market multiples and comparable company valuations, company specific-financial data including actual and projected results, and independent third party valuation estimates. These investments are classified as Level 3.
The Company's repurchase and reverse repurchase agreements are carried at cost, which approximates fair value. Repurchase and reverse repurchase agreements are classified as Level 2, based on the adequacy of the collateral and their short term nature.


100


The Company's valuation process, including the application of validation criteria, is overseen by the Manager's Valuation Committee (the "Valuation Committee"). The Valuation Committee includes senior level executives from various departments within the Manager, and each quarter, the Valuation Committee reviews and approves the valuations of the Company's financial instruments. The valuation process also includes a monthly review by the Company's third-party administrator. The goal of this review is to replicate various aspects of the Company's valuation process based on the Company's documented procedures.
Because of the inherent uncertainty of valuation, the estimated fair value of the Company's financial instruments may differ significantly from the values that would have been used had a ready market for the financial instruments existed, and the differences could be material to the Company's consolidated financial statements.
(C) Accounting for Securities: Purchases and sales of investments in securities are generally recorded on trade date, and realized and unrealized gains and losses are calculated based on identified cost. Investments in securities are recorded in accordance with ASC 320 or ASC 325-40, Beneficial Interests in Securitized Financial Assets ("ASC 325-40"). The Company generally classifies its securities as available-for-sale. The Company has chosen to elect the FVO pursuant to ASC 825 for its investments in securities. Electing the FVO allows the Company to record changes in fair value in the Consolidated Statement of Operations, as a component of Unrealized gains (losses) on securities and loans, net, which, in management's view, more appropriately reflects the results of operations for a particular reporting period as all investment activities will be recorded in a similar manner.
Many of the Company's investments in securities, such as MBS and CLOs, are issued by entities that are deemed to be VIEs. For the majority of such investments, the Company has determined it is not the primary beneficiary of such VIEs and therefore has not consolidated such VIEs. The Company's maximum risk of loss in these unconsolidated VIEs is generally limited to the fair value of the Company's investment in the VIE.
The Company evaluates its investments in interest only securities to determine whether they meet the requirements for classification as financial derivatives under ASC 815. For interest only securities, where the holder is entitled only to a portion of the interest payments made on the mortgages underlying certain MBS, and inverse interest only securities, which are interest only securities whose coupon has an inverse relationship to its benchmark rate, such as LIBOR, the Company has determined that such investments do not meet the requirements for treatment as financial derivatives and are classified as securities.
The Company evaluates the cost basis of its investments in securities for other-than-temporary impairment, or "OTTI," on at least a quarterly basis. The determination of whether a security is other-than-temporarily impaired requires judgments, estimates, and assumptions based on subjective and objective factors. As a result, the timing and amount of an OTTI constitutes an accounting estimate that may change materially over time.
When the fair value of a security is less than its amortized cost basis as of the balance sheet date, the security's cost basis is considered impaired, and the impairment is designated as either temporary or other-than-temporary. When a security's cost basis is impaired, an OTTI is considered to have occurred if (i) the Company intends to sell the security (i.e., a decision has been made as of the reporting date), (ii) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, or (iii) the Company does not expect to recover the security's amortized cost basis, even if the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security. Additionally, for securities accounted for under ASC 325-40, an impairment of the cost basis is recorded when there is an adverse change in the expected cash flows to be received and the fair value of the security is less than its carrying amount. In determining whether an adverse change in cash flows has occurred, the present value of the remaining cash flows, as estimated at the initial transaction date (or the last date previously revised), is compared to the present value of the expected cash flows at the current reporting date. The estimated cash flows reflect those that a "market participant" would use and include observations of current information and events, and assumptions related to fluctuations in interest rates, prepayment speeds and the timing and amount of potential credit losses. Cash flows are discounted at a rate equal to the current yield used to accrete interest income. Any resulting OTTI adjustments made to the cost basis of the security are reflected in Realized gains (losses) on securities and loans, net, on the Consolidated Statement of Operations.
(D) Accounting for Loans: The Company's loan portfolio generally consists of residential mortgage, commercial mortgage, and consumer loans. The Company's loans are accounted for under ASC 310-10, Receivables, and are classified as held-for-investment when the Company has the intent and ability to hold such loans for the foreseeable future or to maturity/payoff. When the Company has the intent to sell loans, such loans will be classified as held-for-sale. Mortgage loans held-for-sale are accounted for under ASC 948-310, Financial services—mortgage banking. The Company may aggregate its loans into pools based on common risk characteristics at purchase. Once a pool of loans is assembled, its composition is maintained. The Company has chosen to elect the FVO pursuant to ASC 825 for its loan portfolios. Loans are recorded at fair value on the Consolidated Balance Sheet and changes in fair value are recorded in earnings on the Consolidated Statement of Operations as a component of Unrealized gains (losses) on securities and loans, net. The Company generates income from fees on certain


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loans, generally commercial mortgage loans, that it originates and holds for investment, including origination and exit fees. Such fee income is recorded when earned and included in Other, net on the Consolidated Statement of Operations. Transfers between held-for-investment and held-for-sale occur once the Company's intent to sell the loans changes.
For residential and commercial mortgage loans, the Company generally accrues interest payments. Such loans are typically moved to non-accrual status if the loan becomes 90 days or more delinquent. The Company does not accrue interest payments on its consumer loans; interest payments are recorded upon receipt. Once consumer loans are more than 120 days past due, the Company will generally charge off such loans. The Company evaluates its charged-off loans and determines collectibility, if any, on such loans.
The Company evaluates the collectibility of both interest and principal on each of its loan investments and whether the cost basis of the loan is impaired. A loan's cost basis is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the existing contractual terms. When a loan's cost basis is impaired, the Company does not record an allowance for loan loss as it has elected the FVO on all of its loan investments. The Company will recognize impairments through an adjustment to the amortized cost basis and recognize a realized loss in the period such adjustment was made, which is included in Realized gains (losses) on securities and loans, net, on the Consolidated Statement of Operations.
(E) Interest Income: The Company amortizes premiums and accretes discounts on its debt securities. Coupon interest income on fixed-income investments is generally accrued based on the outstanding principal balance or notional value and the current coupon interest rate.
For debt securities that are deemed to be of high credit quality at the time of purchase (generally Agency RMBS, exclusive of interest only securities), premiums and discounts are amortized/accreted into interest income over the life of such securities using the effective interest method. For such securities whose cash flows vary depending on prepayments, an effective yield retroactive to the time of purchase is periodically recomputed based on actual prepayments and changes in projected prepayment activity, and a catch-up adjustment, or "Catch-up Premium Amortization Adjustment," is made to amortization to reflect the cumulative impact of the change in effective yield.
For debt securities (generally non-Agency RMBS, CMBS, ABS, CLOs, and interest only securities) that are deemed not to be of high credit quality at the time of purchase, interest income is recognized based on the effective interest method. When the fair value of a debt security is less than its amortized cost basis as of the balance sheet date, the security's cost basis is considered impaired. The Company will adjust such impaired cost basis to the present value of the estimated future cash flows. This adjustment to the cost basis is reported in Realized gains (losses) on securities and loans, net, on the Consolidated Statement of Operations. For purposes of estimating the future expected cash flows, management uses assumptions including, but not limited to, assumptions for future prepayment rates, default rates, and loss severities (each of which may in turn incorporate various macro-economic assumptions, such as future housing prices). These assumptions are re-evaluated not less than quarterly. Changes in projected cash flows will result in prospective changes in the yield/interest income recognized on such securities based on the updated expected future cash flows.
For each loan purchased with the expectation that both interest and principal will be paid in full, the Company generally amortizes or accretes any premium or discount over the life of the loan utilizing the effective interest method. However, based on current information and events, the Company re-assesses the collectibility of interest and principal, and generally designates a loan as in non-accrual status either when any payments have become 90 or more days past due, or when, in the opinion of management, it is probable that the Company will be unable to collect either interest or principal in full. Once a loan is designated as in non-accrual status, as long as principal is still expected to be collectible in full, interest payments are recorded as interest income only when received (i.e., under the cash basis method); accruals of interest income are only resumed when the loan becomes contractually current and performance is demonstrated to be resumed. However, if principal is not expected to be collectible in full, the cost recovery method is used (i.e., no interest income is recognized, and all payments received—whether contractually interest or principal—are applied to cost).
For each loan purchased with evidence of credit deterioration since origination and the expectation that either principal or interest will not be paid in full, interest income is generally recognized using the effective interest method for as long as the cash flows can be reasonably estimated. Here, instead of amortizing the purchase discount (i.e., the excess of the unpaid principal balance over the purchase price) over the life of the loan, the Company effectively amortizes the accretable yield (i.e., the excess of the Company's estimate of the total cash flows to be collected over the life of the loan over the purchase price). Not less than quarterly, the Company updates its estimate of the cash flows expected to be collected over the life of the loan, and revised yields are prospectively applied.
For certain groups of consumer loans that the Company considers as having sufficiently homogeneous characteristics, the Company aggregates such loans into pools, and accounts for each such pool as a single unit of account. The pool is then treated


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analogously to a debt security deemed not to be of high credit quality, in that (i) the aggregate premium or discount for the pool is amortized or accreted into interest income based on the pool's effective interest rate; (ii) the effective interest rate is determined based on the net expected cash flows of the pool, taking into account estimates of prepayments, defaults, and loss severities; and (iii) estimates are updated not less than quarterly and revised yields are prospectively applied.
In estimating future cash flows on the Company's debt securities, there are a number of assumptions that will be subject to significant uncertainties and contingencies, including, in the case of MBS, assumptions relating to prepayment rates, default rates, loan loss severities, and loan repurchases. These estimates require the use of a significant amount of judgment.
(F) Investments in unconsolidated entities: The Company has made and may in the future make non-controlling equity investments in various entities, such as loan originators. Such investments are generally in the form of preferred and/or common equity, or membership interests. In certain cases, the Company can exercise significant influence over the entity (e.g. by having representation on the entity's board of directors) but the requirements for consolidation under ASC 810 are not met; in such cases the Company is required to account for such equity investments under ASC 323-10. The Company has chosen to elect the FVO pursuant to ASC 825 for its investments in unconsolidated entities, which, in management's view, more appropriately reflects the results of operations for a particular reporting period, as all investment activities will be recorded in a similar manner. The period change in fair value of the Company's investments in unconsolidated entities is recorded on the Consolidated Statement of Operations in Earnings from investments in unconsolidated entities.
(G) REO: When the Company obtains possession of real property in connection with a foreclosure or similar action, the Company de-recognizes the associated mortgage loan according to ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure ("ASU 2014-04"). Under the provisions of ASU 2014-04, the Company is deemed to have received physical possession of real estate property collateralizing a mortgage loan when it obtains legal title to the property upon completion of a foreclosure or when the borrower conveys all interest in the property to it through a deed in lieu of foreclosure or similar legal agreement. The Company's cost basis in REO is equal to the fair value of the associated mortgage loan at the time the Company obtains possession. REO valuations are reflected at the lower of cost or fair value. The fair value of such REO is typically based on management's estimates which generally use information including general economic data, BPOs, recent sales, property appraisals, and bids, and takes into account the expected costs to sell the property. REO recorded at fair value on a non-recurring basis are classified as Level 3.
(H) Securities Sold Short: The Company may purchase or engage in short sales of U.S. Treasury securities and sovereign debt to mitigate the potential impact of changes in interest rates and/or foreign exchange rates on the performance of its portfolio. When the Company sells securities short, it typically satisfies its security delivery settlement obligation by borrowing or purchasing the security sold short from the same or a different counterparty. When borrowing a security sold short from a counterparty, the Company generally is required to deliver cash or securities to such counterparty as collateral for the Company's obligation to return the borrowed security. The Company has chosen to elect the FVO pursuant to ASC 825 for its securities sold short. Electing the FVO allows the Company to record changes in fair value in the Consolidated Statement of Operations, which, in management's view, more appropriately reflects the results of operations for a particular reporting period as all securities activities will be recorded in a similar manner. As such, securities sold short are recorded at fair value on the Consolidated Balance Sheet and the period change in fair value is recorded in current period earnings on the Consolidated Statement of Operations as a component of Unrealized gains (losses) on securities and loans, net. A realized gain or loss will be recognized upon the termination of a short sale if the market price is less or greater than the original sale price. Such realized gain or loss is recorded on the Company's Consolidated Statement of Operations in Realized gains (losses) on securities and loans, net.
(I) Financial Derivatives: The Company enters into various types of financial derivatives subject to its investment guidelines, which include restrictions associated with qualifying and maintaining qualification as a REIT. The Company's financial derivatives are predominantly subject to bilateral collateral arrangements or clearing in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the "Dodd-Frank Act." The Company may be required to deliver or receive cash or securities as collateral upon entering into derivative transactions. In addition, changes in the relative value of derivative transactions may require the Company or the counterparty to post or receive additional collateral. In the case of cleared derivatives, the clearinghouse becomes the Company's counterparty and a futures commission merchant acts as an intermediary between the Company and the clearinghouse with respect to all facets of the related transaction, including the posting and receipt of required collateral. Cash collateral received by the Company is included in Due to brokers, on the Consolidated Balance Sheet. Conversely, cash collateral posted by the Company is included in Due from brokers, on the Consolidated Balance Sheet. The types of derivatives primarily utilized by the Company are swaps, TBAs, futures, options, and forwards.


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Swaps: The Company may enter into various types of swaps, including interest rate swaps, credit default swaps, and total return swaps. The primary risk associated with the Company's interest rate swap activity is interest rate risk. The primary risk associated with the Company's credit default swaps and total return swaps is credit risk.
The Company is subject to interest rate risk exposure in the normal course of pursuing its investment objectives. Primarily to help mitigate interest rate risk, the Company enters into interest rate swaps. Interest rate swaps are contractual agreements whereby one party pays a floating interest rate on a notional principal amount and receives a fixed-rate payment on the same notional principal, or vice versa, for a fixed period of time. Interest rate swaps change in value with movements in interest rates. The Company also enters into interest rate swaps whereby the Company pays one floating rate and receives a different floating rate, or "basis swaps."
The Company enters into credit default swaps. A credit default swap is a contract under which one party agrees to compensate another party for the financial loss associated with the occurrence of a "credit event" in relation to a "reference amount" or notional value of a "reference asset" (usually a bond, loan, or an index or basket of bonds or loans). The definition of a credit event may vary from contract to contract. A credit event may occur (i) when the reference asset (or underlying asset, in the case of a reference asset that is an index or basket) fails to make scheduled principal or interest payments to its holders, (ii) with respect to credit default swaps referencing mortgage/asset-backed securities and indices, when the reference asset (or underlying asset, in the case of a reference asset that is an index or basket) is downgraded below a certain rating level, or (iii) with respect to credit default swaps referencing corporate entities and indices, upon the bankruptcy of the obligor of the reference asset (or underlying obligor, in the case of a reference asset that is an index). The Company typically writes (sells) protection to take a "long" position with respect to the underlying reference assets, or purchases (buys) protection to take a "short" position with respect to the underlying reference assets or to hedge exposure to other investment holdings.
The Company enters into total return swaps in order to take a "long" or "short" position with respect to an underlying reference asset. The Company is subject to market price volatility of the underlying reference asset. A total return swap involves commitments to pay interest in exchange for a market-linked return based on a notional value. To the extent that the total return of the corporate debt, security, group of securities or index underlying the transaction exceeds or falls short of the offsetting interest obligation, the Company will receive a payment from or make a payment to the counterparty.
Swaps change in value with movements in interest rates, credit quality, or total return of the reference securities. During the term of swap contracts, changes in value are recognized as unrealized gains or losses on the Consolidated Statement of Operations. When a contract is terminated, the Company realizes a gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Company's basis in the contract, if any. Periodic payments or receipts required by swap agreements are recorded as unrealized gains or losses when accrued and realized gains or losses when received or paid. Upfront payments paid and/or received by the Company to open swap contracts are recorded as an asset and/or liability on the Consolidated Balance Sheet and are recorded as a realized gain or loss on the termination date.
TBA Securities: The Company transacts in the forward settling TBA market. A TBA position is a forward contract for the purchase ("long position") or sale ("short position") of Agency RMBS at a predetermined price, face amount, issuer, coupon, and maturity on an agreed-upon future delivery date. For each TBA contract and delivery month, a uniform settlement date for all market participants is determined by the Securities Industry and Financial Markets Association. The specific Agency RMBS to be delivered into the contract at the settlement date are not known at the time of the transaction. The Company typically does not take delivery of TBAs, but rather enters into offsetting transactions and settles the associated receivable and payable balances with its counterparties. The Company uses TBAs to mitigate interest rate risk, usually by taking short positions. The Company also invests in TBAs as a means of acquiring additional exposure to Agency RMBS, or for speculative purposes, including holding long positions.
TBAs are accounted for by the Company as financial derivatives. The difference between the forward contract price and the market value of the TBA position as of the reporting date is included in Unrealized gains (losses) on financial derivatives, net, on the Consolidated Statement of Operations.
Futures Contracts: A futures contract is an exchange-traded agreement to buy or sell an asset for a set price on a future date. The Company enters into Eurodollar and/or U.S. Treasury security futures contracts to hedge its interest rate risk. The Company may also enter into various other futures contracts, including equity index futures and foreign currency futures. Initial margin deposits are made upon entering into futures contracts and can generally be either in the form of cash or securities. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by marking-to-market to reflect the current market value of the contract. Variation margin payments are made or received periodically, depending upon whether unrealized losses or gains are incurred. When the contract is closed, the Company records a realized gain or loss equal to the difference between the proceeds of the closing transaction and the Company's basis in the contract.


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Options: The Company may purchase or write put or call options contracts or enter into swaptions. The Company enters into options contracts typically to help mitigate overall market, credit, or interest rate risk depending on the type of options contract. However, the Company also enters into options contracts from time to time for speculative purposes. When the Company purchases an options contract, the option asset is initially recorded at an amount equal to the premium paid, if any, and is subsequently marked-to-market. Premiums paid for purchasing options contracts that expire unexercised are recognized on the expiration date as realized losses. If an options contract is exercised, the premium paid is subtracted from the proceeds of the sale or added to the cost of the purchase to determine whether the Company has realized a gain or loss on the related transaction. When the Company writes an options contract, the option liability is initially recorded at an amount equal to the premium received, if any, and is subsequently marked-to-market. Premiums received for writing options contracts that expire unexercised are recognized on the expiration date as realized gains. If an options contract is exercised, the premium received is subtracted from the cost of the purchase or added to the proceeds of the sale to determine whether the Company has realized a gain or loss on the related investment transaction. When the Company enters into a closing transaction, the Company will realize a gain or loss depending upon whether the amount from the closing transaction is greater or less than the premiums paid or received. The Company may also enter into options contracts that contain forward-settling premiums. In this case, no money is exchanged upfront. Instead, the agreed-upon premium is paid by the buyer upon expiration of the option, regardless of whether or not the option is exercised.
Forward Currency Contracts: A forward currency contract is an agreement between two parties to purchase or sell a specific quantity of currency with the delivery and settlement at a specific future date and exchange rate. During the period the forward currency contract is open, changes in the value of the contract are recognized as unrealized gains or losses. When the contract is settled, the Company records a realized gain or loss equal to the difference between the proceeds of the closing transaction and the Company's basis in the contract.
Financial derivative assets are included in Financial derivatives—assets, at fair value, on the Consolidated Balance Sheet. Financial derivative liabilities are included in Financial derivatives—liabilities, at fair value, on the Consolidated Balance Sheet. The Company has chosen to elect the FVO pursuant to ASC 825 for its financial derivatives. Electing the FVO allows the Company to record changes in fair value in the Consolidated Statement of Operations, which, in management's view, more appropriately reflects the results of operations for a particular reporting period as all securities activities will be recorded in a similar manner. Changes in unrealized gains and losses on financial derivatives are included in Unrealized gains (losses) on financial derivatives, net, on the Consolidated Statement of Operations. Realized gains and losses on financial derivatives are included in Realized gains (losses) on financial derivatives, net, on the Consolidated Statement of Operations.
(J) Cash and Cash Equivalents: Cash and cash equivalents include cash and short term investments with original maturities of three months or less at the date of acquisition. Cash and cash equivalents typically include amounts held in interest bearing overnight accounts and amounts held in money market funds, and these balances generally exceed insured limits. The Company holds its cash at institutions that it believes to be highly creditworthy. Restricted cash represents cash that the Company can use only for specific purposes. See Note 18 for further discussion of restricted cash balances.
(K) Repurchase Agreements: The Company enters into repurchase agreements with third-party broker-dealers whereby it sells securities under agreements to be repurchased at an agreed-upon price and date. The Company accounts for repurchase agreements as collateralized borrowings, with the initial sale price representing the amount borrowed, and with the future repurchase price consisting of the amount borrowed plus interest, at the implied interest rate of the repurchase agreement, on the amount borrowed over the term of the repurchase agreement. The interest rate on a repurchase agreement is based on competitive rates (or competitive market spreads, in the case of agreements with floating interest rates) at the time such agreement is entered into. When the Company enters into a repurchase agreement, the lender establishes and maintains an account containing cash and/or securities having a value not less than the repurchase price, including accrued interest, of the repurchase agreement. Repurchase agreements are carried at their contractual amounts, which approximate fair value as the debt is short-term in nature.
(L) Reverse Repurchase Agreements: The Company enters into reverse repurchase agreement transactions whereby it purchases securities under agreements to resell at an agreed-upon price and date. In general, securities received pursuant to reverse repurchase agreements are delivered to counterparties of short sale transactions. The interest rate on a reverse repurchase agreement is based on competitive rates (or competitive market spreads, in the case of agreements with floating interest rates) at the time such agreement is entered into. Assets held pursuant to reverse repurchase agreements are reflected as assets on the Consolidated Balance Sheet. Reverse repurchase agreements are carried at their contractual amounts, which approximates fair value due to their short-term nature.
Repurchase and reverse repurchase agreements that are conducted with the same counterparty may be reported on a net basis if they meet the requirements of ASC 210-20, Balance Sheet Offsetting. There are no repurchase and reverse repurchase agreements reported on a net basis in the Company's consolidated financial statements.


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(M) Transfers of Financial Assets: The Company enters into transactions whereby it transfers financial assets to third parties. Upon such a transfer of financial assets, the Company will sometimes retain or acquire interests in the related assets. The Company evaluates transferred assets pursuant to ASC 860-10, Transfers of Financial Assets, or "ASC 860-10," which requires that a determination be made as to whether a transferor has surrendered control over transferred financial assets. That determination must consider the transferor's continuing involvement in the transferred financial asset, including all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer, even if they were not entered into at the time of the transfer. When a transfer of financial assets does not qualify as a sale, ASC 860-10 requires the transfer to be accounted for as a secured borrowing with a pledge of collateral. ASC 860-10 is a standard that requires the Company to exercise significant judgment in determining whether a transaction should be recorded as a "sale" or a "financing."
(N) Variable Interest Entities: VIEs are entities in which: (i) the equity investors do not have the characteristics of a controlling financial interest, or (ii) there is insufficient equity to permit the entity to finance its activities without additional subordinated financial support from other parties. Consolidation of a VIE is required by the entity that is deemed to be the primary beneficiary of the VIE. The Company evaluates all of its interests in VIEs for consolidation under ASC 810. The primary beneficiary is generally the party with both (i) the power to direct the activities of the VIE that most significantly impact its economic performance, and (ii) the obligation to absorb losses and the right to receive benefits from the VIE which could be potentially significant to the VIE.
When the Company has an interest in an entity that has been determined to be a VIE, the Company assesses whether it is deemed to be the primary beneficiary of the VIE. The Company will only consolidate a VIE for which it has concluded it is the primary beneficiary. To assess whether the Company has the power to direct the activities of a VIE that most significantly impact the VIE's economic performance, the Company considers all facts and circumstances, including its role in establishing the VIE and its ongoing rights and responsibilities. This assessment includes (i) identifying the activities that most significantly impact the VIE's economic performance; and (ii) identifying which party, if any, has power over those activities. To assess whether the Company has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE, it considers all of its economic interests, including debt and/or equity investments, as well as other arrangements deemed to be variable interests in the VIE. These assessments to determine whether the Company is the primary beneficiary require significant judgment. In instances where the Company and its related parties have interests in a VIE, the Company considers whether there is a single party in the related party group that meets the criteria to be deemed the primary beneficiary. If one party within the related party group meets such criteria, that reporting entity would be deemed to be the primary beneficiary of the VIE and no further analysis is needed. If no party within the related party group on its own meets the criteria to be deemed the primary beneficiary, but the related party group as a whole meets such criteria, the determination of the primary beneficiary within the related party group requires significant judgment. The Company performs analysis which is based upon qualitative as well as quantitative factors, such as the relationship of the VIE to each of the members of the related party group, as well as the significance of the VIE's activities to those members, with the objective of determining which party is most closely associated with the VIE.
The Company performs ongoing reassessments of (i) whether any entities previously evaluated have become VIEs, based on certain events, and therefore subject to assessment to determine whether consolidation is appropriate, and (ii) whether changes in the facts and circumstances regarding the Company's involvement with a VIE causes its consolidation conclusion regarding the VIE to change. See Note 9 and Note 13 for further information on the Company's consolidated VIEs.
The Company's maximum amount at risk is generally limited to the Company's investment in the VIE. The Company is generally not contractually required to provide and has not provided any form of financial support to the VIEs.
The Company holds beneficial interests in certain securitization trusts that are considered VIEs. The beneficial interests in these securitization trusts are represented by certificates issued by the trusts. The securitization trusts have been structured as pass-through entities that receive principal and interest payments on the underlying collateral and distribute those payments to the certificate holders, which include both third-party investors and the Company. The certificates held by the Company typically include some or all of the most subordinated tranches. The assets held by the trusts are restricted in that they can only be used to fulfill the obligations of the related trust. In certain cases, the design and structure of the securitization trust is such that the Company effectively retains control of the assets as well as the activities that most significantly impact the economic performance of the trust. In such cases, the Company is determined to be the primary beneficiary, and the Company consolidates the trust and all intercompany transactions are eliminated in consolidation. In cases where the Company does not effectively retain control of the assets of, or have the power to direct the activities that most significantly impact the economic performance of, the related trust, it does not consolidate the trust. See Note 10 for further discussion of the Company's securitization trusts.
(O) Offering Costs/Underwriters' Discount: Offering costs and underwriters' discount are charged against stockholders' equity as incurred. Offering costs typically include legal, accounting, and other fees associated with the cost of raising capital.


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(P) Debt Issuance Costs: Debt issuance costs associated with debt for which the Company has elected the FVO are expensed at the issuance of the debt, and are included in Investment related expenses—Other on the Consolidated Statement of Operations. Costs associated with the issuance of debt for which the Company has not elected the FVO are deferred and amortized over the life of the debt, which approximates the effective interest rate method, and are included in Interest expense on the Consolidated Statement of Operations. Deferred debt issuance costs are presented on the Consolidated Balance Sheet as a direct deduction from the related debt liability, unless such deferred debt issuance costs are associated with borrowing facilities that are expected to have a future benefit, such as giving the Company the ability to access additional borrowings over the contractual term of the debt, in which case such deferred debt issuance costs are included in Other assets on the Consolidated Balance Sheet. Debt issuance costs include legal and accounting fees, purchasers' or underwriters' discount, as well as other fees associated with the cost of the issuance of the related debt.
(Q) Expenses: Expenses are recognized as incurred on the Consolidated Statement of Operations.
(R) Investment Related Expenses: Investment related expenses consist of expenses directly related to specific financial instruments. Such expenses generally include dividend expense on common stock sold short, servicing fees and corporate and escrow advances on mortgage and consumer loans, and various other expenses and fees related directly to the Company's financial instruments. The Company has elected the FVO for its investments, and as a result all investment related expenses are expensed as incurred and included in Investment related expenses on the Consolidated Statement of Operations.
(S) Investment Related Receivables: Investment related receivables on the Company's Consolidated Balance Sheet includes receivables for securities sold and interest and principal receivable on securities and loans.
(T) Long Term Incentive Plan Units: Long term incentive plan units of the Operating Partnership ("OP LTIP Units") have been issued to the Company's dedicated or partially dedicated personnel and certain of its directors as well as the Manager. Costs associated with OP LTIP Units issued to dedicated or partially dedicated personnel, or to the Company's directors, are measured as of the grant date based on the Company's closing stock price on the New York Stock Exchange and are amortized over the vesting period in accordance with ASC 718-10, Compensation—Stock Compensation. The vesting periods for OP LTIP Units are typically one year from issuance for non-executive directors, and are typically one year to two years from issuance for dedicated or partially dedicated personnel.
(U) Non-controlling interests: Non-controlling interests include interests in the Operating Partnership represented by units convertible into shares of the Company's common stock ("Convertible Non-controlling Interests"). Convertible Non-controlling Interests include both the OP LTIP Units and those common units ("OP Units") of the Operating Partnership not held by the Company (collectively, the "Convertible Non-controlling Interest Units"). Non-controlling interests also include the interests of joint venture partners in certain of our consolidated subsidiaries. The joint venture partners' interests are not convertible into shares of the Company's common stock. The Company adjusts the Convertible Non-controlling Interests to align their carrying value with their share of total outstanding Operating Partnership units, including both the OP Units held by the Company and the Convertible Non-controlling Interests. Any such adjustments are reflected in Adjustment to non-controlling interests, on the Consolidated Statement of Changes in Equity. See Note 15 for further discussion of non-controlling interests.
(V) Dividends: Dividends payable on shares of common stock and Convertible Non-controlling Interest Units are recorded on the declaration date.
(W) Shares Repurchased: Shares of common stock that are repurchased by the Company subsequent to issuance are immediately retired upon settlement and decrease the total number of shares of common stock issued and outstanding. The cost of such repurchases is charged against Additional paid-in-capital on the Company's Consolidated Balance Sheet.
(X) Earnings Per Share ("EPS"): Basic EPS is computed using the two class method by dividing net income (loss) after adjusting for the impact of Convertible Non-controlling Interests which are participating securities, by the weighted average number of shares of common stock outstanding calculated including Convertible Non-controlling Interests. Because the Company's Convertible Non-controlling Interests are participating securities, they are included in the calculation of both basic and diluted EPS.
(Y) Foreign Currency: The functional currency of the Company is U.S. dollars. Assets and liabilities denominated in foreign currencies are remeasured into U.S. dollars at current exchange rates at the following dates: (i) assets, liabilities, and unrealized gains/losses—at the valuation date; and (ii) income, expenses, and realized gains/losses—at the accrual/transaction date. The Company isolates the portion of realized and change in unrealized gain (loss) resulting from changes in foreign currency exchange rates on investments and financial derivatives from the fluctuations arising from changes in fair value of investments and financial derivatives held. Changes in realized and change in unrealized gain (loss) due to foreign currency are included in Other, net, on the Consolidated Statement of Operations.


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The Company's reporting currency is U.S. Dollars. If the Company has investments in unconsolidated entities that have a functional currency other than U.S. Dollars, the fair value is translated to U.S. dollars using the current exchange rate at the valuation date. The cumulative translation adjustment, if any, associated with the Company's investments in unconsolidated entities is recorded in accumulated other comprehensive income (loss), a component of consolidated stockholders' equity.
(Z) Income Taxes: The Company will elect to be taxed as a REIT under Sections 856 through 860 of the Code. As a REIT, the Company is generally not subject to corporate-level federal and state income tax on net income it distributes to its stockholders within the prescribed timeframes. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including distributing at least 90% of its annual taxable income to stockholders. Even if the Company qualifies as a REIT, it may be subject to certain federal, state, local and foreign taxes on its income and property, and to federal income and excise taxes on its undistributed taxable income. If the Company fails to qualify as a REIT, and does not qualify for certain statutory relief provisions, it will be subject to U.S. federal, state, and local income taxes and may be precluded from qualifying as a REIT for the four taxable years following the year in which the Company fails to qualify as a REIT. The Company believes that commencing on January 1, 2019, the Company was organized in conformity with the requirements for qualification and taxation as a REIT under the U.S. federal income tax laws and that its manner of operation enables it to meet the requirements for qualification and taxation as a REIT. As a result of Ellington Financial Inc.'s expected REIT qualification and expected distributions, it does not generally expect to pay federal or state corporate income taxes. Many of the REIT requirements, however, are highly technical and complex.
As a REIT, if the Company fails to distribute in any calendar year (subject to specific timing rules for certain dividends paid in January) at least the sum of (i) 85% of its ordinary income for such year, (ii) 95% of its capital gain net income for such year, and (iii) any undistributed taxable income from the prior year, the Company would be subject to a non-deductible 4% excise tax on the excess of such required distribution over the sum of (i) the amounts actually distributed and (ii) the amounts of income retained and on which the Company has paid corporate income tax.
The Company elected to treat certain domestic and foreign subsidiaries as TRSs, and may in the future elect to treat other current or future subsidiaries as TRSs. In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate-related business. A domestic TRS may, but is not required to, declare dividends to the Company; such dividends will be included in the Company's taxable income/(loss) and may necessitate a distribution to the Company's stockholders. Conversely, if the Company retains earnings at the level of a domestic TRS, such earnings will increase the book equity of the consolidated entity. A domestic TRS is subject to U.S. federal, state, and local corporate income taxes. The Company has elected and may elect in the future to treat certain of its foreign corporate subsidiaries as TRSs and, accordingly, taxable income generated by these TRSs may not be subject to U.S. federal, state, and local corporate income taxation, but generally will be included in the Company's income on a current basis as Subpart F income, whether or not distributed. However, certain of the Company's foreign subsidiaries may be subject to income taxes in the relevant foreign jurisdictions.
The Company's financial results are generally not expected to reflect provisions for current or deferred income taxes, except for any activities conducted through one or more TRSs that are subject to corporate income taxation.
The Company follows the authoritative guidance on accounting for and disclosure of uncertainty on tax positions, which requires management to determine whether a tax position of the Company is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. For uncertain tax positions, the tax benefit to be recognized is measured as the largest amount of benefit that is more than 50% likely to be realized upon ultimate settlement. The Company did not have any unrecognized tax benefits resulting from tax positions related to the current period or its open tax years. In the normal course of business, the Company may be subject to examination by federal, state, local, and foreign jurisdictions, where applicable, for the current period and its open tax years. The Company may take positions with respect to certain tax issues which depend on legal interpretation of facts or applicable tax regulations. Should the relevant tax regulators successfully challenge any of such positions, the Company might be found to have a tax liability that has not been recorded in the accompanying consolidated financial statements. Also, management's conclusions regarding the authoritative guidance may be subject to review and adjustment at a later date based on changing tax laws, regulations, and interpretations thereof.
(AA) Recent Accounting Pronouncements: In August 2018, the Financial Accounting Standards Board, or "FASB," issued ASU 2018-13, Fair Value Measurement—Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"). This amends ASC 820 to remove or modify various current disclosure requirements related to fair value measurement. Additionally, ASU 2018-13 requires certain additional disclosures around fair value measurement. ASU 2018-13 is effective for annual periods beginning after December 15, 2019 and interim periods within those years, with early adoption permitted. Entities are permitted to early adopt any removed or modified disclosures and delay adoption of the additional disclosures until their effective date. The Company has elected to early adopt the removal and modification of


108


various disclosure requirements in accordance with ASU 2018-13; early adoption has not had a material impact on the Company's consolidated financial statements. The Company has elected not to early adopt the additional disclosure requirements. The adoption of the additional disclosure requirements, as required under ASU 2018-13, is not expected to have a material impact on the Company's consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses ("ASU 2016-13"). ASU 2016-13 introduces a new model related to the accounting for credit losses on financial assets subject to credit losses and measured at amortized cost and certain off-balance sheet credit exposures. ASU 2016-13 amends the current guidance, which requires an OTTI charge only when fair value is below the amortized cost of an asset. The length of time the fair value of an available-for-sale debt security has been below the amortized cost will no longer impact the determination of whether a credit loss exists. As a result, it is no longer an other-than-temporary model. In addition, credit losses on available-for-sale debt securities will now be limited to the difference between the security's amortized cost basis and its fair value. The new debt security model will also require the use of an allowance to record estimated credit losses. The new guidance also expands the disclosure requirements regarding an entity's assumptions and models. In addition, public entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination (i.e., by vintage year). ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The adoption of the additional disclosure requirements, as required under ASU 2018-13, is not expected to have a material impact on the Company's consolidated financial statements as all of the Company's securities and loans are carried at fair value, with changes in fair value recorded in earnings.


109


3. Valuation
The table below reflects the value of the Company's Level 1, Level 2, and Level 3 financial instruments that are measured at fair value on a recurring basis as of December 31, 2019:
Description
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In thousands)
Assets:
 
 
 
 
 
 
 
 
Securities, at fair value:
 
 
 
 
 
 
 
 
Agency RMBS
 
$

 
$
1,917,059

 
$
19,904

 
$
1,936,963

Non-Agency RMBS
 

 
76,969

 
89,581

 
166,550

CMBS
 

 
95,063

 
29,805

 
124,868

CLOs
 

 
125,464

 
44,979

 
170,443

Asset-backed securities, backed by consumer loans
 

 

 
48,610

 
48,610

Corporate debt securities
 

 

 
1,113

 
1,113

Corporate equity securities
 

 

 
1,394

 
1,394

Loans, at fair value:
 
 
 
 
 
 
 
 
Residential mortgage loans
 

 

 
932,203

 
932,203

Commercial mortgage loans
 

 

 
274,759

 
274,759

Consumer loans
 

 

 
186,954

 
186,954

Corporate loans
 

 

 
18,510

 
18,510

Investment in unconsolidated entities, at fair value
 

 

 
71,850

 
71,850

Financial derivatives–assets, at fair value:
 
 
 
 
 
 
 
 
Credit default swaps on asset-backed securities
 

 

 
993

 
993

Credit default swaps on asset-backed indices
 

 
3,319

 

 
3,319

Credit default swaps on corporate bonds
 

 
2

 

 
2

Credit default swaps on corporate bond indices
 

 
5,599

 

 
5,599

Interest rate swaps
 

 
5,468

 

 
5,468

TBAs
 

 
596

 

 
596

Total return swaps
 

 

 
620

 
620

Futures
 
148

 

 

 
148

Forwards
 

 
43

 

 
43

Total assets
 
$
148

 
$
2,229,582

 
$
1,721,275

 
$
3,951,005

Liabilities:
 
 
 
 
 
 
 
 
Securities sold short, at fair value:
 
 
 
 
 
 
 
 
Government debt
 
$

 
$
(72,938
)
 
$

 
$
(72,938
)
Corporate debt securities
 

 
(471
)
 

 
(471
)
Financial derivatives–liabilities, at fair value:
 
 
 
 
 
 
 
 
Credit default swaps on asset-backed indices
 

 
(250
)
 

 
(250
)
Credit default swaps on corporate bonds
 

 
(1,693
)
 

 
(1,693
)
Credit default swaps on corporate bond indices
 

 
(14,524
)
 

 
(14,524
)
Interest rate swaps
 

 
(8,719
)
 

 
(8,719
)
TBAs
 

 
(1,012
)
 

 
(1,012
)
Futures
 
(45
)
 

 

 
(45
)
Forwards
 

 
(169
)
 

 
(169
)
Total return swaps
 

 
(773
)
 
(436
)
 
(1,209
)
Other secured borrowings, at fair value
 

 

 
(594,396
)
 
(594,396
)
Total liabilities
 
$
(45
)
 
$
(100,549
)
 
$
(594,832
)
 
$
(695,426
)



110


The following table identifies the significant unobservable inputs that affect the valuation of the Company's Level 3 assets and liabilities as of December 31, 2019:
 
 
Fair Value
 
Valuation 
Technique
 
Unobservable Input
 
Range
 
Weighted
Average
Description
 
 
 
 
Min
 
Max
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Non-Agency RMBS
 
$
38,754

 
Market Quotes
 
Non Binding Third-Party Valuation
 
$
6.68

 
$
144.79

 
$
86.21

CMBS
 
29,630

 
Market Quotes
 
Non Binding Third-Party Valuation
 
5.08

 
80.72

 
64.73

CLOs
 
38,220

 
Market Quotes
 
Non Binding Third-Party Valuation
 
40.00

 
96.00

 
73.98

Agency interest only RMBS
 
3,753

 
Market Quotes
 
Non Binding Third-Party Valuation
 
1.36

 
16.61

 
5.11

Corporate loans
 
6,010

 
Market Quotes
 
Non Binding Third-Party Valuation
 
100.00

 
100.00

 
100.00

ABS backed by consumer loans
 
139

 
Market Quotes
 
Non Binding Third-Party Valuation
 
95.47

 
96.78

 
96.12

Non-Agency RMBS
 
50,827

 
Discounted Cash Flows
 
Yield
 
3.3
%
 
60.9
%
 
10.0
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
0.8
%
 
72.0
%
 
49.3
%
 
 
 
 
 
 
Projected Collateral Losses
 
0.0
%
 
22.7
%
 
6.6
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
0.0
%
 
32.4
%
 
6.9
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
16.9
%
 
92.9
%
 
37.2
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Non-Agency CMBS
 
175

 
Discounted Cash Flows
 
Yield
 
10.0
%
 
10.0
%
 
10.0
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
100.0
%
 
100.0
%
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Corporate debt and equity
 
2,507

 
Discounted Cash Flows
 
Yield
 
10.0
%
 
10.0
%
 
10.0
%
CLOs
 
6,759

 
Discounted Cash Flows
 
Yield
 
14.0
%
 
41.9
%
 
26.2
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
48.5
%
 
84.6
%
 
72.5
%
 
 
 
 
 
 
Projected Collateral Losses
 
11.7
%
 
36.4
%
 
19.9
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
3.7
%
 
15.1
%
 
7.6
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
ABS backed by consumer loans
 
48,471

 
Discounted Cash Flows
 
Yield
 
12.0
%
 
20.2
%
 
12.1
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
0.0
%
 
11.2
%
 
9.7
%
 
 
 
 
 
 
Projected Collateral Losses
 
0.6
%
 
18.0
%
 
15.4
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
71.3
%
 
99.4
%
 
74.9
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 


111


(continued)
 
Fair Value
 
Valuation 
Technique
 
Unobservable Input
 
Range
 
Weighted
Average
Description
 
 
 
 
Min
 
Max
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Consumer loans
 
$
186,954

 
Discounted Cash Flows
 
Yield
 
7.0
%
 
10.0
%
 
8.1
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
0.0
%
 
44.2
%
 
16.0
%
 
 
 
 
 
 
Projected Collateral Losses
 
3.0
%
 
84.5
%
 
8.6
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
15.5
%
 
95.8
%
 
75.4
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Corporate loans
 
12,500

 
Discounted Cash Flows
 
Yield
 
15.0
%
 
18.0
%
 
16.8
%
Performing commercial mortgage loans
 
248,214

 
Discounted Cash Flows
 
Yield
 
7.7
%
 
16.6
%
 
8.8
%
Non-performing commercial mortgage loans
 
26,545

 
Discounted Cash Flows
 
Yield
 
9.8
%
 
14.7
%
 
12.4
%
 
 
 
 
 
 
Months to Resolution
 
1.1

 
23.0

 
11.4

Performing and re-performing residential mortgage loans
 
289,672

 
Discounted Cash Flows
 
Yield
 
1.6
%
 
19.5
%
 
6.2
%
Securitized residential mortgage loans(1)(2)
 
628,415

 
Discounted Cash Flows
 
Yield
 
3.2
%
 
4.3
%
 
3.6
%
Non-performing residential mortgage loans
 
14,116

 
Discounted Cash Flows
 
Yield
 
1.0
%
 
26.6
%
 
9.1
%
 
 
 
 
 
 
Months to Resolution
 
1.1

 
165.4

 
54.6

Total return swaps—asset
 
620

 
Discounted Cash Flows
 
Yield
 
8.5
%
 
27.7
%
 
11.5
%
Credit default swaps on asset-backed securities
 
993

 
Net Discounted Cash Flows
 
Projected Collateral Prepayments
 
35.4
%
 
42.0
%
 
37.3
%
 
 
 
 
 
 
Projected Collateral Losses
 
4.2
%
 
12.4
%
 
10.2
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
10.0
%
 
18.2
%
 
15.3
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
36.2
%
 
41.5
%
 
37.2
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Agency interest only RMBS
 
16,151

 
Option Adjusted Spread ("OAS")
 
LIBOR OAS(3)
 
93

 
3,527

 
701

 
 
 
 
 
 
Projected Collateral Prepayments
 
12.3
%
 
100.0
%
 
72.3
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
0.0
%
 
87.7
%
 
27.7
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Investment in unconsolidated entities
 
41,392

 
Enterprise Value
 
Equity Price-to-Book(4)
 
1.0x
 
4.7x
 
1.7x
Investment in unconsolidated entities
 
30,458

 
Discounted Cash Flows
 
Yield(5)
 
3.7%
 
14.8%
 
9.9%
Other secured borrowings, at fair value(1)
 
(594,396
)
 
Discounted Cash Flows
 
Yield
 
2.9%
 
4.0%
 
3.3%
Total return swaps—liability
 
(436
)
 
Discounted Cash Flows
 
Yield
 
27.7%
 
27.7%
 
27.7%
(1)
Securitized residential mortgage loans and Other secured borrowings, at fair value, represent financial assets and liabilities of the Company's CFEs as discussed in Note 2.
(2)
Includes $1.5 million of non-performing securitized residential mortgage loans.
(3)
Shown in basis points.
(4)
Represent an estimation of where market participants might value an enterprise on a price-to-book basis.
(5)
Represents the significant unobservable inputs used to fair value the financial instruments of the unconsolidated entity. The fair value of such financial instruments is the largest component of the valuation of such entity as a whole.
Third-party non-binding valuations are validated by comparing such valuations to internally generated prices based on the Company's models and, when available, to recent trading activity in the same or similar instruments.
For those instruments valued using discounted and net discounted cash flows, collateral prepayments, losses, recoveries, and scheduled amortization are projected over the remaining life of the collateral and expressed as a percentage of the


112


collateral's current principal balance. Averages are weighted based on the fair value of the related instrument. In the case of credit default swaps on asset-backed securities, averages are weighted based on each instrument's bond equivalent value. Bond equivalent value represents the investment amount of a corresponding position in the reference obligation, calculated as the difference between the outstanding principal balance of the underlying reference obligation and the fair value, inclusive of accrued interest, of the derivative contract. For those assets valued using the LIBOR Option Adjusted Spread ("LIBOR OAS") valuation methodology, cash flows are projected using the Company's models over multiple interest rate scenarios, and these projected cash flows are then discounted using the LIBOR rates implied by each interest rate scenario. The LIBOR OAS of an asset is then computed as the unique constant yield spread that, when added to all LIBOR rates in each interest rate scenario generated by the model, will equate (a) the expected present value of the projected asset cash flows over all model scenarios to (b) the actual current market price of the asset. LIBOR OAS is therefore model-dependent. Generally speaking, LIBOR OAS measures the additional yield spread over LIBOR that an asset provides at its current market price after taking into account any interest rate options embedded in the asset. The Company considers the expected timeline to resolution in the determination of fair value for its non-performing commercial and residential mortgage loans.
Material changes in any of the inputs above in isolation could result in a significant change to reported fair value measurements. Additionally, fair value measurements are impacted by the interrelationships of these inputs. For example, for instruments subject to prepayments and credit losses, such as non-Agency RMBS and consumer loans and ABS backed by consumer loans, a higher expectation of collateral prepayments will generally be accompanied by a lower expectation of collateral losses. Conversely, higher losses will generally be accompanied by lower prepayments. Because the Company's credit default swaps on asset-backed security holdings represent credit default swap contracts whereby the Company has purchased credit protection, such credit default swaps on asset-backed securities generally have the directionally opposite sensitivity to prepayments, losses, and recoveries as compared to the Company's long securities holdings. Prepayments do not represent a significant input for the Company's commercial mortgage-backed securities and commercial mortgage loans. Losses and recoveries do not represent a significant input for the Company's Agency RMBS interest only securities, given the guarantee of the issuing government agency or government-sponsored enterprise.


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The table below includes a roll-forward of the Company's financial instruments for the year ended December 31, 2019 (including the change in fair value), for financial instruments classified by the Company within Level 3 of the valuation hierarchy.
Year Ended December 31, 2019
(In thousands)
Beginning Balance as of 
January 1, 2019
 
Accreted
Discounts /
(Amortized
Premiums)
 
Net Realized
Gain/
(Loss)
 
Change in Net
Unrealized
Gain/(Loss)
 
Purchases/Payments(1)
 
Sales/Issuances(2)
 
Transfers Into Level 3
 
Transfers Out of Level 3
 
Ending
Balance as of 
December 31, 2019
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities, at fair value:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency RMBS
$
7,293

 
$
(3,464
)
 
$
(1,787
)
 
$
808

 
$
13,818

 
$
(1,306
)
 
$
5,370

 
$
(828
)
 
$
19,904

Non-Agency RMBS
91,291

 
270

 
5,636

 
(3,654
)
 
21,512

 
(33,664
)
 
15,354

 
(7,164
)
 
89,581

CMBS
803

 
16

 
180

 
(246
)
 
31,464

 
(5,271
)
 
2,859

 

 
29,805

CLOs
14,915

 
(268
)
 
(3,190
)
 
2,329

 
25,531

 
(5,112
)
 
11,984

 
(1,210
)
 
44,979

Asset-backed securities backed by consumer loans
22,800

 
(2,520
)
 
(891
)
 
873

 
42,137

 
(13,789
)
 

 

 
48,610

Corporate debt securities
6,318

 
22

 
(1,341
)
 
188

 
11,024

 
(15,098
)
 

 

 
1,113

Corporate equity securities
1,534

 

 
(1,807
)
 
205

 
1,462

 

 

 

 
1,394

Loans, at fair value:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage loans
496,830

 
(6,081
)
 
1,466

 
8,800

 
661,813

 
(230,625
)
 

 

 
932,203

Commercial mortgage loans
195,301

 
(282
)
 
2,412

 
(2,083
)
 
175,689

 
(96,278
)
 

 

 
274,759

Consumer loans
183,961

 
(28,521
)
 
(6,291
)
 
3,000

 
183,994

 
(149,189
)
 

 

 
186,954

Corporate loan

 
36

 

 
(36
)
 
18,510

 

 

 

 
18,510

Investments in unconsolidated entities, at fair value
72,298

 

 
1,545

 
8,664

 
42,173

 
(52,830
)
 

 

 
71,850

Financial derivatives–assets, at fair value-
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit default swaps on asset-backed securities
1,472

 

 
528

 
(479
)
 
33

 
(561
)
 

 

 
993

Total return swaps

 

 
160

 
620

 

 
(160
)
 

 

 
620

Total assets, at fair value
$
1,094,816

 
$
(40,792
)
 
$
(3,380
)
 
$
18,989

 
$
1,229,160

 
$
(603,883
)
 
$
35,567

 
$
(9,202
)
 
$
1,721,275

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Financial derivatives–assets, at fair value-
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total return swaps
$

 
$

 
$
(15
)
 
$
(436
)
 
$
15

 
$

 
$

 
$

 
$
(436
)
Other secured borrowings, at fair value
(297,948
)
 

 

 
(502
)
 
182,291

 
(478,237
)
 

 

 
(594,396
)
Total liabilities, at fair value
$
(297,948
)
 
$

 
$
(15
)
 
$
(938
)
 
$
182,306

 
$
(478,237
)
 
$

 
$

 
$
(594,832
)
(1)
For Investments in unconsolidated entities, at fair value, amount represents contributions to investments in unconsolidated entities.
(2)
For Investments in unconsolidated entities, at fair value, amount represents distributions from investments in unconsolidated entities.
All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at December 31, 2019, as well as Level 3 financial instruments disposed of by the Company during the year ended December 31, 2019. For Level 3 financial instruments held by the Company at December 31, 2019, change in net unrealized gain (loss) of $2.4 million, $11.5 million, $5.2 million, $0.1 million, $(0.4) million, and $0.1 million, for the year ended December 31, 2019 relate to securities, loans, investments in unconsolidated entities, financial derivatives–assets, financial derivatives–liabilities, and other secured borrowings, at fair value, respectively.
At December 31, 2019, the Company transferred $9.2 million of assets from Level 3 to Level 2 and $35.6 million from Level 2 to Level 3. Transfers between these hierarchy levels were based on the availability of sufficient observable inputs to


114


meet Level 2 versus Level 3 criteria. The leveling of each financial instrument is reassessed at the end of each period, and is based on pricing information received from third-party pricing sources.
The following table summarizes the estimated fair value of all other financial instruments not measured at fair value on a recurring basis as of December 31, 2019:
(In thousands)
 
Fair Value
 
Carrying Value
Other financial instruments
 
 
 
 
Assets:
 
 
 
 
Cash and cash equivalents
 
$
72,302

 
$
72,302

Restricted cash
 
175

 
175

Due from brokers
 
79,829

 
79,829

Reverse repurchase agreements
 
73,639

 
73,639

Liabilities:
 
 
 
 
Repurchase agreements
 
2,445,300

 
2,445,300

Other secured borrowings
 
150,334

 
150,334

Senior notes, net
 
88,365

 
85,298

Due to brokers
 
2,197

 
2,197

Cash and cash equivalents generally includes cash held in interest bearing overnight accounts, for which fair value equals the carrying value, and investments which are liquid in nature, such as investments in money market accounts or U.S. Treasury Bills, for which fair value equals the carrying value; such assets are considered Level 1. Restricted cash includes cash held in a segregated account for which fair value equals the carrying value; such assets are considered Level 1. Due from brokers and Due to brokers include collateral transferred to or received from counterparties, along with receivables and payables for open and/or closed derivative positions. These receivables and payables are short term in nature and any collateral transferred consists primarily of cash; fair value of these items is approximated by carrying value and such items are considered Level 1. The Company's reverse repurchase agreements, repurchase agreements, and other secured borrowings are carried at cost, which approximates fair value due to their short term nature. Reverse repurchase agreements, repurchase agreements, and other secured borrowings are classified as Level 2 based on the adequacy of the collateral and their short term nature. The Senior notes are considered Level 3 liabilities given the relative unobservability of the most significant inputs to valuation estimation as well as the lack of trading activity of these instruments. As of December 31, 2019, the estimated fair value of the Company's Senior notes was based on a third-party valuation.


115


4. Investment in Securities
The Company's securities portfolio primarily consists of Agency RMBS, non-Agency RMBS, CMBS, CLOs, ABS backed by consumer loans, and corporate debt and equity. The following table details the Company's investment in securities as of December 31, 2019.
 
 
 
 
 
 
 
 
Gross Unrealized
 
 
 
Weighted Average
($ in thousands)
 
Current Principal
 
Unamortized Premium (Discount)
 
Amortized Cost
 
Gains
 
Losses
 
Fair Value
 
Coupon(1)
 
Yield
 
Life (Years)(2)
Long:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-year fixed-rate mortgages
 
$
314,636

 
$
6,369

 
$
321,005

 
$
2,604

 
$
(203
)
 
$
323,406

 
3.05
%
 
2.28
%
 
3.05
20-year fixed-rate mortgages
 
804

 
49

 
853

 
24

 

 
877

 
4.62
%
 
2.99
%
 
4.80
30-year fixed-rate mortgages
 
1,358,762

 
64,846

 
1,423,608

 
13,821

 
(2,830
)
 
1,434,599

 
4.20
%
 
2.95
%
 
6.63
Adjustable rate mortgages
 
9,651

 
315

 
9,966

 
90

 
(54
)
 
10,002

 
3.99
%
 
2.03
%
 
4.09
Reverse mortgages
 
122,670

 
8,133

 
130,803

 
2,023

 
(26
)
 
132,800

 
4.43
%
 
2.78
%
 
6.67
Interest only securities
 
 n/a

 
 n/a

 
34,044

 
1,624

 
(389
)
 
35,279

 
2.81
%
 
9.27
%
 
3.86
Non-Agency RMBS
 
274,353

 
(122,685
)
 
151,668

 
12,549

 
(1,081
)
 
163,136

 
3.41
%
 
7.25
%
 
5.31
CMBS
 
185,417

 
(67,961
)
 
117,456

 
2,990

 
(480
)
 
119,966

 
3.31
%
 
6.62
%
 
8.94
Non-Agency interest only securities
 
 n/a

 
 n/a

 
6,517

 
1,817

 
(18
)
 
8,316

 
1.10
%
 
8.18
%
 
4.14
CLOs
 
 n/a

 
 n/a

 
169,238

 
4,219

 
(3,014
)
 
170,443

 
5.05
%
 
9.62
%
 
4.75
ABS backed by consumer loans
 
67,080

 
(19,154
)
 
47,926

 
1,596

 
(912
)
 
48,610

 
12.17
%
 
14.00
%
 
1.22
Corporate debt
 
22,125

 
(21,241
)
 
884

 
229

 

 
1,113

 
%
 
%
 
0.33
Corporate equity
 
 n/a

 
 n/a

 
1,242

 
152

 

 
1,394

 
n/a

 
n/a

 
n/a
Total Long
 
2,355,498

 
(151,329
)
 
2,415,210

 
43,738

 
(9,007
)
 
2,449,941

 
4.15
%
 
4.09
%
 
5.88
Short:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate debt
 
(450
)
 
(6
)
 
(456
)
 

 
(15
)
 
(471
)
 
5.44
%
 
5.21
%
 
4.90
U.S. Treasury securities
 
(63,140
)
 
381

 
(62,759
)
 
63

 
(298
)
 
(62,994
)
 
1.76
%
 
1.87
%
 
6.11
European sovereign bonds
 
(9,759
)
 
133

 
(9,626
)
 

 
(318
)
 
(9,944
)
 
0.77
%
 
0.12
%
 
1.58
Total Short
 
(73,349
)
 
508

 
(72,841
)
 
63

 
(631
)
 
(73,409
)
 
1.65
%
 
1.66
%
 
5.49
Total
 
$
2,282,149

 
$
(150,821
)
 
$
2,342,369

 
$
43,801

 
$
(9,638
)
 
$
2,376,532

 
4.23
%
 
4.01
%
 
5.90
(1)
Weighted average coupon represents the weighted average coupons of the securities, rather than, in the case of collateralized securities, the coupon rates or loan rates on the underlying collateral.
(2)
Average lives of MBS are generally shorter than stated contractual maturities. Average lives are affected by the contractual maturities of the underlying mortgages, scheduled periodic payments of principal, and unscheduled prepayments of principal.


116


The following table details weighted average life of the Company's Agency RMBS as of December 31, 2019.
($ in thousands)
 
Agency RMBS
 
Agency Interest Only Securities
Estimated Weighted Average Life(1)
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon(2)
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon(2)
Less than three years
 
$
188,593

 
$
187,099

 
3.39
%
 
$
9,011

 
$
8,611

 
3.35
%
Greater than three years and less than seven years
 
961,839

 
953,031

 
4.25
%
 
25,334

 
24,512

 
2.66
%
Greater than seven years and less than eleven years
 
713,862

 
708,805

 
3.89
%
 
934

 
921

 
1.90
%
Greater than eleven years
 
37,390

 
37,300

 
3.51
%
 

 

 
%
Total
 
$
1,901,684

 
$
1,886,235

 
4.02
%
 
$
35,279

 
$
34,044

 
2.81
%
(1)
Average lives of RMBS are generally shorter than stated contractual maturities. Average lives are affected by the contractual maturities of the underlying mortgages, scheduled periodic payments of principal, and unscheduled prepayments of principal.
(2)
Weighted average coupon represents the weighted average coupons of the securities, rather than the coupon rates or loan rates on the underlying collateral.
The following table details weighted average life of the Company's long non-Agency RMBS, CMBS, and CLOs and other securities as of December 31, 2019.
($ in thousands)
 
Non-Agency RMBS and CMBS
 
Non-Agency IOs
 
CLOs and Other Securities(2)
Estimated Weighted Average Life(1)
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon(3)
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon(3)
 
Fair Value
 
Amortized Cost
 
Weighted Average Coupon(3)
Less than three years
 
$
50,120

 
$
48,213

 
2.73
%
 
$
439

 
$
401

 
1.37
%
 
$
54,446

 
$
54,090

 
11.11
%
Greater than three years and less than seven years
 
87,436

 
79,326

 
4.42
%
 
7,877

 
6,116

 
1.08
%
 
157,384

 
155,651

 
5.38
%
Greater than seven years and less than eleven years
 
127,533

 
123,924

 
3.31
%
 

 

 
%
 
8,336

 
8,307

 
%
Greater than eleven years
 
18,013

 
17,661

 
0.81
%
 

 

 
%
 

 

 
%
Total
 
$
283,102

 
$
269,124

 
3.37
%
 
$
8,316

 
$
6,517

 
1.10
%
 
$
220,166

 
$
218,048

 
6.60
%
(1)
Average lives of MBS are generally shorter than stated contractual maturities. Average lives are affected by the contractual maturities of the underlying mortgages, scheduled periodic payments of principal, and unscheduled prepayments of principal.
(2)
Other Securities includes asset-backed securities, backed by consumer loans, corporate debt, and U.S. Treasury securities.
(3)
Weighted average coupon represents the weighted average coupons of the securities, rather than the coupon rates or loan rates on the underlying collateral.
The following table details the components of interest income by security type for the year ended December 31, 2019:
(In thousands)
 
Year Ended
December 31, 2019
Security Type
 
Coupon Interest
 
Net Amortization
 
Interest Income
Agency RMBS
 
$
62,103

 
$
(24,731
)
 
$
37,372

Non-Agency RMBS and CMBS
 
13,855

 
2,782

 
16,637

CLOs
 
15,857

 
(1,599
)
 
14,258

Other securities(1)
 
7,157

 
(2,468
)
 
4,689

Total
 
$
98,972

 
$
(26,016
)
 
$
72,956

(1)
Other securities includes ABS backed by consumer loans, corporate debt securities, and U.S. Treasury securities.
For the year ended December 31, 2019 the Catch-Up Premium Amortization Adjustment was $(4.7) million.


117


The following table presents proceeds from sales and the resulting realized gains and (losses) of the Company's securities for the year ended December 31, 2019.
(In thousands)
 
Year Ended
December 31, 2019
Security Type
 
Proceeds(1)
 
Gross Realized Gains
 
Gross Realized Losses
 
Net Realized Gain (Loss)
Agency RMBS
 
$
1,010,251

 
$
9,006

 
$
(4,924
)
 
$
4,082

Non-Agency RMBS and CMBS
 
184,725

 
12,552

 
(7,348
)
 
5,204

CLOs
 
62,063

 
1,286

 
(19,464
)
 
(18,178
)
Other securities(2)
 
636,886

 
1,113

 
(4,863
)
 
(3,750
)
Total
 
$
1,893,925

 
$
23,957

 
$
(36,599
)
 
$
(12,642
)
(1)
Includes proceeds on sales of securities not yet settled as of period end.
(2)
Other securities includes ABS backed by consumer loans, corporate debt and equity, exchange-traded equity, and U.S. Treasury securities.
The following table presents the fair value and gross unrealized losses of our long securities by length of time that such securities have been in an unrealized loss position at December 31, 2019.
(In thousands)
 
Less than 12 Months
 
Greater than 12 Months
 
Total
Security Type
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
Agency RMBS
 
$
328,968

 
$
(1,503
)
 
$
125,095

 
$
(1,999
)
 
$
454,063

 
$
(3,502
)
Non-Agency RMBS and CMBS
 
88,495

 
(880
)
 
27,218

 
(699
)
 
115,713

 
(1,579
)
CLOs
 
37,354

 
(1,911
)
 
9,245

 
(1,103
)
 
46,599

 
(3,014
)
Other securities(1)
 
16,562

 
(852
)
 
1,380

 
(60
)
 
17,942

 
(912
)
Total
 
$
471,379

 
$
(5,146
)
 
$
162,938

 
$
(3,861
)
 
$
634,317

 
$
(9,007
)
(1)
Other securities includes ABS backed by consumer loans, corporate debt and equity, and U.S. Treasury securities.
As described in Note 2, the Company evaluates the cost basis of its securities for impairment on at least a quarterly basis. For the year ended December 31, 2019, the Company recognized an impairment charge of $28.7 million, on the cost basis of its securities, which is included in Realized gains (losses) on securities and loans, net, on the Consolidated Statement of Operations. For each of the remaining securities in a loss position at December 31, 2019, the unrealized loss is due to market conditions and not to a change in the credit quality of the securities. In addition, any unrealized losses on the Company's Agency RMBS accounted for under ASC 320 are not due to credit losses given their explicit guarantee of principal and interest by the issuing government agency or government-sponsored enterprise, but rather are due to changes in interest rates and prepayment expectations.
5. Investment in Loans
The Company invests in various types of loans, such as residential mortgage, commercial mortgage, consumer, and corporate loans. As discussed in Note 2, the Company has elected the FVO for its investments in loans. The following table is a summary of the Company's investments in loans as of December 31, 2019:
Loan Type
 
Unpaid Principal Balance
 
Fair Value
 
 
(In thousands)
Residential mortgage loans
 
$
911,705

 
$
932,203

Commercial mortgage loans
 
277,870

 
274,759

Consumer loans
 
179,743

 
186,954

Corporate loans
 
18,415

 
18,510

Total
 
$
1,387,733

 
$
1,412,426




118


The Company is subject to credit risk in connection with its investments in loans. The two primary components of credit risk are default risk, which is the risk that a borrower fails to make scheduled principal and interest payments, and severity risk, which is the risk of loss upon a borrower default on a mortgage loan or other secured or unsecured loan. Severity risk includes the risk of loss of value of the property or other asset, if any, securing the loan, as well as the risk of loss associated with taking over the property or other asset, if any, including foreclosure costs.
The following table provides details, by accrual status, for loans that are 90 days or more past due as of December 31, 2019:
(In thousands)
 
Unpaid Principal Balance
 
Fair Value
90 days or more past due—non-accrual status
 
 
 
 
Residential mortgage loans
 
$
22,092

 
$
19,401

Commercial mortgage loans
 
28,936

 
26,545

Consumer loans
 
5,633

 
5,225


Residential Mortgage Loans
The table below details certain information regarding the Company's residential mortgage loans as of December 31, 2019:
 
 
 
 
 
 
 
 
Gross Unrealized
 
 
 
Weighted Average
($ in thousands)
 
Unpaid Principal Balance
 
Premium (Discount)
 
 Amortized Cost
 
 Gains
 
Losses
 
Fair Value
 
Coupon
 
Yield
 
Life (Years)(1)
Residential mortgage loans, held-for-investment(2)
 
$
911,705

 
$
9,354

 
$
921,059

 
$
13,082

 
$
(1,938
)
 
$
932,203

 
6.44
%
 
5.79
%
 
1.90
(1)
Average lives of loans are generally shorter than stated contractual maturities. Average lives are affected by scheduled periodic payments of principal and unscheduled prepayments of principal.
(2)
Includes $628.4 million of non-QM loans that have been securitized and are held in consolidated securitization trusts; see Note 10.
The table below summarizes the geographic distribution of the real estate collateral underlying the Company's residential mortgage loans as of December 31, 2019:
Property Location by U.S. State
 
Percentage of Total Outstanding Unpaid Principal Balance
California
 
46.6
%
Florida
 
11.9
%
Texas
 
11.9
%
Colorado
 
3.2
%
Massachusetts
 
2.9
%
Arizona
 
2.4
%
Oregon
 
2.2
%
Utah
 
1.9
%
Illinois
 
1.7
%
Nevada
 
1.6
%
Washington
 
1.6
%
New York
 
1.3
%
Maryland
 
1.1
%
New Jersey
 
1.1
%
Other
 
8.6
%
 
 
100.0
%



119


The following table presents information on the Company's residential mortgage loans by re-performing or non-performing status, as of December 31, 2019.
(In thousands)
 
Unpaid Principal Balance
 
Fair Value
Re-performing
 
$
27,663

 
$
25,323

Non-performing
 
17,757

 
15,580


As described in Note 2, the Company evaluates the cost basis of its residential mortgage loans for impairment on at least a quarterly basis. For the year ended December 31, 2019, the Company recognized an impairment charge of $0.9 million on the cost basis of its residential mortgage loans, which is included in Realized gains (losses) on securities and loans, net, on the Consolidated Statement of Operations.
As of December 31, 2019, the Company had residential mortgage loans that were in the process of foreclosure with a fair value of $10.9 million.
Commercial Mortgage Loans
The table below details certain information regarding the Company's commercial mortgage loans as of December 31, 2019:
 
 
 
 
 
 
 
 
Gross Unrealized
 
 
 
Weighted Average
($ in thousands)
 
Unpaid Principal Balance
 
Premium (Discount)
 
 Amortized Cost
 
 Gains
 
Losses
 
Fair Value
 
Coupon
 
Yield(1)
 
Life (Years)(2)
Commercial mortgage loans, held-for-investment
 
$
277,870

 
$
(3,302
)
 
$
274,568

 
$
253

 
$
(62
)
 
$
274,759

 
7.65
%
 
8.58
%
 
1.07
(1)
Excludes commercial mortgage loans, held at par in non-accrual status, with a fair value of $10.7 million.
(2)
Average lives of loans are generally shorter than stated contractual maturities. Average lives are affected by scheduled periodic payments of principal and unscheduled prepayments of principal.
The table below summarizes the geographic distribution of the real estate collateral underlying the Company's commercial mortgage loans as of December 31, 2019:
Property Location by U.S. State
 
Percentage of Total Outstanding Unpaid Principal Balance
Florida
 
31.7
%
New York
 
17.7
%
New Jersey
 
13.3
%
Connecticut
 
8.2
%
Virginia
 
6.8
%
Massachusetts
 
4.7
%
Missouri
 
4.6
%
Arizona
 
3.8
%
Indiana
 
2.1
%
North Carolina
 
1.8
%
Nevada
 
1.5
%
Tennessee
 
1.5
%
Illinois
 
1.2
%
Other
 
1.1
%
 
 
100.0
%

As of December 31, 2019, the Company had three non-performing commercial mortgage loans with an unpaid principal balance and fair value of $28.9 million and $26.5 million, respectively. The Company evaluates the cost basis of its commercial mortgage loans for impairment on at least a quarterly basis.


120


As of December 31, 2019, the Company had two commercial mortgage loans with a fair value of $16.0 million that were in the process of foreclosure.
Consumer Loans
The table below details certain information regarding the Company's consumer loans as of December 31, 2019:
 
 
 
 
 
 
 
 
Gross Unrealized
 
 
 
Weighted Average
($ in thousands)
 
Unpaid Principal Balance
 
Premium (Discount)
 
Amortized Cost
 
Gains
 
Losses
 
Fair Value(1)
 
Life (Years)(2)
 
Delinquency (Days)
Consumer loans, held-for-investment
 
$
179,743

 
$
5,027

 
$
184,770

 
$
2,561

 
$
(377
)
 
$
186,954

 
0.82
 
4
(1)
Includes $0.6 million of charged-off loans for which the Company has determined that it is probable the servicer will be able to collect principal and interest.
(2)
Average lives of loans are generally shorter than stated contractual maturities. Average lives are affected by scheduled periodic payments of principal and unscheduled prepayments of principal.
The table below provides details on the delinquency status of the Company's consumer loans, which the Company uses as an indicator of credit quality, as of December 31, 2019:
Days Past Due
 
Delinquency Status(1)
Current
 
95.3
%
30-59 Days
 
2.1
%
60-89 Days
 
1.4
%
90-119 Days
 
1.2
%
 
 
100.0
%
(1)
As a percentage of total unpaid principal balance.
During the year ended December 31, 2019, the Company charged off $19.0 million of unpaid principal balance of consumer loans that were greater than 120 days delinquent. As of December 31, 2019, the Company held charged-off consumer loans with an aggregate fair value of $0.6 million for which the Company has determined that it is probable the servicer will be able to collect principal and interest.
As described in Note 2, the Company evaluates the cost basis of its pools of consumer loans for impairments on at least a quarterly basis. For the year ended December 31, 2019, the Company recognized an impairment charge of $6.3 million on the cost basis of its consumer loan pools, which is included in Realized gains (losses) on securities and loans, net, on the Consolidated Statement of Operations.
Corporate Loans
The table below details certain information regarding the Company's corporate loans as of December 31, 2019:
 
 
 
 
 
 
Weighted Average
($ in thousands)
 
Unpaid
Principal Balance
 
Fair Value
 
Rate
 
Remaining Term (Years)
Corporate loans, held-for-investment(1)(2)
 
$
18,415

 
$
18,510

 
17.62
%
 
0.87
(1)
See Note 13 for further details on the Company's transactions involving a loan originator in which the Company also holds an equity investment.
(2)
See Note 21 for further details on the Company's unfunded commitments related to certain of its corporate loans.


121


6. Investments in Unconsolidated Entities
As of December 31, 2019 the Company had various equity investments in entities where the Company has the ability to exert significant influence over such entity, but does not control such entity. In these cases the criteria for consolidation have not been met and the Company is required to account for such investments under ASC 323-10; the Company has elected the FVO for its investments in unconsolidated entities. As of December 31, 2019, the Company's investments in unconsolidated entities had an aggregate fair value of $71.9 million, which is included on the Consolidated Balance Sheet in Investments in unconsolidated entities, at fair value. For the year ended December 31, 2019, the Company recognized $10.2 million in Earnings from investments in unconsolidated entities, on its Consolidated Statement of Operations. Certain of the entities that the Company accounts for under ASC 323-10 are deemed to be VIEs, and the maximum amount at risk is generally limited to the Company's investment in the VIE. As of December 31, 2019, the fair value of the Company's investments in unconsolidated entities that have been deemed to be VIEs was $28.5 million.
The following table provides details about the Company's investments in unconsolidated entities as of December 31, 2019:
Investment in Unconsolidated Entity
 
Form of Investment
 
Percentage Ownership
of Unconsolidated Entity
Longbridge Financial, LLC(1)
 
Preferred shares
 
49.7%
LendSure Mortgage Corp.(1)
 
Common shares
 
49.9%
Jepson Holdings Limited(1)(2)
 
Membership Interest
 
30.1%
Elizon AFG 2018-1 LLC(1)(2)
 
Membership Interest
 
13.4%
Elizon DB 2015-1 LLC(1)(2)
 
Membership Interest
 
3.5%
Other
 
Various
 
7.7%–51.0%
(1)
See Note 13 for additional details on the Company's related party transactions.
(2)
The Company has evaluated this entity and determined that it meets the definition of a VIE. The Company evaluated its interest in the VIE and determined that the Company does not have the power to direct the activities of the VIE and does not have control of the underlying assets, where applicable. As a result, the Company determined that it is not the primary beneficiary of this VIE and therefore has not consolidated the VIE.
The following table provides a summary of the combined financial position of the unconsolidated entities as of December 31, 2019, in which the Company has an investment:
 
 
December 31, 2019
 
 
(In thousands)
Assets
 
 
Investments in securities, loans, MSRs, and REO(1)
 
$
560,949

Other assets
 
65,580

Total assets
 
$
626,529

Liabilities
 

Borrowings
 
$
387,910

Other liabilities
 
28,134

Total liabilities
 
416,044

Equity
 
210,485

Total liabilities and equity
 
$
626,529

(1)
Includes investments carried as the lower of cost or fair value as well as investments where the unconsolidated entity has elected the FVO.


122


The following table provides a summary of the combined results of operations of the unconsolidated entities as of December 31, 2019, in which the Company has an investment:
 
 
Year Ended December 31, 2019
 
 
(In thousands)
Net Interest Income
 
 
Interest income
 
$
30,587

Interest expense
 
(13,316
)
Total net interest income
 
17,271

Other Income (Loss)
 
 
Realized and unrealized gains (losses) on securities, loans, MSRs, and REO, net
 
40,901

Other, net
 
31,848

Total other income (loss)
 
72,749

Total expenses
 
58,018

Net income (loss) before income tax expense
 
32,002

Income tax expense (benefit)
 
979

Net Income (Loss)
 
$
31,023


7. Real Estate Owned
As discussed in Note 2, the Company obtains possession of REO as a result of foreclosures on the associated mortgage loans. The following table details activity in the Company's carrying value of REO for the year ended December 31, 2019.
 
 
Year Ended
December 31, 2019
 
 
Number of Properties
 
Carrying Value
 
 
 
 
(In thousands)
Beginning Balance (January 1, 2019)
 
20

 
$
30,778

Transfers from mortgage loans
 
8

 
22,577

Capital expenditures and other adjustments to cost
 
 
 
240

Adjustments to record at the lower of cost or fair value
 
 
 
(1,002
)
Disposals
 
(13
)
 
(22,009
)
Ending Balance (December 31, 2019)
 
15

 
$
30,584


During the year ended December 31, 2019, the Company sold 13 REO properties, realizing a net gain (loss) of approximately $2.3 million. Such realized gains (losses) are included in Realized gains (losses) on real estate owned, net, on the Company's Consolidated Statement of Operations. As of December 31, 2019 all of the Company's REO had been obtained as a result of obtaining physical possession through foreclosure. As of December 31, 2019, the Company had REO measured at fair value on a non-recurring basis of $19.4 million.
8. Financial Derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company manages certain risks associated with its investments and borrowings, including interest rate, credit, liquidity, and foreign exchange rate risk primarily by managing the amount, sources, and duration of its investments and borrowings, and through the use of derivative financial instruments. The Company's derivative financial instruments are used to manage differences in the amount, timing, and duration of its known or expected cash receipts and its known or expected cash payments principally related to its investments and borrowings.


123


The following table details the fair value of the Company's holdings of financial derivatives as of December 31, 2019:
 
 
December 31, 2019
 
 
(In thousands)
Financial derivatives–assets, at fair value:
 
 
TBA securities purchase contracts
 
$
90

TBA securities sale contracts
 
506

Fixed payer interest rate swaps
 
3,914

Fixed receiver interest rate swaps
 
1,554

Credit default swaps on asset-backed securities
 
993

Credit default swaps on asset-backed indices
 
3,319

Credit default swaps on corporate bonds
 
2

Credit default swaps on corporate bond indices
 
5,599

Total return swaps
 
620

Futures
 
148

Forwards
 
43

Total financial derivatives–assets, at fair value
 
16,788

Financial derivatives–liabilities, at fair value:
 
 
TBA securities sale contracts
 
(1,012
)
Fixed payer interest rate swaps
 
(8,513
)
Fixed receiver interest rate swaps
 
(206
)
Credit default swaps on asset-backed indices
 
(250
)
Credit default swaps on corporate bonds
 
(1,693
)
Credit default swaps on corporate bond indices
 
(14,524
)
Total return swaps
 
(1,209
)
Futures
 
(45
)
Forwards
 
(169
)
Total financial derivatives–liabilities, at fair value
 
(27,621
)
Total
 
$
(10,833
)



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Interest Rate Swaps
The following table provides information about the Company's fixed payer interest rate swaps as of December 31, 2019:
 
 
 
 
 
 
Weighted Average
Maturity
 
Notional Amount(1)
 
Fair Value(1)
 
Pay Rate(2)(3)
 
Receive Rate(2)
 
Remaining Years to Maturity(4)
 
 
(In thousands)
 
 
 
 
 
 
2020
 
$
68,607

 
$
(234
)
 
1.74
%
 
1.93
%
 
0.24
2021
 
268,929

 
(419
)
 
1.73

 
1.95

 
1.64
2022
 
31,350

 
9

 
1.65

 
1.93

 
2.14
2023
 
101,012

 
(1,265
)
 
2.06

 
1.91

 
3.29
2024
 
13,000

 
99

 
1.56

 
1.89

 
4.90
2025
 
12,800

 
(24
)
 
n/a

 
n/a

 
5.22
2026
 
59,902

 
1,946

 
1.24

 
1.94

 
6.50
2028
 
32,942

 
(1,634
)
 
2.40

 
1.93

 
8.34
2029
 
136,838

 
(2,018
)
 
2.02

 
1.96

 
9.61
2030
 
685

 
(32
)
 
2.38

 
1.90

 
10.90
2036
 
1,100

 
87

 
1.45

 
1.94

 
16.14
2049
 
5,796

 
(1,114
)
 
2.89

 
2.09

 
29.03
Total
 
$
732,961

 
$
(4,599
)
 
1.83
%
 
1.94
%
 
4.31
(1)
Includes forward-starting interest rate swaps with a notional amount of $20.9 million and fair value of $(41) thousand.
(2)
Excludes forward-starting interest rate swaps.
(3)
Including forward-starting interest rate swaps the total weighted average pay rate was 1.83%.
(4)
Includes forward-starting interest rate swaps, all of which start within six months of period end.
The following table provides information about the Company's fixed receiver interest rate swaps as of December 31, 2019:
 
 
 
 
 
 
Weighted Average
Maturity
 
Notional Amount
 
Fair Value
 
Pay Rate
 
Receive Rate
 
Remaining Years to Maturity
 
 
(In thousands)
 
 
 
 
 
 
2021
 
$
181,950

 
$
(49
)
 
1.89
%
 
1.67
%
 
1.84
2022
 
53,974

 
441

 
1.91

 
1.85

 
2.17
2023
 
48,657

 
709

 
1.92

 
2.00

 
3.26
2024
 
11,342

 
306

 
2.09

 
2.33

 
4.23
2029
 
9,800

 
(59
)
 
1.91

 
1.78

 
9.77
Total
 
$
305,723

 
$
1,348

 
1.91
%
 
1.78
%
 
2.47


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Credit Default Swaps
The following table provides information about the Company's credit default swaps as of December 31, 2019:
Type(1)
 
Notional
 
Fair Value
 
Weighted Average Remaining Term (Years)
 
 
(In thousands)
 
 
Asset:
 
 
 
 
 
 
Long:
 
 
 
 
 
 
Credit default swaps on asset-backed indices
 
$
695

 
$
10

 
23.80
Credit default swaps on corporate bonds
 
430

 
2

 
0.47
Credit default swaps on corporate bond indices
 
130,707

 
5,547

 
2.42
Short:
 
 
 
 
 
 
Credit default swaps on asset-backed securities
 
(2,640
)
 
993

 
15.63
Credit default swaps on asset-backed indices
 
(63,515
)
 
3,309

 
38.40
Credit default swaps on corporate bond indices
 
(1,997
)
 
52

 
3.97
Liability:
 
 
 
 
 
 
Long:
 
 
 
 
 
 
Credit default swaps on asset-backed indices
 
344

 
(145
)
 
29.35
Short:
 
 
 
 
 
 
Credit default swaps on asset-backed indices
 
(4,501
)
 
(105
)
 
40.31
Credit default swaps on corporate bonds
 
(10,800
)
 
(1,693
)
 
3.92
Credit default swaps on corporate bond indices
 
(250,088
)
 
(14,524
)
 
2.51
 
 
$
(201,365
)
 
$
(6,554
)
 
14.88
(1)
Long notional represents contracts where the Company has written protection and short notional represents contracts where the Company has purchased protection.
Futures
The following table provides information about the Company's short positions in futures as of December 31, 2019:
Description
 
Notional Amount
 
Fair Value
 
Remaining Months to Expiration
 
 
(In thousands)
 
 
U.S. Treasury futures
 
$
(16,000
)
 
$
148

 
2.77
Eurodollar futures
 
(14,000
)
 
(45
)
 
4.05
Total
 
$
(30,000
)
 
$
103

 
3.37

TBAs
The Company transacts in the forward settling TBA market. Pursuant to these TBA transactions, the Company agrees to purchase or sell, for future delivery, Agency RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular Agency RMBS to be delivered is not identified until shortly before the TBA settlement date. TBAs are generally liquid, have quoted market prices, and represent the most actively traded class of MBS. The Company uses TBAs to mitigate interest rate risk, usually by taking short positions. The Company also invests in TBAs as a means of acquiring additional exposure to Agency RMBS, or for speculative purposes, including holding long positions.
The Company does not generally take delivery of TBAs; rather, it settles the associated receivable and payable with its trading counterparties on a net basis. Transactions with the same counterparty for the same TBA that result in a reduction of the position are treated as extinguished.


126


As of December 31, 2019, the Company had outstanding TBA purchase and sale contracts as follows:
TBA Securities
 
Notional Amount(1)
 
Cost
Basis(2)
 
Market Value(3)
 
Net Carrying Value(4)
(In thousands)
 
 
 
 
 
 
 
 
Purchase contracts:
 
 
 
 
 
 
 
 
Assets
 
$
40,100

 
$
40,585

 
$
40,675

 
$
90

 
 
40,100

 
40,585

 
40,675

 
90

Sale contracts:
 
 
 
 
 
 
 
 
Assets
 
(319,981
)
 
(332,080
)
 
(331,574
)
 
506

Liabilities
 
(773,749
)
 
(806,568
)
 
(807,580
)
 
(1,012
)
 
 
(1,093,730
)
 
(1,138,648
)
 
(1,139,154
)
 
(506
)
Total TBA securities, net
 
$
(1,053,630
)
 
$
(1,098,063
)
 
$
(1,098,479
)
 
$
(416
)
(1)
Notional amount represents the principal balance of the underlying Agency RMBS.
(2)
Cost basis represents the forward price to be paid (received) for the underlying Agency RMBS.
(3)
Market value represents the current market value of the underlying Agency RMBS (on a forward delivery basis) as of period end.
(4)
Net carrying value represents the difference between the market value of the TBA contract as of period end and the cost basis, and is reported in Financial derivatives-assets, at fair value and Financial derivatives-liabilities, at fair value on the Consolidated Balance Sheet.
Gains and losses on the Company's derivative contracts for the year ended December 31, 2019 are summarized in the table below:
Derivative Type
 
Primary 
Risk
Exposure
 
Net Realized Gains (Losses) on Periodic Settlements of Interest Rate Swaps
 
Net Realized Gains (Losses) on Financial Derivatives Other Than Periodic Settlements of Interest Rate Swaps(1)
 
Net Realized Gains (Losses) on Financial Derivatives(1)
 
Change in Net Unrealized Gains (Losses) on Accrued Periodic Settlements of Interest Rate Swaps
 
Change in Net Unrealized Gains (Losses) on Financial Derivatives Other Than on Accrued Periodic Settlements of Interest Rate Swaps(2)
 
Change in Net Unrealized Gains (Losses) on Financial Derivatives(2)
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
Interest Rate
 
$
1,695

 
$
(876
)
 
$
819

 
$
(764
)
 
$
(5,778
)
 
$
(6,542
)
Credit default swaps on asset-backed securities
 
Credit
 
 
 
528

 
528

 
 
 
(479
)
 
(479
)
Credit default swaps on asset-backed indices
 
Credit
 
 
 
(1,883
)
 
(1,883
)
 
 
 
(1,848
)
 
(1,848
)
Credit default swaps on corporate bond indices
 
Credit
 
 
 
(5,262
)
 
(5,262
)
 
 
 
(1,364
)
 
(1,364
)
Credit default swaps on corporate bonds
 
Credit
 
 
 
(708
)
 
(708
)
 
 
 
1,007

 
1,007

Total return swaps
 
Equity Market/Credit
 
 
 
(1,460
)
 
(1,460
)
 
 
 
(584
)
 
(584
)
TBAs
 
Interest Rate
 
 
 
(15,755
)
 
(15,755
)
 
 
 
4,026

 
4,026

Futures
 
Interest Rate/Currency
 
 
 
(7,924
)
 
(7,924
)
 
 
 
458

 
458

Forwards
 
Currency
 
 
 
813

 
813

 
 
 
(12
)
 
(12
)
Options
 
Interest Rate
 
 
 
(35
)
 
(35
)
 
 
 
1

 
1

Total
 
 
 
$
1,695

 
$
(32,562
)
 
$
(30,867
)
 
$
(764
)
 
$
(4,573
)
 
$
(5,337
)
(1)
Includes gain/(loss) on foreign currency transactions on financial derivatives in the amount of $45 thousand for the year ended December 31, 2019, which is included on the Consolidated Statement of Operations in Other, net.
(2)
Includes foreign currency remeasurement on financial derivatives in the amount of $1 thousand for the year ended December 31, 2019, which is included on the Consolidated Statement of Operations in Other, net.


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The table below details the average notional values of the Company's financial derivatives, using absolute value of month end notional values, for the year ended December 31, 2019:
Derivative Type
 
Year Ended
December 31, 2019
(In thousands)
 
 
Interest rate swaps
 
$
731,941

TBAs
 
973,331

Credit default swaps
 
399,316

Total return swaps
 
39,434

Futures
 
167,708

Options
 
19,825

Forwards
 
30,930

Warrants
 
2,222


From time to time the Company enters into credit derivative contracts for which the Company sells credit protection ("written credit derivatives"). As of December 31, 2019, all of the Company's open written credit derivatives were credit default swaps on either mortgage/asset-backed indices (ABX and CMBX indices) or corporate bond indices (CDX), collectively referred to as credit indices, or on individual corporate bonds, for which the Company receives periodic payments at fixed rates from credit protection buyers, and is obligated to make payments to the credit protection buyer upon the occurrence of a "credit event" with respect to underlying reference assets.
Written credit derivatives held by the Company at December 31, 2019 are summarized below:
Credit Derivatives
 
December 31, 2019
(In thousands)
 
 
Fair Value of Written Credit Derivatives, Net
 
$
5,414

Fair Value of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties (1)
 
(3,248
)
Notional Value of Written Credit Derivatives (2)
 
132,176

Notional Value of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties (1)
 
(81,637
)
(1)
Offsetting transactions with third parties include purchased credit derivatives which have the same reference obligation.
(2)
The notional value is the maximum amount that a seller of credit protection would be obligated to pay, and a buyer of credit protection would receive, upon occurrence of a "credit event." Movements in the value of credit default swap transactions may require the Company or the counterparty to post or receive collateral. Amounts due or owed under credit derivative contracts with an International Swaps and Derivatives Association, or "ISDA," counterparty may be offset against amounts due or owed on other credit derivative contracts with the same ISDA counterparty. As a result, the notional value of written credit derivatives involving a particular underlying reference asset or index has been reduced (but not below zero) by the notional value of any contracts where the Company has purchased credit protection on the same reference asset or index with the same ISDA counterparty.
A credit default swap on a credit index or a corporate bond typically terminates at the stated maturity date in the case of corporate indices or bonds, or, in the case of ABX and CMBX indices, the date that all of the reference assets underlying the index are paid off in full, retired, or otherwise cease to exist. Implied credit spreads may be used to determine the market value of such contracts and are reflective of the cost of buying/selling credit protection. Higher spreads would indicate a greater likelihood that a seller will be obligated to perform (i.e., make protection payments) under the contract. In situations where the credit quality of the underlying reference assets has deteriorated, the percentage of notional values that would be paid up front to enter into a new such contract ("points up front") is frequently used as an indication of credit risk. Credit protection sellers entering the market in such situations would expect to be paid points up front corresponding to the approximate fair value of the contract. For the Company's written credit derivatives that were outstanding at December 31, 2019, implied credit spreads on such contracts ranged between 10.9 and 440.0 basis points. Excluded from these spread ranges are contracts outstanding for which the individual spread is greater than 2,000 basis points. The Company believes that these contracts would be quoted based on estimated points up front. The total fair value of contracts with individual implied credit spreads in excess of 2,000 basis points was $(0.1) million as of December 31, 2019. Estimated points up front on these contracts as of December 31, 2019 was 57.0. Total net up-front payments (paid) or received relating to written credit derivatives outstanding at December 31, 2019 were $(3.3) million.


128


9. Consolidated VIEs
As discussed in Note 2, the Company has interests in entities that it has determined to be VIEs. The following table summarizes the assets and liabilities of the Company's consolidated VIEs that are included on the Company's Consolidated Balance Sheet as of December 31, 2019.
(In thousands)
 
December 31, 2019(1)
Assets
 
 
Cash and cash equivalents
 
$
6,016

Restricted cash
 
175

Securities, at fair value
 
47,923

Loans, at fair value
 
1,393,916

Investments in unconsolidated entities, at fair value
 
5,641

Real estate owned
 
30,584

Due from brokers
 

Investment related receivables
 
28,668

Other assets
 
6,191

Total Assets
 
$
1,519,114

Liabilities
 
 
Repurchase agreements
 
$
302,791

Investment related payables
 
3,275

Other secured borrowings
 
150,334

Other secured borrowings, at fair value
 
594,396

Interest payable
 
1,247

Accrued expenses and other liabilities
 
2,279

Total Liabilities
 
1,054,322

Total Stockholders' Equity
 
440,394

Non-controlling interests
 
24,400

Total Equity
 
464,794

Total Liabilities and Equity
 
$
1,519,116

(1)
See Note 10 and Note 13 for additional information on the Company's consolidated VIEs.
10. Securitization Transactions
Participation in Multi-Seller Consumer Loan Securitization
In August 2016, the Company participated in a securitization transaction whereby the Company, together with another entity managed by Ellington (the "co-participant"), sold consumer loans with an aggregate unpaid principal balance of approximately $124 million to a newly formed securitization trust (the "Issuer"). Of the $124 million in loans sold to the Issuer, the Company's share was 51% while the co-participant's share was 49%. The transfer was accounted for as a sale in accordance with ASC 860-10. Pursuant to the securitization, the Issuer issued senior and subordinated notes in the principal amount of $87.0 million and $18.7 million, respectively. Trust certificates representing beneficial ownership of the Issuer were also issued. In connection with the transaction, and through a jointly owned newly formed entity (the "Acquiror"), the Company and the co-participant acquired all of the subordinated notes as well as the trust certificates in the Issuer. The Company and the co-participant acquired 51% and 49%, respectively, of the interests in the Acquiror. Subsequently, at the direction of the Company and the co-participant, the Acquiror sold the subordinated notes to a third party; such sales occurred prior to January 1, 2019. As of December 31, 2019, the Company's total interest in the Acquiror was approximately 51.0%. The Company's interest in the Acquiror, for which the Company has elected the FVO, is included on the Consolidated Balance Sheet in Investments in unconsolidated entities, at fair value.
The notes and trust certificates issued by the Issuer are backed by the cash flows from the underlying consumer loans. If there are breaches of representations and warranties with respect to any underlying consumer loans, the Company could, under certain circumstances, be required to repurchase or replace such loans. Absent such breaches, the Company has no obligation to repurchase or replace any underlying consumer loans that become delinquent or otherwise default. Cash flows collected on the underlying consumer loans are distributed to service providers to the trust, noteholders, and trust certificate holders in


129


accordance with the contractual priority of payments. In addition, another affiliate of Ellington (the "Administrator"), acts as the administrator for the securitization and is paid a monthly fee for its services.
The Issuer and the Acquiror are each deemed to be a VIE. The Company has evaluated its interest in the Issuer under ASC 810, and while the Company retains credit risk in the securitization trust through its beneficial ownership of most of the subordinated interests of the securitization trust, which are the first to absorb credit losses on the securitized assets, the Company does not retain control of these assets or the power to direct the activities of the Issuer that most significantly impact the Issuer's economic performance. As a result the Company determined that neither the Company nor the Acquiror is the primary beneficiary of the Issuer, and therefore the Company has not consolidated the Issuer. Additionally, the Company evaluated its interest in the Acquiror and determined that is does not have the power to direct the activities of the Acquiror that most significantly impact the Acquiror's economic performance. As a result, the Company determined that it is not the primary beneficiary of the Acquiror, and therefore the Company has not consolidated the Acquiror. The maximum amount at risk related to the Company's investment in the Acquiror is limited to the fair value of such investment, which was $3.2 million as of December 31, 2019.
Participation in CLO Transactions
Since June 2017, an affiliate of Ellington has sponsored four CLO securitization transactions (the "CLO I Securitization," the "CLO II Securitization," the "CLO III Securitization," and the "CLO IV Securitization"; collectively, the "Ellington-sponsored CLO Securitizations"), collateralized by corporate loans and managed by an affiliate of Ellington (the "CLO Manager"). Ellington, the Company, several other affiliates of Ellington, and in the case of the CLO II Securitization, the CLO III Securitization, and the CLO IV Securitization, several third parties, participated in the Ellington-sponsored CLO Securitizations (collectively, the "CLO Co-Participants").
Pursuant to each Ellington-sponsored CLO Securitization, a newly formed securitization trust (the "CLO I Issuer," the "CLO II Issuer," the "CLO III Issuer," and the "CLO IV Issuer"; collectively, the "CLO Issuers") issued various classes of notes, which were in turn sold to unrelated third parties and the applicable CLO Co-Participants. The notes issued by each CLO Issuer are backed by the cash flows from the underlying corporate loans (including loans to be purchased during a reinvestment period), which are applied in accordance with the contractual priority of payments.
For each of the Ellington-sponsored CLO Securitizations, with the exception of the CLO I Securitization, the Company, along with certain other CLO Co-Participants, advanced funds in the form of loans (the "Advances") to the applicable CLO Issuers prior to the CLO pricing date to enable it to establish warehouse facilities for the purpose of acquiring the assets to be securitized. Pursuant to their terms, the Advances are required to be repaid at the closing of the respective securitization.
In each Ellington-sponsored CLO Securitization, the Company and each of the applicable CLO Co-Participants purchased various classes of notes issued by the corresponding CLO Issuer. In accordance with the Company's accounting policy for recording certain investment transactions on trade date, these purchases were recorded on the CLO pricing date rather than on the CLO closing date.
The CLO Issuers are each deemed to be a VIE. The Company evaluates its interests in the CLO Issuers under ASC 810, and while the Company retains credit risk in each of the securitization trusts through its beneficial ownership of a portion of the subordinated interests of each of the securitization trusts, which are the first to absorb credit losses on the securitized assets, the Company does not retain control of these assets or the power to direct the activities of the CLO Issuers that most significantly impact the CLO Issuers' economic performance. As a result, the Company determined that it is not the primary beneficiary of the CLO Issuers, and therefore the Company has not consolidated the CLO Issuers. The Company's maximum amount at risk is limited to the Company's investment in each of the CLO Issuers. As of December 31, 2019, the fair value of the Company's investment in the notes issued by the CLO Issuers was $39.7 million.
The following table provides details of the Ellington-sponsored CLO Securitizations and the Company's initial investments in notes issued by the Ellington-sponsored CLO Securitizations:
 
 
CLO Issuer(1)
 
CLO Pricing Date
 
CLO Closing Date
 
Total Face Amount of Notes Issued
 
Notes Initially Purchased by the Company
Securitization Transaction
 
 
 
 
 
Face
Amount
 
Aggregate Purchase Price
 
 
 
 
 
 
 
 
(In thousands)
CLO I Securitization
 
CLO I Issuer
 
8/18
 
8/18
 
$
461,840

 
$
36,579

(2) 
 
$
25,622

CLO II Securitization
 
CLO II Issuer
 
12/17
 
1/18
 
452,800

 
18,223

(3) 
 
16,621

CLO III Securitization
 
CLO III Issuer
 
6/18
 
7/18
 
407,100

 
35,480

(3) 
 
32,394

CLO IV Securitization
 
CLO IV Issuer
 
2/19
 
3/19
 
478,488

 
12,700

(3) 
 
10,618



130


(1)
The Company is not deemed to be the primary beneficiary of the CLO Issuers, which are deemed to be VIEs, as discussed above.
(2)
The Company purchased secured and unsecured subordinated notes.
(3)
The Company purchased secured senior and secured and unsecured subordinated notes.
See Note 13 for further details on the Company's participation in CLO transactions.
Residential Mortgage Loan Securitizations
Since November 2017, the Company, through certain wholly owned subsidiaries (each, a "Sponsor"), has sponsored several securitizations of non-QM loans. In each case, the applicable Sponsor transferred a pool of non-QM loans (each, a Collateral Pool") to a wholly owned entity (each, a "Depositor") and on the closing date such loans were deposited into newly created securitization trusts (collectively, the "Issuing Entities"). Pursuant to the securitizations, the Issuing Entities issued various classes of mortgage pass-through certificates (the "Certificates") which are backed by the cash flows from the underlying non-QM loans.
Under the Dodd-Frank Act, sponsors of securitizations are generally required to retain at least 5% of the economic interest in the credit risk of the securitized assets (the "Risk Retention Rules"). In order to comply with the Risk Retention Rules, in each securitization, the applicable Sponsor purchased the two most subordinated classes of Certificates and the excess cash flow certificates. The applicable Sponsor also purchased the Certificates entitled to excess servicing fees in each securitization, while the remaining classes of Certificates were purchased by unrelated parties.
Notwithstanding that the Certificates carry final scheduled distribution dates of October 25, 2047 or later, the applicable Depositor may, at its sole option, purchase all of the outstanding Certificates (an "Optional Redemption") following the earlier of (1) the applicable anniversary of the closing date (typically two or three years) of the respective securitization or (2) the date on which the aggregate unpaid principal balance of the applicable Collateral Pool has declined below 30% of the aggregate unpaid principal balance of the applicable Collateral Pool as of the date as of which such loans were originally transferred to the applicable Issuing Entity. The purchase price that the Depositor is required to pay in connection with an Optional Redemption is equal to the sum of the unpaid principal balance of each class of Certificates as of the redemption date and any accrued and unpaid interest thereon. In light of these Optional Redemption rights held by the applicable Depositor, the transfers of non-QM loans to each of the Issuing Entities do not qualify as sales under ASC 860-10.
In the event that certain breaches of representations or warranties are discovered with respect to any underlying non-QM loans, the Company could be required to repurchase or replace such loans.
Each Sponsor also serves as the servicing administrator of its respective securitization, for which it is entitled to receive a monthly fee equal to one-twelfth of the product of (a) 0.03% and (b) the unpaid principal balance of the underlying non-QM loans as of the first day of the related due period. Each Sponsor in its role as servicing administrator provides direction and consent for certain loss mitigation activities to the third-party servicer of the underlying non-QM loans. In certain circumstances, the servicing administrator will be required to reimburse the servicer for principal and interest advances and servicing advances made by the servicer.
In light of the Company's retained interests in each of the securitizations, together with the Optional Redemption rights and the Company's ability to direct the third-party servicer regarding certain loss mitigation activities, the Company is deemed to be the primary beneficiary of the Issuing Entities, which are VIEs, and has consolidated the Issuing Entities. Interest income from these loans and the expenses related to the servicing of these loans are included in Interest income and Investment related expenses—Servicing expense, respectively, on the Consolidated Statement of Operations.
The Issuing Entities each meet the definition of a CFE as defined in Note 2, and as a result the assets of each of the Issuing Entities have been valued using the fair value of the liabilities of the respective Issuing Entity, as such liabilities have been assessed to be more observable than such assets.
The debt of the Issuing Entities is included in Other secured borrowings, at fair value, on the Consolidated Balance Sheet and is shown net of the Certificates held by the Company. In November 2019, the Company exercised its Optional Redemption right with respect to Ellington Financial Mortgage Trust 2017-1.


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The following table details the Company's outstanding consolidated residential mortgage loan securitizations:
Issuing Entity
 
Closing Date
 
Principal Balance of Loans Transferred to the Depositor
 
Total Face Amount of Certificates Issued
 
 
 
 
(In thousands)
Ellington Financial Mortgage Trust 2018-1
 
11/18
 
$
232,518

 
$
232,518

(1) 
Ellington Financial Mortgage Trust 2019-1
 
6/19
 
226,913

 
226,913

(2) 
Ellington Financial Mortgage Trust 2019-2
 
11/19
 
267,255

 
267,255

(3) 
(1)
In order to comply with the Risk Retention Rules, the Sponsor purchased the two most subordinated classes of Certificates and the excess cash flow certificates, with an aggregate value equal to 5.7% of the fair value of all Certificates issued. The Sponsor also purchased, for an aggregate purchase price of $1.3 million, the Certificates entitled to excess servicing fees, while the remaining classes of Certificates were purchased by unrelated third parties.
(2)
In order to comply with the Risk Retention Rules, the Sponsor purchased the two most subordinated classes of Certificates and the excess cash flow certificates, with an aggregate value equal to 6.1% of the fair value of all Certificates issued. The Sponsor also purchased, for an aggregate purchase price of $1.2 million, the Certificates entitled to excess servicing fees, while the remaining classes of Certificates were purchased by unrelated third parties.
(3)
In order to comply with the Risk Retention Rules, the Sponsor purchased the two most subordinated classes of Certificates and the excess cash flow certificates, with an aggregate value equal to 6.4% of the fair value of all Certificates issued. The Sponsor also purchased, for an aggregate purchase price of $1.7 million, the Certificates entitled to excess servicing fees, while the remaining classes of Certificates were purchased by unrelated third parties.
The following table details the assets and liabilities of the consolidated securitization trusts included in the Company's Consolidated Balance Sheet as of December 31, 2019:
(In thousands)
 
December 31, 2019
Assets:
 
 
Loans, at fair value
 
$
628,415

Real estate owned
 
658

Investment related receivables
 
10,409

Liabilities:
 
 
Other secured borrowings, at fair value
 
594,396


11. Borrowings
Secured Borrowings
The Company's secured borrowings consist of repurchase agreements, Other secured borrowings, and Other secured borrowings, at fair value. As of December 31, 2019, the Company's total secured borrowings were $3.2 billion.
Repurchase Agreements
The Company enters into repurchase agreements. A repurchase agreement involves the sale of an asset to a counterparty together with a simultaneous agreement to repurchase the transferred asset or similar asset from such counterparty at a future date. The Company accounts for its repurchase agreements as collateralized borrowings, with the transferred assets effectively serving as collateral for the related borrowing. The Company's repurchase agreements typically range in term from 30 to 180 days, although the Company also has repurchase agreements that provide for longer or shorter terms. The principal economic terms of each repurchase agreement—such as loan amount, interest rate, and maturity date—are typically negotiated on a transaction-by-transaction basis. Other terms and conditions, such as those relating to events of default, are typically governed under the Company's master repurchase agreements. Absent an event of default, the Company maintains beneficial ownership of the transferred securities during the term of the repurchase agreement and receives the related principal and interest payments. Interest rates on these borrowings are generally fixed based on prevailing rates corresponding to the terms of the borrowings, and for most repurchase agreements, interest is generally paid at the termination of the repurchase agreement, at which time the Company may enter into a new repurchase agreement at prevailing market rates with the same counterparty, repay that counterparty and possibly negotiate financing terms with a different counterparty, or choose to no longer finance the related asset. Some repurchase agreements provide for periodic payments of interest, such as monthly payments. In response to a decline in the fair value of the transferred securities, whether as a result of changes in market conditions, security paydowns, or other factors, repurchase agreement counterparties will typically make a margin call, whereby the Company will be required to post additional securities and/or cash as collateral with the counterparty in order to re-establish the agreed-upon collateralization requirements. In the event of increases in fair value of the transferred securities, the Company can generally require the counterparty to post collateral with it in the form of cash or securities. The Company is generally permitted to sell or re-pledge any securities posted by the counterparty as collateral; however, upon termination of the repurchase agreement, or


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other circumstance in which the counterparty is no longer required to post such margin, the Company must return to the counterparty the same security that had been posted.
At any given time, the Company seeks to have its outstanding borrowings under repurchase agreements with several different counterparties in order to reduce the exposure to any single counterparty. The Company had outstanding borrowings under repurchase agreements with 28 counterparties as of December 31, 2019.
As of December 31, 2019 remaining days to maturity on the Company's open repurchase agreements ranged from 2 days to 882 days. Interest rates on the Company's open repurchase agreements ranged from 0.15% to 5.20% as of December 31, 2019.
The following table details the Company's outstanding borrowings under repurchase agreements for Agency RMBS and credit assets (which include non-Agency RMBS, CMBS, CLOs, corporate debt, residential mortgage loans, and commercial mortgage loans and REO), by remaining maturity as of December 31, 2019:
(In thousands)
 
December 31, 2019
 
 
 
 
Weighted Average
Remaining Maturity
 
Outstanding
Borrowings
 
Interest Rate
 
Remaining Days to Maturity
Agency RMBS:
 
 
 
 
 
 
30 Days or Less
 
$
511,996

 
2.08
%
 
17
31-60 Days
 
744,387

 
1.93
%
 
47
61-90 Days
 
594,738

 
1.96
%
 
76
91-120 Days
 
10,270

 
2.24
%
 
93
151-180 Days
 
3,082

 
2.67
%
 
171
Total Agency RMBS
 
1,864,473

 
1.98
%
 
48
Credit:
 
 
 
 
 
 
30 Days or Less
 
16,549

 
3.38
%
 
25
31-60 Days
 
104,491

 
3.14
%
 
48
61-90 Days
 
138,837

 
3.03
%
 
73
121-150 Days
 
7,460

 
3.89
%
 
123
151-180 Days
 
31,498

 
3.87
%
 
173
181-360 Days
 
186,661

 
3.80
%
 
250
> 360 Days
 
95,331

 
4.52
%
 
678
Total Credit Assets
 
580,827

 
3.61
%
 
229
Total
 
$
2,445,300

 
2.37
%
 
91

Repurchase agreements involving underlying investments that the Company sold prior to period end, for settlement following period end, are shown using their original maturity dates even though such repurchase agreements may be expected to be terminated early upon settlement of the sale of the underlying investment.
As of December 31, 2019, the fair value of investments transferred as collateral under outstanding borrowings under repurchase agreements was $2.763 billion. Collateral transferred under outstanding borrowings under repurchase agreements as of December 31, 2019 include investments in the amount of $64.7 million that were sold prior to period end but for which such sale had not yet settled. In addition the Company posted net cash collateral of $31.0 million and additional securities with a fair value of $0.2 million as of December 31, 2019 to its counterparties.
As of December 31, 2019, there were no counterparties for which the amount at risk relating to our repurchase agreements was greater than 10% of total equity.
Other Secured Borrowings
In February 2018, the Company entered into agreements to finance a portfolio of unsecured loans through a recourse secured borrowing facility. The facility has a term ending in February 2021. The facility accrues interest on a floating-rate basis. As of December 31, 2019, the Company had outstanding borrowings under this facility in the amount of $16.0 million which is included under the caption Other secured borrowings, on the Company's Consolidated Balance Sheet, and the effective


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interest rate, inclusive of related deferred financing costs, was 3.85%. As of December 31, 2019, the fair value of unsecured loans collateralizing this borrowing was $22.3 million.
In November 2019, the Company amended its non-recourse secured borrowing facility that is used to finance a portfolio of unsecured loans. The facility includes a reinvestment period ending in December 2020 (or earlier following an early amortization event), whereby the Company can vary its borrowings based on the size of its portfolio, subject to certain maximum limits. Following the reinvestment period, the facility will begin to amortize based on the collections from the underlying loans. The facility accrues interest on a floating rate basis. As of December 31, 2019, the Company had outstanding borrowings under this facility in the amount of $102.5 million, which is included under the caption Other secured borrowings, on the Company's Consolidated Balance Sheet, and the effective interest rate on this facility, inclusive of related deferred financing costs, was 4.01%. As of December 31, 2019, the fair value of unsecured loans collateralizing this borrowing was $144.1 million.
In December 2019, the Company entered into an agreement to finance a portfolio of ABS backed by consumer loans through a recourse secured borrowing facility. The facility includes a revolving borrowing period ending in June 2021 (or earlier following a trigger event), whereby the Company can vary its borrowings based on the size of its portfolio, subject to certain maximum limits. Following the revolving borrowing period, the facility amortizes, with a final termination date in June 2023. The facility accrues interest on a floating rate basis. As of December 31, 2019, the Company had outstanding borrowings under this facility in the amount of $31.8 million, which is included under the caption Other secured borrowings, on the Company's Consolidated Balance Sheet, and the effective interest rate on this facility, inclusive of related deferred financing costs, was 5.23%. As of December 31, 2019, the fair value of ABS backed by consumer loans collateralizing this borrowing was $47.9 million.
The Company has completed securitization transactions, as discussed in Note 10, whereby it financed portfolios of non-QM loans. As of December 31, 2019, the fair value of the Company's outstanding liabilities associated with these securitization transactions was $594.4 million, representing the fair value of the securitization trust certificates held by third parties as of such date, and is included on the Company's Consolidated Balance Sheet in Other secured borrowings, at fair value. The weighted average coupon of the Certificates held by third parties was 3.19% as of December 31, 2019. As of December 31, 2019, the fair value of non-QM loans and the carrying value of REO held in the consolidated securitization trusts was $629.1 million.
Unsecured Borrowings
Senior Notes
On August 18, 2017, the Company issued $86.0 million in aggregate principal amount of unsecured senior notes (the "Old Senior Notes"). The total net proceeds to the Company from the issuance of the Old Senior Notes was approximately $84.7 million, after deducting debt issuance costs. The Old Senior Notes had an interest rate of 5.25%, subject to adjustment based on changes in the ratings, if any, of the Old Senior Notes. On February 13, 2019, in connection with the REIT Election, the Company exchanged all $86.0 million in principal amount of the Old Senior Notes for new unsecured long-term debt jointly and severally co-issued by certain of its consolidated subsidiaries and fully guaranteed by the Company (the "Senior Notes"). At any time, the Company is permitted to add others of its consolidated subsidiaries as co-issuers of the Senior Notes. The Senior Notes bear interest at a rate of 5.50%, subject to adjustment based on changes, if any, in the ratings of the Senior Notes. Interest on the Senior Notes is payable semi-annually in arrears on March 1 and September 1 of each year. The Senior Notes mature on September 1, 2022. The Company may redeem the Senior Notes, at its option, in whole or in part, prior to March 1, 2022 at a price equal to 100% of the principal amount thereof, plus the applicable "make-whole" premium as of the applicable date of redemption. At any time on or after March 1, 2022, the Company may redeem the Senior Notes, in whole or in part, at a redemption price equal to 100% of the aggregate principal amount of the Senior Notes to be redeemed, plus accrued and unpaid interest. The Senior Notes are carried at amortized cost. There are a number of covenants, including several financial covenants, associated with the Senior Notes. As of December 31, 2019, the Company was in compliance with all of its covenants.
The Company amortizes debt issuance costs over the life of the associated debt; the amortized portion of debt issuance costs is included in Interest expense on the Consolidated Statement of Operations. The Senior Notes have an effective interest rate of 5.80%, inclusive of debt issuance costs.
The Senior Notes are unsecured and are effectively subordinated to secured indebtedness of the Company, to the extent of the value of the collateral securing such indebtedness.


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Schedule of Principal Repayments
The following table details the Company's principal repayment schedule for outstanding borrowings as of December 31, 2019:
Year
 
Repurchase Agreements(1)
 
Other
Secured Borrowings(2)
 
Senior Notes(1)
 
Total
(In thousands)
 
 
 
 
 
 
 
 
2020
 
$
2,349,969

 
$
291,364

 
$

 
$
2,641,333

2021
 
38,516

 
243,856

 

 
282,372

2022
 
56,815

 
203,039

 
86,000

 
345,854

2023
 

 

 

 

2024
 

 

 

 

Total
 
$
2,445,300

 
$
738,259

 
$
86,000

 
$
3,269,559

(1)
Reflects the Company's contractual principal repayment dates.
(2)
Reflects the Company's expected principal repayment dates, which may be prior to the stated contractual maturities.
12. Income Taxes
The Company believes that, commencing on January 1, 2019, it was organized in conformity with the requirements for qualification and taxation as a REIT under the U.S. federal income tax laws and that its manner of operation enables it to meet the requirements for qualification and taxation as a REIT. A REIT is generally not subject to U.S. federal, state, and local income tax on the portion of its income that is distributed to its owners if it distributes at least 90% of its REIT taxable income within the prescribed time frames, determined without regard to the deduction for dividends paid and excluding any net capital gains. The Company intends to operate in a manner which will allow it to continue to meet the requirements for qualification as a REIT. Accordingly, Ellington Financial Inc. does not believe that it will be subject to U.S. federal, state, and local income tax on the portion of its net taxable income that is distributed to its stockholders as long as certain asset, income, and share ownership tests are met.
Cash dividends declared by the Company that do not exceed its current or accumulated earnings and profits will be considered ordinary income to stockholders for income tax purposes unless all or a portion of a dividend is designated by the Company as a capital gain dividend. Distributions in excess of the Company's current and accumulated earnings and profits will be characterized as return of capital or capital gains.
The following table details the tax characteristics of the Company's dividends declared on its shares of common and preferred stock for the year ended December 31, 2019.
Tax Characteristic
 
Year Ended
December 31, 2019
Ordinary income
 
85.0
%
Return of capital
 
9.4
%
Capital gains
 
5.6
%
 
 
100.0
%

Certain foreign and domestic subsidiaries of the Company have elected to be treated as TRSs and therefore are taxed as corporations for U.S. federal, state, and local income tax purposes. To the extent that those entities incur U.S. federal, state, or local income taxes, or foreign income taxes, such taxes are recorded in the Company's consolidated financial statements.
For the year ended December 31, 2019, the Company recorded income tax expense of $1.6 million, of which $1.1 million related to a net deferred tax liability. The Company accounts for income taxes in accordance with ASC 740, Income Taxes. Deferred income taxes reflect the net tax effects of temporary differences that may exist between the carrying amounts of assets and liabilities under U.S. GAAP and the carrying amounts used for income tax purposes.
Taxable income can differ from net income (loss) principally due to differences in the timing of recognition of interest, taxes, depreciation, and amortization of assets.


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The following table summarizes the Company's income tax provision for the year ended December 31, 2019.
(In thousands)
 
Year Ended
December 31, 2019
Current income tax provision
 
 
Federal
 
$
185

State
 
293

Total current income tax provision, net
 
478

Deferred income tax provision
 
 
Federal
 
1,080

State
 

Total deferred income tax provision, net
 
1,080

Total income tax provision
 
$
1,558


The following table details the components of the Company's net deferred tax asset (liability) at December 31, 2019.
(In thousands)
 
Year Ended
December 31, 2019
Deferred tax asset
 
 
Net operating loss available for carry-back and carry-forward
 
$
3,907

Basis difference for investments
 
669

Valuation allowance
 
(157
)
Deferred tax asset
 
4,419

Deferred tax liability
 
 
Basis difference for investments
 
(5,484
)
Deferred tax liability
 
(5,484
)
Net deferred tax asset (liability)
 
$
(1,065
)

The following table details the reconciliation between the Company's U.S. federal and state statutory income tax rate and the effective tax rate for the year ended December 31, 2019.
 
 
Year Ended
December 31, 2019
Federal statutory rate
 
21.00
 %
State statutory rate, net of federal benefit
 
0.45
 %
Income attributable to non-controlling interests
 
(1.28
)%
REIT earnings not subject to corporate taxes
 
(17.76
)%
Effective tax rate
 
2.41
 %

13. Related Party Transactions
The Company is party to the Management Agreement (which may be amended from time to time), pursuant to which the Manager manages the assets, operations, and affairs of the Company, in consideration of which the Company pays the Manager management and incentive fees. The descriptions of the Base Management Fees and Incentive Fees are detailed below.
Base Management Fees
The Operating Partnership pays the Manager 1.50% per annum of total equity of the Operating Partnership calculated in accordance with U.S. GAAP as of the end of each fiscal quarter (before deductions for base management fees and incentive fees payable with respect to such fiscal quarter), provided that total equity is adjusted to exclude one-time events pursuant to changes in U.S. GAAP, as well as non-cash charges after discussion between the Manager and the Company's independent directors, and approval by a majority of the Company's independent directors in the case of non-cash charges.
Pursuant to the Management Agreement, if the Company invests at issuance in the equity of any collateralized debt obligation that is managed, structured, or originated by Ellington or one of its affiliates, or if the Company invests in any other


136


investment fund or other investment for which Ellington or one of its affiliates receives management, origination, or structuring fees, then, unless agreed otherwise by a majority of the Company's independent directors, the base management and incentive fees payable by the Company to its Manager will be reduced by an amount equal to the applicable portion (as described in the Management Agreement) of any such management, origination, or structuring fees.
For the year ended December 31, 2019, the total base management fee incurred was $8.0 million, consisting of $10.0 million of total gross base management fee incurred, less $2.0 million of management fee rebates. See "—Participation in CLO Transactions" below for details on management fee rebates.
Incentive Fees
The Manager is entitled to receive a quarterly incentive fee equal to the positive excess, if any, of (i) the product of (A) 25% and (B) the excess of (1) Adjusted Net Income (described below) for the Incentive Calculation Period (which means such fiscal quarter and the immediately preceding three fiscal quarters) over (2) the sum of the Hurdle Amounts (described below) for the Incentive Calculation Period, over (ii) the sum of the incentive fees already paid or payable for each fiscal quarter in the Incentive Calculation Period preceding such fiscal quarter.
For purposes of calculating the incentive fee, "Adjusted Net Income" for the Incentive Calculation Period means the net increase in equity from operations of the Operating Partnership, after all base management fees but before any incentive fees for such period, and excluding any non-cash equity compensation expenses for such period, as reduced by any Loss Carryforward (as described below) as of the end of the fiscal quarter preceding the Incentive Calculation Period.
For purposes of calculating the incentive fee, the "Loss Carryforward" as of the end of any fiscal quarter is calculated by determining the excess, if any, of (1) the Loss Carryforward as of the end of the immediately preceding fiscal quarter over (2) the Company's net increase in equity from operations (expressed as a positive number) or net decrease in equity from operations (expressed as a negative number) of the Operating Partnership for such fiscal quarter. As of December 31, 2019, there was no Loss Carryforward.
For purposes of calculating the incentive fee, the "Hurdle Amount" means, with respect to any fiscal quarter, the product of (i) one-fourth of the greater of (A) 9% and (B) 3% plus the 10-year U.S. Treasury rate for such fiscal quarter, (ii) the sum of (A) the weighted average gross proceeds per share of all common stock and OP Unit issuances since inception of the Company and up to the end of such fiscal quarter, with each issuance weighted by both the number of shares of common stock and OP Units issued in such issuance and the number of days that such issued shares of common stock and OP Units were outstanding during such fiscal quarter, using a first-in first-out basis of accounting (i.e. attributing any share of common stock and OP Unit repurchases to the earliest issuances first) and (B) the result obtained by dividing (I) retained earnings attributable to shares of common stock and OP Units at the beginning of such fiscal quarter by (II) the average number of shares of common stock and OP Units outstanding for each day during such fiscal quarter, (iii) the sum of (x) the average number of shares of common stock and long term incentive plan units of the Company outstanding for each day during such fiscal quarter, and (y) the average number of Convertible Non-controlling Interests outstanding for each day during such fiscal quarter. For purposes of determining the Hurdle Amount, issuances of common stock, and Convertible Non-controlling Interests (a) as equity incentive awards, (b) to the Manager as part of its base management fee or incentive fee and (c) to the Manager or any of its affiliates in privately negotiated transactions, are excluded from the calculation. The payment of the incentive fee will be in a combination of shares of common stock and cash, provided that at least 10% of any quarterly payment will be made in shares of common stock.
Total incentive fee incurred for the year ended December 31, 2019 was $0.1 million.
Termination Fees
The Management Agreement requires the Company to pay a termination fee to the Manager in the event of (1) the Company's termination or non-renewal of the Management Agreement without cause or (2) the Company's termination of the Management Agreement based on unsatisfactory performance by the Manager that is materially detrimental to the Company or (3) the Manager's termination of the Management Agreement upon a default by the Company in the performance of any material term of the Management Agreement. Such termination fee will be equal to the amount of three times the sum of (i) the average annual quarterly base management fee amounts paid or payable with respect to the two 12-month periods ending on the last day of the latest fiscal quarter completed on or prior to the date of the notice of termination or non-renewal and (ii) the average annual quarterly incentive fee amounts paid or payable with respect to the two 12-month periods ending on the last day of the latest fiscal quarter completed on or prior to the date of the notice of termination or non-renewal.


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Expense Reimbursement
Under the terms of the Management Agreement the Company is required to reimburse the Manager for operating expenses related to the Company that are incurred by the Manager, including expenses relating to legal, accounting, due diligence, other services, and all other costs and expenses. The Company's reimbursement obligation is not subject to any dollar limitation. Expenses will be reimbursed in cash within 60 days following delivery of the expense statement by the Manager; provided, however, that such reimbursement may be offset by the Manager against amounts due to the Company from the Manager. The Company will not reimburse the Manager for the salaries and other compensation of the Manager's personnel except that the Company will be responsible for expenses incurred by the Manager in employing certain dedicated or partially dedicated personnel as further described below.
The Company reimburses the Manager for the allocable share of the compensation, including, without limitation, wages, salaries, and employee benefits paid or reimbursed, as approved by the Compensation Committee of the Board of Directors to certain dedicated or partially dedicated personnel who spend all or a portion of their time managing the Company's affairs, based upon the percentage of time devoted by such personnel to the Company's affairs. In their capacities as officers or personnel of the Manager or its affiliates, such personnel will devote such portion of their time to the Company's affairs as is necessary to enable the Company to operate its business.
For the year ended December 31, 2019, the Company reimbursed the Manager $10.9 million for previously incurred operating expenses. As of December 31, 2019, the outstanding payable to the Manager for operating expenses was $2.0 million, which are included in Accrued expenses and other liabilities on the Consolidated Balance Sheet.
Transactions Involving Certain Loan Originators
As of December 31, 2019, the loan originators in which the Company holds equity investments represent related parties. Transactions that have been entered into with these related party mortgage originators are summarized below.
The Company is a party to a mortgage loan purchase and sale flow agreement, with a mortgage originator in which the Company holds an investment in common stock, whereby the Company purchases residential mortgage loans that satisfy certain specified criteria. The Company has also provided a $5.0 million line of credit to the mortgage originator. Under the terms of this line of credit, the Company has agreed to make advances to the mortgage originator solely for the purpose of funding specifically identified residential mortgage loans designated for sale to the Company. To the extent the advances are drawn by the mortgage originator, it must pay interest, at a rate of 15% per annum, on the outstanding balance of each advance from the date the advance is made until such advance is repaid in full. The mortgage originator is required to repay advances in full no later than two business days following the date that the Company purchases the related residential mortgage loans from the mortgage originator. As of December 31, 2019, there were no advances outstanding. The Company has also entered into two agreements whereby it guarantees the performance of such mortgage originator under third-party master repurchase agreements. See Note 21, Commitments and Contingencies, for further information on the Company's guarantees of the third-party borrowing arrangements.
The Company, through a related party of Ellington, or the "Loan Purchaser," is a party to a consumer loan purchase and sale flow agreement with a consumer loan originator in which the Company holds an investment in preferred stock and warrants to purchase additional preferred stock, whereby the Loan Purchaser purchases consumer loans that satisfy certain specified criteria. The Company has investments in participation certificates related to consumer loans titled in the name of the Loan Purchaser. Through its participation certificates, the Company has beneficial interests in the loan cash flows, net of servicing-related fees and expenses. The total fair value of the Company's participation certificates was $47.9 million as of December 31, 2019.
In May 2019 the Company entered into a note purchase agreement whereby it agreed to lend up to $5.0 million to a mortgage originator ("the Initial Note") in which the Company also holds an equity investment. The Initial Note carries an interest rate of 15% per annum on the outstanding balance. In July and December 2019, the Company amended the note purchase agreement whereby it agreed to lend an additional $5.0 million and $2.5 million, respectively, (the "Additional Notes") to the mortgage originator. The Additional Notes each carry an interest rate of 18% per annum. As of December 31, 2019, the aggregate outstanding balance on the Initial Note and the Additional Note was $12.5 million. The Initial Note and the Additional Notes are classified as Corporate loans and included in Loans, at fair value on the Consolidated Balance Sheet.
Consumer, Residential, and Commercial Loan Transactions with Affiliates
The Company purchases certain of its consumer loans through an affiliate, or the "Purchasing Entity." The Purchasing Entity has entered into purchase agreements, open-ended in duration, with third party consumer loan originators whereby it has agreed to purchase eligible consumer loans. The amount of loans purchased under these purchase agreements is dependent on,


138


among other factors, the amount of loans originated in any given period by the selling originators. The Company and other affiliates of Ellington have entered into agreements with the Purchasing Entity whereby the Company and each of the affiliates of Ellington have agreed to purchase their allocated portion (subject to monthly determination based on available capital and other factors) of the eligible loans acquired by the Purchasing Entity under each purchase agreement. Immediately after the Purchasing Entity purchases beneficial interests in the loans, the Company and other affiliates of Ellington purchase such beneficial interests from the Purchasing Entity, at the same price paid by the Purchasing Entity. During the year ended December 31, 2019, the Company purchased loans under these agreements with an aggregate principal balance of $134.4 million. As of December 31, 2019, the estimated remaining contingent purchase obligations of the Company under these purchase agreements was approximately $287.1 million in principal balance.
The Company's beneficial interests in the consumer loans purchased through the Purchasing Entity are evidenced by participation certificates issued by trusts that hold legal title to the loans. These trusts are owned by a related party of Ellington and were established to hold such loans. Through its participation certificates, the Company participates in the cash flows of the underlying loans held by each trust. The total amount of consumer loans underlying the Company's participation certificates and held in the related party trusts was $185.4 million as of December 31, 2019.
The Company has beneficial interests in residential mortgage loans and REO held in a trust owned by a related party of Ellington. Through these beneficial interests, the Company participates in the cash flows of the underlying loans held by such trust. The total amount of residential mortgage loans and REO underlying the Company's beneficial interests and held in the related party trust was $304.8 million as of December 31, 2019.
The Company is a co-investor in certain small balance commercial mortgage loans with several other investors, including an unrelated third party and various affiliates of Ellington. These loans are beneficially owned by a consolidated subsidiary of the Company. As of December 31, 2019, the aggregate fair value of the small balance commercial loans was $29.5 million. The non-controlling interests held by the unrelated third party and the Ellington affiliates were $3.6 million and $7.0 million, respectively. As of December 31, 2019, the Company had a payable to an Ellington affiliate in the amount of $0.7 million, which is included in Accrued expenses and other liabilities on the Consolidated Balance Sheet.
The Company is also a co-investor in certain small balance commercial mortgage loans with other investors, including various unrelated third parties and various affiliates of Ellington. Each co-investor in a particular loan has an interest in the limited liability company that owns such loan. As of December 31, 2019, the aggregate fair value of the Company's investments in the jointly owned limited liability companies was approximately $17.3 million. Such investments are included in Investments in unconsolidated entities, on the Consolidated Balance Sheet.
The consumer, residential mortgage, and certain commercial mortgage loans that are the subject of the foregoing loan transactions are held in trusts, each of which the Company has determined to be a VIE. The Company has evaluated each of these VIEs and determined that the Company has the power to direct the activities of each VIE that most significantly impact such VIE's economic performance and the Company has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. As a result the Company has determined it is the primary beneficiary of each of these VIEs and has consolidated each VIE.
Equity Investment in Unconsolidated Entity
The Company was a co-investor, together with other affiliates of Ellington, in Jepson Holdings Limited, the parent of an entity (the "Right Holder Entity") that held a call right (the "Call Right") to a European mortgage loan securitization (the "Initial Securitization"). The Right Holder Entity issued notes (the "Right Holder Notes") to the Company and its affiliates, and to an unrelated third party.
In March 2019, the Right Holder Entity assigned the Call Right to a newly formed entity, which exercised the Call Right and re-securitized the underlying European mortgage loan assets of the Initial Securitization through a new securitization trust (the "New Securitization"). In exchange for assigning the Call Right, the Right Holder Entity received a combination of (i) cash and (ii) certain notes issued by the New Securitization (the "New Securitization Notes"). The Right Holder Entity fully repaid the unrelated third party's Right Holder Note with a combination of cash and New Securitization Notes. The Right Holder Notes held by the Company and its affiliates were also fully repaid with cash and New Securitization Notes. Certain of the New Securitization Notes were distributed to the Company and its affiliates on a pro rata basis. The Right Holder Entity is expected to continue to hold certain of the New Securitization Notes in order to comply with European risk retention rules. As of December 31, 2019, the Company's equity investment in Jepson Holdings Limited had a fair value of $1.9 million. See Note 6 for additional details on this equity investment.


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Participation in Multi-Borrower Financing Facilities
The Company is a co-participant with certain other entities managed by Ellington or its affiliates (the "Affiliated Entities") in various entities (each, a "Joint Entity"), which were formed in order to facilitate the financing of small balance commercial mortgage loans, residential mortgage loans, and REO (collectively, the "Mortgage Loan and REO Assets"), through repurchase agreements. Each Joint Entity has a master repurchase agreement with a particular financing counterparty.
In connection with the financing of the Mortgage Loan and REO Assets under repurchase agreements, each of the Company and the Affiliated Entities transferred certain of their respective Mortgage Loan and REO Assets to one of the Joint Entities in exchange for its pro rata share of the financing proceeds that the respective Joint Entity received from the financing counterparty. While the Company's Mortgage Loan and REO Assets were transferred to the Joint Entity, the Company's Mortgage Loan and REO Assets and the related debt were not derecognized for financial reporting purposes, in accordance with ASC 860-10, because the Company continued to retain the risks and rewards of ownership of its Mortgage Loan and REO Assets. As of December 31, 2019, the Joint Entities had aggregate outstanding issued debt under the repurchase agreements in the amount of $350.6 million. The Company's segregated portion of this debt as of December 31, 2019, was $174.4 million, and is included under the caption Repurchase agreements on the Company's Consolidated Balance Sheet. To the extent that there is a default under the repurchase agreements, all of the assets of each respective Joint Entity, including those beneficially owned by any non-defaulting owners of such Joint Entity, could be used to satisfy the outstanding obligations under such repurchase agreement. As of December 31, 2019, no party to any of the repurchase agreements was in default.
Each of the Joint Entities has been determined to be a VIE. The Company has evaluated each of these VIEs and determined that it continued to retain the risks and rewards of ownership of its Mortgage Loan and REO Assets. Such Mortgage Loan and REO Assets and the related debt are segregated for the Company and each of the Affiliated Entities. On account of the segregation of each of the co-participant's assets and liabilities within each of the Joint Entities, as well as the retention by each co-participant of control over its specific Mortgage Loan and REO Assets within the Joint Entities, the Company has determined that it is the primary beneficiary of, and has consolidated its segregated portion of assets and liabilities within, each of the Joint Entities. See Note 9 and Note 11 for additional information.
Participation in CLO Transactions
As discussed in Note 10, the Company participated in a number of CLO securitization transactions, all managed by the CLO Manager.
The CLO Manager is entitled to receive management and incentive fees in accordance with the respective management agreements between the CLO Manager and the respective CLO Issuers. In accordance with the Management Agreement, the Manager rebates to the Company the portion of the management fees payable by each CLO Issuer to the CLO Manager that are allocable to the Company's participating interest in the unsecured subordinated notes issued by such CLO Issuer. For the year ended December 31, 2019, the amount of such management fee rebates was $2.0 million.
In addition, from time to time, the Company along with various other affiliates of Ellington, and in certain cases various third parties, advance funds in the form of loans ("Initial Funding Loans") to securitization vehicles to enable them to establish warehouse facilities for the purpose of acquiring the assets to be securitized. Pursuant to the terms of the warehouse facilities and the Initial Funding Loans, the applicable securitization trust is required, at the closing of each respective CLO securitization, first to repay the warehouse facility, then to repay the Initial Funding Loans, and then to distribute interest earned, net of any necessary reserves and/or interest expense, and the aggregate realized or unrealized gains, if any, on assets purchased into the warehouse facility. In the event that such CLO securitization fails to close, the assets held by the respective securitization vehicle would, subject to a cure period, be liquidated. As of December 31, 2019, the Company's investments in such warehouse facilities was $8.1 million, which are included on the Consolidated Balance Sheet in Investments in unconsolidated entities.
During the year ended December 31, 2019, the Company purchased various underperforming corporate debt and equity securities from certain of the Ellington-sponsored CLO Securitizations at market prices determined through the procedures set forth in the indentures of the respective Ellington-sponsored CLO Securitization. The total amount of such debt and equity securities purchased was $8.8 million.
14. Long-Term Incentive Plan Units
OP LTIP Units subject to the Company's incentive plans are generally exercisable by the holder at any time after vesting. Each OP LTIP Unit is convertible into an OP Unit on a one-for-one basis. Subject to certain conditions, the OP Units are redeemable by the holder for an equivalent number of shares of common stock of the Company or for the cash value of such shares of common stock, at the Company's election. Costs associated with the OP LTIP Units issued under the Company's


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incentive plans are measured as of the grant date and expensed ratably over the vesting period. Total expense associated with OP LTIP Units issued under the Company's incentive plans for the year ended December 31, 2019 was $0.5 million.
On September 11, 2019, the Company's Board of Directors authorized the issuance of 14,552 OP LTIP Units to certain of its directors pursuant to the Company's 2017 Equity Incentive Plan.
On September 12, 2019, certain of the Company's independent directors converted 3,610 OP LTIP Units into shares of common stock.
On November 14, 2019 and November 29, 2019, certain current and former Ellington employees converted 7,608 and 1,874 OP LTIP Units, respectively, into shares of common stock.
On December 13, 2019, the Company's Board of Directors authorized the issuance of 22,885 OP LTIP Units to certain of its partially dedicated employees pursuant to the Company's 2017 Equity Incentive Plan.
The below table details unvested OP LTIP Units as of December 31, 2019:
Grant Recipient
 
Number of OP LTIP Units Granted
 
Grant Date
 
Vesting Date(1)
Directors:
 
 
 
 
 
 
 
 
14,552

 
September 11, 2019
 
September 10, 2020
Partially dedicated employees:
 
 
 
 
 
 
 
 
12,818

 
December 13, 2019
 
December 13, 2020
 
 
10,067

 
December 13, 2019
 
December 13, 2021
 
 
8,691

 
December 11, 2018
 
December 11, 2020
Total unvested OP LTIP Units at December 31, 2019
 
46,128

 
 
 
 
(1)
Date at which such OP LTIP Units will vest and become non-forfeitable.
The following table summarizes issuance and exercise activity of OP LTIP Units for the year ended December 31, 2019:
 
Year Ended
December 31, 2019
 
Manager
 
Director/
Employee
 
Total
OP LTIP Units Outstanding (January 1, 2019)
375,000

 
146,371

 
521,371

Granted

 
37,437

 
37,437

Exercised
(9,482
)
 
(3,610
)
 
(13,092
)
OP LTIP Units Outstanding (December 31, 2019)
365,518

 
180,198

 
545,716

OP LTIP Units Unvested and Outstanding (December 31, 2019)

 
46,128

 
46,128

OP LTIP Units Vested and Outstanding (December 31, 2019)
365,518

 
134,070

 
499,588


As of December 31, 2019, there were an aggregate of 1,832,309 shares of common stock of the Company underlying awards, including OP LTIP Units, available for future issuance under the Company's 2017 Equity Incentive Plan.
15. Non-controlling Interests
Operating Partnership
Non-controlling interests include the Convertible Non-controlling Interests in the Operating Partnership owned by an affiliate of our Manager, our directors, and certain current and former Ellington employees and their related parties. On December 31, 2018, the Company redeemed 503,988 outstanding long term incentive plan units of the Company and exchanged them on a one-for-one basis for OP LTIP Units. Income allocated to Convertible Non-controlling Interests is based on the non-controlling interest owners' ownership percentage of the Operating Partnership during the period, calculated using a daily weighted average of all shares of common stock of the Company and Convertible Non-controlling Interests outstanding during the period. Holders of Convertible Non-controlling Interests are entitled to receive the same distributions that holders of shares of common stock of the Company receive. Convertible Non-controlling Interests are non-voting with respect to matters as to which holders of common stock of the Company are entitled to vote.


141


On November 14, 2019 and November 29, 2019, certain current and former Ellington employees converted 29,762 and 4,313 OP Units, respectively, into shares of common stock.
As December 31, 2019, the Convertible Non-controlling Interests consisted of the outstanding 545,716 OP LTIP Units and 177,925 OP Units, and represented an interest of approximately 1.6% in the Operating Partnership. As of December 31, 2019, non-controlling interests related to all outstanding Convertible Non-controlling Interests was $13.4 million.
Joint Venture Interests
Non-controlling interests also include the interests of joint venture partners in various consolidated subsidiaries of the Company. These subsidiaries hold the Company's investments in certain commercial mortgage loans and REO. The joint venture partners participate in the income, expense, gains and losses of such subsidiaries as set forth in the related operating agreements of the subsidiaries. The joint venture partners make capital contributions to the subsidiaries as new approved investments are purchased by the subsidiaries, and are generally entitled to distributions when investments are sold or otherwise disposed of. As of December 31, 2019, the joint venture partners' interests in subsidiaries of the Company were $25.9 million.
The joint venture partners' interests are not convertible into shares of common stock of the Company or OP Units, nor are the joint venture partners entitled to receive distributions that holders of shares of common stock of the Company receive.
16. Equity
Preferred Stock
The Company has authorized 100,000,000 shares of preferred stock, $0.001 par value per share. As of December 31, 2019, there were 4,600,000 shares of preferred stock outstanding.
On October 22, 2019, the Company issued 4,600,000 shares of 6.750% Series A Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, $0.001 par value per share ("Series A Preferred Stock"), of which 600,000 shares were issued pursuant to the exercise of the underwriters' over-allotment option. The issuance and sale of the 4,600,000 shares of Series A Preferred Stock resulted in total net proceeds to the Company of approximately $111.0 million, after underwriters' discount and offering costs.
The Company's Series A Preferred Stock ranks senior to its common stock and Convertible Non-controlling Interests with respect to the payment of dividends and the distribution of assets upon a voluntary or involuntary liquidation, dissolution or winding up of the Company. Additionally, the Company's Series A Preferred Stock has no stated maturity and is not subject to any sinking fund or mandatory redemption. The Series A Preferred Stock is not redeemable by the Company prior to October 30, 2024, except under circumstances where it is necessary to allow the Company to qualify and maintain its qualification as a REIT for U.S. federal income tax purposes and except in certain instances upon the occurrence of a change of control. Holders of the Company's Series A Preferred Stock generally do not have any voting rights.
Holders of the Series A Preferred Stock are entitled to receive cumulative cash dividends (i) from and including the original issue date to, but excluding, October 30, 2024, at a fixed rate equal to 6.750% per annum of the $25.00 per share liquidation preference and (ii) from and including October 30, 2024, at a floating rate equal to three-month LIBOR plus a spread of 5.196% per annum of the $25.00 per share liquidation preference. Dividends are payable quarterly in arrears on or about the 30th day of each January, April, July, and October, commencing with the first dividend payment on January 30, 2020, which the Board of Directors declared in December 2019. As of December 31, 2019, the total amount of cumulative preferred dividends in arrears was $1.5 million.
Common Stock
The Company has authorized 100,000,000 shares of common stock, $0.001 par value per share. The Board of Directors may authorize the issuance of additional shares, subject to the approval of the holders of at least a majority of the shares of common stock then outstanding present in person or represented by proxy at a meeting of the stockholders. As of December 31, 2019, there were 38,647,943 shares of common stock outstanding.
On July 22, 2019, the Company completed a follow-on offering of 3,500,000 shares of its common stock, which generated net proceeds, after underwriters' discount and offering costs, of $60.7 million. On July 25, 2019, the Company issued an additional 525,000 shares of its common stock in connection with the exercise of the underwriters' option granted in the initial offering. The exercise of the underwriters' option resulted in net proceeds to the Company of an additional $9.1 million, after underwriters' discount and offering costs.


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On September 12, 2019, certain of the Company's independent directors converted 3,610 OP LTIP Units into shares of common stock.
On November 14, 2019, certain current and former Ellington employees converted 29,762 OP Units and 7,608 OP LTIP Units into shares of common stock.
On November 29, 2019, certain current and former Ellington employees converted 4,313 OP Units and 1,874 OP LTIP Units into shares of common stock.
On November 21, 2019, the Company completed a follow-on offering of 4,200,000 shares of its common stock, which generated net proceeds, after underwriters' discount and offering costs, of $75.3 million. On December 3, 2019, the Company issued an additional 630,000 shares of its common stock in connection with the exercise of the underwriters' option granted in the initial offering. The exercise of the underwriters' option resulted in net proceeds to the Company of an additional $11.2 million, after underwriters' discount and offering costs.
The following table summarizes issuance, repurchase, and other activity with respect to the Company's common stock for the year ended December 31, 2019:
 
 
Year Ended
December 31, 2019
Shares of Common Stock Outstanding (January 1, 2019)
 
29,796,601

Share Activity:
 
 
Shares of common stock issued
 
8,855,000

Shares of common stock repurchased
 
(50,825
)
OP LTIP Units exercised
 
13,092

OP Units exercised
 
34,075

Shares of Common Stock Outstanding (December 31, 2019)
 
38,647,943


If all Convertible Non-controlling Interests that have been previously issued were to become fully vested and exchanged for shares of common stock as of December 31, 2019, the Company's issued and outstanding shares of common stock would increase to 39,371,584 shares.
On June 13, 2018, the Board of Directors approved the adoption of a share repurchase program under which the Company is authorized to repurchase up to 1.55 million shares of common stock. The program, which is open-ended in duration, allows the Company to make repurchases from time to time on the open market or in negotiated transactions, including under Rule 10b5-1 plans. Repurchases are at the Company's discretion, subject to applicable law, share availability, price and financial performance, among other considerations. During the year ended December 31, 2019, the Company repurchased 50,825 shares at an average price per share of $15.39 and a total cost of $0.8 million. From inception of the current repurchase plan through December 31, 2019, the Company repurchased 411,915 shares at an average price per share of $15.34 and a total cost of $6.3 million.


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17. Earnings Per Share
The components of the computation of basic and diluted EPS are as follows:
 
Year Ended
December 31, 2019
(In thousands except share amounts)
 
Net income (loss) attributable to common stockholders
$
56,467

Add: Net income (loss) attributable to Convertible Non-controlling Interests(1)
1,305

Net income (loss) attributable to common stockholders and Convertible Non-controlling Interests
57,772

Dividends Paid:
 
Common stockholders
(58,499
)
Convertible Non-controlling Interests
(1,325
)
Total dividends paid to common stockholders and Convertible Non-controlling Interests
(59,824
)
Undistributed (Distributed in excess of) earnings:
 
Common stockholders
(2,032
)
Convertible Non-controlling Interests
(20
)
Total undistributed (distributed in excess of) earnings attributable to common stockholders and Convertible Non-controlling Interests
$
(2,052
)
Weighted average shares outstanding (basic and diluted):
 
Weighted average shares of common stock outstanding
32,067,768

Weighted average Convertible Non-controlling Interest Units outstanding
732,456

Weighted average shares of common stock and Convertible Non-controlling Interest Units outstanding
32,800,224

Basic earnings per share of common stock and Convertible Non-controlling Interest Unit:
 
Distributed
$
1.81

Undistributed (Distributed in excess of)
(0.05
)
 
$
1.76

Diluted earnings per share of common stock and Convertible Non-controlling Interest Unit:
 
Distributed
$
1.81

Undistributed (Distributed in excess of)
(0.05
)
 
$
1.76

(1)
For the year ended December 31, 2019, excludes net income (loss) of $3.9 million attributable to joint venture partners, which have non-participating interests as described in Note 15.
18. Restricted Cash
The Company is required to maintain a specific cash balance in a segregated account pursuant to a flow consumer loan purchase and sale agreement. As of December 31, 2019, the Company's restricted cash balance related to the flow consumer loan purchase and sale agreement was $0.2 million.
19. Offsetting of Assets and Liabilities
The Company generally records financial instruments at fair value as described in Note 2. All financial instruments are recorded on a gross basis on the Consolidated Balance Sheet. In connection with the vast majority of its derivative, reverse repurchase and repurchase agreements, and the related trading agreements, the Company and its counterparties are required to pledge collateral. Cash or other collateral is exchanged as required with each of the Company's counterparties in connection with open derivative positions, and reverse repurchase and repurchase agreements.


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The following table presents information about certain assets and liabilities representing financial instruments as of December 31, 2019. The Company has not entered into master netting agreements with any of its counterparties. Certain of the Company's reverse repurchase and repurchase agreements and financial derivative transactions are governed by underlying agreements that generally provide a right of offset in the event of default or in the event of a bankruptcy of either party to the transaction.
December 31, 2019:
Description
 
Amount of Assets (Liabilities) Presented in the Consolidated Balance Sheet(1)
 
Financial Instruments Available for Offset
 
Financial Instruments Transferred or Pledged as Collateral(2)(3)
 
Cash Collateral (Received) Pledged(2)(3)
 
Net Amount
(In thousands)
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
Financial derivatives–assets
 
$
16,788

 
$
(12,755
)
 
$

 
$
(807
)
 
$
3,226

Reverse repurchase agreements
 
73,639

 
(73,639
)
 

 

 

Liabilities
 
 
 
 
 
 
 
 
 
 
Financial derivatives–liabilities
 
(27,621
)
 
12,755

 

 
12,233

 
(2,633
)
Repurchase agreements
 
(2,445,300
)
 
73,639

 
2,340,656

 
31,005

 

(1)
In the Company's Consolidated Balance Sheet, all balances associated with repurchase agreements, reverse repurchase agreements, and financial derivatives are presented on a gross basis.
(2)
For the purpose of this presentation, for each row the total amount of financial instruments transferred or pledged and cash collateral (received) or pledged may not exceed the applicable gross amount of assets or (liabilities) as presented here. Therefore, the Company has reduced the amount of financial instruments transferred or pledged as collateral related to the Company's reverse repurchase agreements and cash collateral pledged on the Company's financial derivative liabilities. Total financial instruments transferred or pledged as collateral on the Company's reverse repurchase agreements as of December 31, 2019 was $2.8 billion. As of December 31, 2019, total cash collateral on financial derivative assets and liabilities excludes excess net cash collateral pledged of $4.3 million and $23.4 million, respectively.
(3)
When collateral is pledged to or pledged by a counterparty, it is often pledged or posted with respect to all positions with such counterparty, and in such cases such collateral cannot be specifically identified as relating to a particular asset or liability. As a result, in preparing the above tables, the Company has made assumptions in allocating pledged or posted collateral among the various rows.
20. Counterparty Risk
The Company is exposed to concentrations of counterparty risk. It seeks to mitigate such risk by diversifying its exposure among various counterparties, when appropriate. The following table summarizes the Company's exposure to counterparty risk as of December 31, 2019.
 
 
Amount of Exposure
 
Number of Counterparties with Exposure
 
Maximum Percentage of Exposure to a Single Counterparty(1)
 
 
(In thousands)
 
 
 
 
Cash and cash equivalents
 
$
72,302

 
11

 
42.2
%
Collateral on repurchase agreements held by dealers(2)
 
2,793,696

 
28

 
13.8
%
Due from brokers
 
79,829

 
24

 
30.9
%
Receivable for securities sold(3)
 
69,995

 
5

 
62.3
%
(1)
Each counterparty is a large creditworthy financial institution.
(2)
Includes securities, loans, and REO as well as cash posted as collateral for repurchase agreements.
(3)
Included in Investment related receivables on the Consolidated Balance Sheet.
21. Commitments and Contingencies
The Company provides current directors and officers with a limited indemnification against liabilities arising in connection with the performance of their duties to the Company.
In the normal course of business the Company may also enter into contracts that contain a variety of representations, warranties, and general indemnifications. The Company's maximum exposure under these arrangements, including future claims that may be made against the Company that have not yet occurred, is unknown. The Company has not incurred any costs to defend lawsuits or settle claims related to these indemnification agreements. As of December 31, 2019 the Company


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has no liabilities recorded for these agreements.
The Company's maximum risk of loss from credit events on its securities (excluding Agency securities, which are guaranteed by the issuing government agency or government-sponsored enterprise), loans, and investments in unconsolidated entities is limited to the amount paid for such investment.
Commitments and Contingencies Related to Investments in Residential Mortgage Loans
In connection with certain of the Company's investments in residential mortgage loans, the Company has unfunded commitments in the amount of $5.2 million as of December 31, 2019.
Commitments and Contingencies Related to Investments in Mortgage Loan Originators
In connection with certain of its investments in mortgage loan originators, the Company has outstanding commitments and contingencies as described below.
As described in Note 13, the Company is party to a flow mortgage loan purchase and sale agreement with a mortgage loan originator. The Company has entered into two agreements whereby it guarantees the performance of this mortgage loan originator under master repurchase agreements. The Company's maximum guarantees are capped at $25.0 million. As of December 31, 2019 the mortgage loan originator had $0.4 million of outstanding borrowings under the agreements guaranteed by the Company. The Company's obligations under these arrangements are deemed to be guarantees under ASC 460-10. The Company has elected the FVO for its guarantees, which are included in Accrued expenses and other liabilities on the Consolidated Balance Sheet. As of December 31, 2019, the estimated fair value of such guarantees was insignificant.
Commitments and Contingencies Related to Corporate Loans
The Company has investments in certain corporate loans whereby the borrowers can request additional funds under the respective agreements. As of December 31, 2019 the Company had unfunded commitments related to such investments in the amount of $1.9 million.


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22. Condensed Quarterly Financial Data (Unaudited)
Detailed below is unaudited quarterly financial data for the year ended December 31, 2019.
 
Three Month Period Ended
 
March 31, 2019
 
June 30, 2019
 
September 30, 2019
 
December 31, 2019
(In thousands except per share amounts)
 
 
 
 
 
 
 
Net Interest Income
 
 
 
 
 
 
 
Interest income
$
36,016

 
$
38,547

 
$
39,985

 
$
45,353

Interest expense
(17,618
)
 
(19,702
)
 
(19,954
)
 
(21,205
)
Total net interest income
18,398

 
18,845

 
20,031

 
24,148

Other Income (Loss)
 
 
 
 
 
 
 
Realized gains (losses) on securities and loans, financial derivatives, and real estate owned, net
(16,950
)
 
(12,327
)
 
(4,827
)
 
(7,266
)
Unrealized gains (losses) on securities and loans, financial derivatives, and real estate owned, net
20,452

 
13,300

 
7,970

 
6,139

Other, net
2,002

 
1,808

 
539

 
1,001

Total other income (loss)
5,504

 
2,781

 
3,682

 
(126
)
Expenses
 
 
 
 
 
 
 
Base management fee to affiliate (Net of fee rebates of $447, $508, $503, and $509, respectively)(1)
1,722

 
1,661

 
1,942

 
2,663

Incentive fee to affiliate

 

 

 
116

Investment related expenses:
 
 
 
 
 
 
 
Servicing expense
2,393

 
2,244

 
1,940

 
2,055

Debt issuance costs related to Other secured borrowings, at fair value

 
1,671

 

 
1,865

Other
1,083

 
1,238

 
1,347

 
1,941

Professional fees
1,956

 
1,178

 
698

 
1,021

Compensation expense
1,072

 
903

 
712

 
962

Other expenses
985

 
1,053

 
1,156

 
1,160

Total expenses
9,211

 
9,948

 
7,795

 
11,783

Net Income (Loss) before Income Tax Expense and Earnings from Investments in Unconsolidated Entities
14,691

 
11,678

 
15,918

 
12,239

Income tax expense (benefit)

 
376

 
2

 
1,180

Earnings from investments in unconsolidated entities
1,797

 
2,354

 
2,796

 
3,262

Net Income (Loss)
16,488

 
13,656

 
18,712

 
14,321

Net income (loss) attributable to non-controlling interests
1,080

 
1,012

 
1,419

 
1,733

Dividends on preferred stock

 

 

 
1,466

Net Income (Loss) Attributable to Common Stockholders
$
15,408

 
$
12,644

 
$
17,293

 
$
11,122

Net Income (Loss) per Share of Common Stock:
 
 
 
 
 
 
 
Basic and Diluted (2)
$
0.52

 
$
0.43

 
$
0.53

 
$
0.31

(1)
See Note 13 for further details on management fee rebates.
(2)
For the year ended December 31, 2019 the sum of EPS for the four quarters of the year does not equal EPS as calculated for the entire year (see Note 17) as a result of changes in the number of shares of common stock outstanding during the year due to issuances of shares of common stock, as EPS is calculated using average shares of common stock outstanding during the period.


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23. Subsequent Events
On January 8, 2020, the Board of Directors approved a dividend in the amount of $0.15 per share of common stock payable on February 25, 2020 to stockholders of record as of January 31, 2020.
On January 24, 2020, the Company completed a follow-on offering of 5,290,000 shares of its common stock, of which 690,000 shares were issued pursuant to the exercise of the underwriters' option. The issuance and sale of 5,290,000 shares of common stock generated net proceeds, after underwriters' discount and offering costs, of $95.3 million.
On February 7, 2020, the Board of Directors approved a dividend in the amount of $0.15 per share of common stock payable on March 25, 2020 to stockholders of record as of February 28, 2020.
On March 6, 2020, the Board of Directors approved a dividend in the amount of $0.15 per share of common stock payable on April 27, 2020 to stockholders of record as of March 31, 2020.


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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Ellington Financial Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated statement of assets, liabilities, and equity, including the consolidated condensed schedule of investments, of Ellington Financial LLC and its subsidiaries (the "Company") as of December 31, 2018, and the related consolidated statements of operations, of changes in equity and of cash flows for the year then ended, including the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
New York, New York
March 14, 2019
We have served as the Company's auditor since 2007.



149


ELLINGTON FINANCIAL LLC
CONSOLIDATED STATEMENT OF ASSETS, LIABILITIES, AND EQUITY

 
December 31, 2018
(In thousands except share amounts)
Expressed in U.S. Dollars
ASSETS
 
Cash and cash equivalents
$
44,656

Restricted cash
425

Investments, financial derivatives, and repurchase agreements:
 
Investments, at fair value (Cost – $2,970,306)
2,939,311

Financial derivatives–assets, at fair value (Net cost – $22,526)
20,001

Repurchase agreements, at fair value (Cost – $61,274)
61,274

Total investments, financial derivatives, and repurchase agreements
3,020,586

Due from brokers
71,794

Receivable for securities sold and financial derivatives
780,826

Interest and principal receivable
37,676

Other assets
15,536

Total Assets
$
3,971,499

LIABILITIES
 
Investments and financial derivatives:
 
Investments sold short, at fair value (Proceeds – $844,604)
$
850,577

Financial derivatives–liabilities, at fair value (Net proceeds – $19,019)
20,806

Total investments and financial derivatives
871,383

Reverse repurchase agreements
1,498,849

Due to brokers
5,553

Payable for securities purchased and financial derivatives
488,411

Other secured borrowings (Proceeds – $114,100)
114,100

Other secured borrowings, at fair value (Proceeds – $298,706)
297,948

Senior notes, net
85,035

Accounts payable and accrued expenses
5,723

Base management fee payable to affiliate
1,744

Interest and dividends payable
7,159

Other liabilities
424

Total Liabilities
3,376,329

EQUITY
595,170

TOTAL LIABILITIES AND EQUITY
$
3,971,499

Commitments and contingencies (Note 17)
 
ANALYSIS OF EQUITY:
 
Common shares, no par value, 100,000,000 shares authorized;
 
(29,796,601 shares issued and outstanding)
$
563,833

Additional paid-in capital – Long term incentive plan units

Total Shareholders' Equity
563,833

Non-controlling interests
31,337

Total Equity
$
595,170

PER SHARE INFORMATION:
 
Common shares
$
18.92


See Notes to Consolidated Financial Statements
150

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018

Current Principal/Number of Shares
 
Description
 
Rate
 
Maturity
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
Expressed in U.S.
Dollars
Cash Equivalents—Money Market Funds (2.09%) (a) (b)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Funds
 
 
 
 
 
 
$
12,460

 
Various
 
2.31% - 2.34%
 
 
 
$
12,460

Total Cash Equivalents—Money Market Funds (Cost $12,460)
 
 
 
 
 
$
12,460

Long Investments (493.86%) (a) (b) (ad)
 
 
 
 
 
 
Mortgage-Backed Securities (300.21%)
 
 
 
 
 
 
Agency Securities (243.66%) (c)
 
 
 
 
 
 
Fixed Rate Agency Securities (230.23%)
 
 
 
 
 
 
Principal and Interest - Fixed Rate Agency Securities (148.68%)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Mortgage-related—Residential
 
 
 
 
 
 
$
143,523

 
Federal National Mortgage Association Pools (30 Year)
 
4.00%
 
9/39 - 11/48
 
$
147,395

111,109

 
Federal Home Loan Mortgage Corporation Pools (30 Year)
 
4.00%
 
11/41 - 12/48
 
114,104

82,189

 
Federal National Mortgage Association Pools (30 Year)
 
3.50%
 
9/42 - 2/48
 
82,450

74,478

 
Government National Mortgage Association Pools (30 Year)
 
4.50%
 
9/46 - 1/49
 
77,266

65,892

 
Federal National Mortgage Association Pools (30 Year)
 
4.50%
 
10/41 - 12/48
 
68,853

51,362

 
Government National Mortgage Association Pools (30 Year)
 
4.00%
 
7/45 - 5/48
 
52,544

46,026

 
Government National Mortgage Association Pools (30 Year)
 
5.00%
 
2/48 - 12/48
 
48,245

45,670

 
Federal Home Loan Mortgage Corporation Pools (30 Year)
 
4.50%
 
9/43 - 10/48
 
47,583

42,663

 
Federal National Mortgage Association Pools (15 Year)
 
3.50%
 
3/28 - 3/32
 
43,241

38,420

 
Federal National Mortgage Association Pools (30 Year)
 
5.00%
 
10/35 - 8/48
 
40,652

32,106

 
Government National Mortgage Association Pools (30 Year)
 
3.50%
 
12/42 - 12/47
 
32,253

25,082

 
Federal Home Loan Mortgage Corporation Pools (30 Year)
 
3.50%
 
1/42 - 3/48
 
25,185

21,807

 
Government National Mortgage Association Pools (30 Year)
 
5.50%
 
4/48 - 12/48
 
23,207

10,899

 
Federal National Mortgage Association Pools (15 Year)
 
3.00%
 
4/30 - 9/32
 
10,895

8,275

 
Federal Home Loan Mortgage Corporation Pools (15 Year)
 
3.50%
 
9/28 - 12/32
 
8,389

7,287

 
Federal Home Loan Mortgage Corporation Pools (Other)
 
3.50%
 
4/43 - 9/46
 
7,316

6,096

 
Federal Home Loan Mortgage Corporation Pools (30 Year)
 
5.00%
 
7/44 - 10/48
 
6,423

5,728

 
Federal National Mortgage Association Pools (15 Year)
 
4.00%
 
6/26 - 5/31
 
5,823

5,023

 
Federal National Mortgage Association Pools (30 Year)
 
5.50%
 
10/39 - 6/48
 
5,342

4,547

 
Federal National Mortgage Association Pools (Other)
 
5.00%
 
9/43 - 1/44
 
4,772

4,394

 
Federal National Mortgage Association Pools (Other)
 
4.00%
 
12/47
 
4,478

3,408

 
Government National Mortgage Association Pools (30 Year)
 
6.00%
 
5/48 - 11/48
 
3,666

2,773

 
Federal Home Loan Mortgage Corporation Pools (30 Year)
 
3.00%
 
7/43 - 6/45
 
2,722

2,603

 
Federal National Mortgage Association Pools (30 Year)
 
3.00%
 
1/42 - 6/45
 
2,556

2,508

 
Government National Mortgage Association Pools (30 Year)
 
3.75%
 
7/47
 
2,537

2,348

 
Federal Home Loan Mortgage Corporation Pools (Other)
 
4.50%
 
5/44
 
2,432

2,343

 
Federal Home Loan Mortgage Corporation Pools (15 Year)
 
3.00%
 
 4/30
 
2,342

2,177

 
Federal National Mortgage Association Pools (15 Year)
 
4.50%
 
4/26
 
2,265

2,025

 
Federal National Mortgage Association Pools (Other)
 
4.50%
 
5/41
 
2,079

1,677

 
Federal Home Loan Mortgage Corporation Pools (30 Year)
 
5.50%
 
8/33 - 5/48
 
1,786

1,478

 
Federal National Mortgage Association Pools (20 Year)
 
4.00%
 
12/33
 
1,526


See Notes to Consolidated Financial Statements
151

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONTINUED)

Current Principal/Notional Value
 
Description
 
Rate
 
Maturity
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
Expressed in U.S.
Dollars
(continued)
 
 
 
 
$
976

 
Federal Home Loan Mortgage Corporation Pools (20 Year)
 
4.50%
 
12/33
 
$
1,021

886

 
Federal Home Loan Mortgage Corporation Pools (15 Year)
 
4.00%
 
2/29
 
897

651

 
Federal Home Loan Mortgage Corporation Pools (30 Year)
 
6.00%
 
5/40
 
697

710

 
Government National Mortgage Association Pools (30 Year)
 
3.00%
 
11/42
 
695

588

 
Federal National Mortgage Association Pools (30 Year)
 
6.00%
 
9/39 - 2/40
 
631

524

 
Government National Mortgage Association Pools (30 Year)
 
2.49%
 
10/43
 
496

109

 
Federal National Mortgage Association Pools (30 Year)
 
3.28%
 
6/42
 
106

 
 
 
 
 
 
 
 
884,870

Interest Only - Fixed Rate Agency Securities (1.77%)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Mortgage-related—Residential
 
 
 
 
 
 
17,505

 
Government National Mortgage Association
 
4.00%
 
2/45 - 6/45
 
2,828

10,446

 
Federal National Mortgage Association
 
4.50%
 
12/20 - 6/44
 
1,223

4,768

 
Government National Mortgage Association
 
6.00%
 
6/38 - 8/39
 
978

5,949

 
Government National Mortgage Association
 
4.50%
 
6/39 - 7/44
 
808

3,401

 
Federal National Mortgage Association
 
5.50%
 
10/39
 
749

3,612

 
Government National Mortgage Association
 
5.50%
 
11/43
 
623

3,642

 
Federal Home Loan Mortgage Corporation
 
3.50%
 
12/32
 
515

3,560

 
Federal National Mortgage Association
 
4.00%
 
5/39 - 11/43
 
513

2,659

 
Federal National Mortgage Association
 
5.00%
 
1/38 - 5/40
 
463

5,122

 
Federal Home Loan Mortgage Corporation
 
5.00%
 
11/38
 
402

3,749

 
Federal Home Loan Mortgage Corporation
 
5.50%
 
1/39 - 9/39
 
336

1,613

 
Federal National Mortgage Association
 
6.00%
 
1/40
 
274

1,463

 
Federal Home Loan Mortgage Corporation
 
4.50%
 
7/43
 
254

2,291

 
Federal National Mortgage Association
 
3.00%
 
9/41
 
203

3,043

 
Government National Mortgage Association
 
5.00%
 
5/37 - 5/41
 
181

842

 
Government National Mortgage Association
 
4.75%
 
7/40
 
160

 
 
 
 
 
 
 
 
10,510

TBA - Fixed Rate Agency Securities (79.78%)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Mortgage-related—Residential
 
 
 
 
 
 
299,455

 
Government National Mortgage Association (30 Year)
 
5.00%
 
1/19
 
311,515

122,003

 
Federal National Mortgage Association (30 Year)
 
4.00%
 
1/19
 
124,376

21,540

 
Federal Home Loan Mortgage Corporation (30 Year)
 
3.50%
 
1/19
 
21,529

10,579

 
Government National Mortgage Association (30 Year)
 
5.50%
 
1/19
 
11,058

4,800

 
Government National Mortgage Association (30 Year)
 
3.00%
 
1/19
 
4,727

1,660

 
Federal Home Loan Mortgage Corporation (15 Year)
 
3.00%
 
1/19
 
1,655

 
 
 
 
 
 
 
 
474,860

Total Fixed Rate Agency Securities (Cost $1,388,115)
 
 
 
 
 
1,370,240

 
 
 
 
 
 
 
 
 

See Notes to Consolidated Financial Statements
152

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONTINUED)

Current Principal/Notional Value
 
Description
 
Rate
 
Maturity
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
Expressed in U.S.
Dollars
Floating Rate Agency Securities (13.43%)
 
 
 
 
 
 
Principal and Interest - Floating Rate Agency Securities (10.24%)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Mortgage-related—Residential
 
 
 
 
 
 
$
52,532

 
Government National Mortgage Association Pools
 
4.39% - 4.67%
 
7/61 - 12/67
 
$
55,475

3,515

 
Federal National Mortgage Association Pools
 
2.70% - 4.69%
 
9/35 - 5/45
 
3,650

1,808

 
Federal Home Loan Mortgage Corporation Pools
 
3.49% - 4.72%
 
6/37 - 5/44
 
1,846

 
 
 
 
 
 
 
 
60,971

Interest Only - Floating Rate Agency Securities (3.19%)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Mortgage-related—Residential
 
 
 
 
 
 
228,763

 
Other Government National Mortgage Association
 
0.38% - 5.64%
 
6/31 - 10/66
 
10,772

70,568

 
Other Federal National Mortgage Association
 
1.13% - 5.50%
 
6/33 - 11/46
 
4,880

48,699

 
Other Federal Home Loan Mortgage Corporation
 
1.55% - 4.19%
 
3/36 - 1/44
 
3,256

5,220

 
Resecuritization of Government National Mortgage Association (d)
 
2.21%
 
8/60
 
98

 
 
 
 
 
 
 
 
19,006

Total Floating Rate Agency Securities (Cost $81,873)
 
 
 
 
 
79,977

Total Agency Securities (Cost $1,469,988)
 
 
 
 
 
1,450,217

Private Label Securities (56.55%)
 
 
 
 
 
 
Principal and Interest - Private Label Securities (55.33%)
 
 
 
 
 
 
North America (27.62%)
 
 
 
 
 
 
Mortgage-related—Residential
 
 
 
 
 
 
227,479

 
Various
 
0.00% - 24.56%
 
5/19 - 3/47
 
149,273

Mortgage-related—Commercial
 
 
 
 
 
 
37,171

 
Various
 
2.80% - 3.29%
 
3/49 - 5/61
 
15,137

Total North America (Cost $153,769)
 
 
 
 
 
164,410

Europe (27.71%)
 
 
 
 
 
 
Mortgage-related—Residential
 
 
 
 
 
 
183,154

 
Various
 
0.00% - 5.50%
 
6/25 - 12/52
 
149,425

Mortgage-related—Commercial
 
 
 
 
 
 
24,978

 
Various
 
0.38% - 4.29%
 
10/20 - 8/45
 
15,482

Total Europe (Cost $172,661)
 
 
 
 
 
164,907

Total Principal and Interest - Private Label Securities (Cost $326,430)
 
 
 
 
 
329,317

 
 
 
 
 
 
 

See Notes to Consolidated Financial Statements
153

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONTINUED)

Current Principal/Notional Value
 
Description
 
Rate
 
Maturity
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
Expressed in U.S.
Dollars
Interest Only - Private Label Securities (1.22%)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Mortgage-related—Residential
 
 
 
 
 
 
$
30,842

 
Various
 
 0.00% - 2.00%
 
 12/30 - 9/47
 
$
3,941

Mortgage-related—Commercial
 
 
 
 
 
 
41,707

 
Various
 
 1.25% - 2.00%
 
 3/49 - 5/61
 
3,289

Total Interest Only - Private Label Securities (Cost $5,189)
 
 
 
 
 
7,230

Other Private Label Securities (0.00%)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Mortgage-related—Commercial
 
 
 
 
 
 

 
Various
 
—%
 
7/45 - 5/61
 

Total Other Private Label Securities (Cost $0)
 
 
 
 
 

Total Private Label Securities (Cost $331,619)
 
 
 
 
 
336,547

Total Mortgage-Backed Securities (Cost $1,801,607)
 
 
 
 
 
1,786,764

Collateralized Loan Obligations (20.82%)
 
 
 
 
 
 
North America (20.82%) (e)
 
 
 
 
 
 
269,224

 
Various
 
0.00% - 10.54%
 
4/20- 10/2118
 
123,893

Total North America (Cost $139,424)
 
 
 
 
 
123,893

Total Collateralized Loan Obligations (Cost $139,424)
 
 
 
 
 
123,893

Consumer Loans and Asset-backed Securities backed by Consumer Loans (34.74%) (f)
 
 
 
 
 
 
North America (34.59%)
 
 
 
 
 
 
Consumer (g) (h)
 
 
 
 
 
 
233,602

 
Various
 
5.31% - 76.50%
 
1/19 - 12/23
 
205,877

Total North America (Cost $211,221)
 
 
 
 
 
205,877

Europe (0.15%)
 
 
 
 
 
 
Consumer
 
 
 
 
 
 
3,540

 
Various
 
—%
 
12/30
 
884

Total Europe (Cost $761)
 
 
 
 
 
884

Total Consumer Loans and Asset-backed Securities backed by Consumer Loans (Cost $211,982)
 
 
 
 
 
206,761

 
 
 
 
 
 
 
 
 

See Notes to Consolidated Financial Statements
154

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONTINUED)

Current Principal/Number of Properties
 
 
 
Rate
 
Maturity
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
Expressed in U.S.
Dollars
Corporate Debt (3.76%)
 
 
 
 
 
 
North America (1.95%)
 
 
 
 
 
 
Communications
 
 
 
 
 
 
$
938

 
Various
 
—%
 
5/22
 
$
824

Consumer
 
 
 
 
 
 
3,342

 
Various
 
6.69%
 
1/27
 
3,141

Energy
 
 
 
 
 
 
2,080

 
Various
 
4.63%
 
9/21
 
1,877

Industrial
 
 
 
 
 
 
1,755

 
Various
 
3.75%
 
12/21
 
1,742

Technology
 
 
 
 
 
 
4,570

 
Various
 
0.00% - 4.38%
 
5/20 - 5/22
 
4,002

Total North America (Cost $11,949)
 
 
 
 
 
11,586

Europe (1.81%)
 
 
 
 
 
 
Consumer
 
 
 
 
 
 
20,574

 
Various
 
—%
 
1/19
 

Financial
 
 
 
 
 
 
11,235

 
Various
 
0.00% - 16.00%
 
10/20 - 11/22
 
10,806

Total Europe (Cost $12,319)
 
 
 
 
 
10,806

Total Corporate Debt (Cost $24,268)
 
 
 
 
 
22,392

Secured Notes (1.83%) (n)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Mortgage-related—Residential
 
 
 
 
 
 
17,608

 
Various
 
5.00%
 
11/57
 
10,917

Total Secured Notes (Cost $12,138)
 
 
 
 
 
10,917

Mortgage Loans (118.96%) (f)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Mortgage-related—Commercial (j)
 
 
 
 
 
 
235,459

 
Various
 
4.31% - 12.74%
 
3/19 - 10/37
 
211,185

Mortgage-related—Residential (k) (m)
 
 
 
 
 
 
493,248

 
Various
 
2.00% - 15.00%
 
3/19 - 12/58
 
496,830

Total Mortgage Loans (Cost $703,366)
 
 
 
 
 
708,015

Real Estate Owned (5.80%) (f) (l)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Real estate-related
 
 
 
 
 
 
5

 
Single-Family Houses
 
 
 
 
 
1,296

18

 
Commercial Properties
 
 
 
 
 
33,204

Total Real Estate Owned (Cost $35,371)
 
 
 
 
 
34,500

 
 
 
 
 
 
 
 
 

See Notes to Consolidated Financial Statements
155

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONTINUED)

Current Principal/Number of Shares
 
 
 
Rate
 
Maturity
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
Expressed in U.S.
Dollars
Common Stock (0.37%)
 
 
 
 
 
 
North America (0.37%)
 
 
 
 
 
 
Consumer
 
 
 
 
 
 
24

 
Exchange Traded Equity
 
 
 
 
 
$
25

Financial
 
 
 
 
 
 
213

 
Exchange Traded Equity
 
 
 
 
 
2,175

Total North America (Cost $2,482)
 
 
 
 
 
2,200

Total Corporate Equity Investments (Cost $2,482)
 
 
 
 
 
2,200

Corporate Equity Investments (7.36%)
 
 
 
 
 
 
North America (7.36%)
 
 
 
 
 
 
Communications
 
 
 
 
 
 
7

 
Non-Exchange Traded Corporate Equity
 
 
 
 
 
97

Consumer
 
 
 
 
 
 
 n/a

 
Non-Controlling Equity Interest in Limited Liability Company (i)
 
 
 
 
 
4,045

3,000

 
Non-Exchange Traded Preferred Equity Investment in Consumer Loan Originators (n)
 
 
 
 
 
3,000

1,540

 
Non-Exchange Traded Corporate Equity
 
 
 
 
 

Diversified
 
 
 
 
 
 
144

 
Non-Exchange Traded Corporate Equity
 
 
 
 
 
1,433

Mortgage-related—Commercial (n)
 
 
 
 
 
 
 n/a

 
Non-Controlling Equity Interest in Limited Liability Company
 
 
 
 
 
1,147

Mortgage-related—Residential (n)
 
 
 
 
 
 
23

 
Non-Exchange Traded Preferred Equity Investment in Mortgage Originators
 
 
 
 
 
27,317

9,818

 
Non-Exchange Traded Common Equity Investment in Mortgage Originators
 
 
 
 
 
6,750

Total North America (Cost $39,587)
 
 
 
 
 
43,789

Europe (0.00%)
 
 
 
 
 
 
Consumer
 
 
 
 
 
 
125

 
Non-Exchange Traded Corporate Equity
 
 
 
 
 

Financial
 
 
 
 
 
 

 
Non-Exchange Traded Corporate Equity
 
 
 
 
 
4

Total Europe (Cost $5)
 
 
 
 
 
4

Total Corporate Equity Investments (Cost $39,592)
 
 
 
 
 
43,793

U.S. Treasury Securities (0.01%)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Government
 
 
 
 
 
 
$
75

 
U.S. Treasury Note
 
2.75%
 
4/23
 
76

Total U.S. Treasury Securities (Cost $76)
 
 
 
 
 
76

Total Long Investments (Cost $2,970,306)
 
 
 
 
 
$
2,939,311



See Notes to Consolidated Financial Statements
156

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONTINUED)

Current Principal
 
Description
 
Rate
 
Maturity
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
Expressed in U.S.
Dollars
Repurchase Agreements (10.30%) (a) (b) (o)
 
 
 
 
 
 
$
13,854

 
JP Morgan Securities LLC
 
3.25%
 
1/19
 
$
13,854

 
 
Collateralized by Par Value $13,600
 
 
 
 
 
 
 
 
U.S. Treasury Note, Coupon 2.88%,
 
 
 
 
 
 
 
 
Maturity Date 11/21
 
 
 
 
 
 
10,712

 
JP Morgan Securities LLC
 
3.15%
 
1/19
 
10,712

 
 
Collateralized by Par Value $10,451
 
 
 
 
 
 
 
 
U.S. Treasury Note, Coupon 2.88%,
 
 
 
 
 
 
 
 
Maturity Date 10/23
 
 
 
 
 
 
10,365

 
JP Morgan Securities LLC
 
(0.75)%
 
1/19
 
10,365

 
 
Collateralized by Par Value $10,102
 
 
 
 
 
 
 
 
Sovereign Government Bond, Coupon 0.75%
 
 
 
 
 
 
 
 
Maturity Date 7/21
 
 
 
 
 
 
9,379

 
JP Morgan Securities LLC
 
(0.65)%
 
1/19
 
9,379

 
 
Collateralized by Par Value $9,161
 
 
 
 
 
 
 
 
Sovereign Government Bond, Coupon 2.75%,
 
 
 
 
 
 
 
 
Maturity Date 4/19
 
 
 
 
 
 
3,562

 
JP Morgan Securities LLC
 
3.05%
 
1/19
 
3,562

 
 
Collateralized by Par Value $3,400
 
 
 
 
 
 
 
 
U.S. Treasury Note, Coupon 3.13%,
 
 
 
 
 
 
 
 
Maturity Date 11/28
 
 
 
 
 
 
2,884

 
JP Morgan Securities LLC
 
2.95%
 
1/19
 
2,884

 
 
Collateralized by Par Value $2,800
 
 
 
 
 
 
 
 
U.S. Treasury Note, Coupon 2.88%,
 
 
 
 
 
 
 
 
Maturity Date 8/28
 
 
 
 
 
 
2,098

 
Bank of America Securities
 
2.90%
 
1/19
 
2,098

 
 
Collateralized by Par Value $2,062
 
 
 
 
 
 
 
 
U.S. Treasury Note, Coupon 2.88%,
 
 
 
 
 
 
 
 
Maturity Date 11/23
 
 
 
 
 
 
1,975

 
Bank of America Securities
 
2.90%
 
1/19
 
1,975

 
 
Collateralized by Par Value $1,939
 
 
 
 
 
 
 
 
U.S. Treasury Note, Coupon 2.75%,
 
 
 
 
 
 
 
 
Maturity Date 8/23
 
 
 
 
 
 
1,710

 
Barclays Capital Inc
 
(1.65)%
 
1/19
 
1,710

 
 
Collateralized by Par Value $1,900
 
 
 
 
 
 
 
 
Exchange-Traded Corporate Debt, Coupon 5.95%,
 
 
 
 
 
 
 
 
Maturity Date 12/26
 
 
 
 
 
 
1,369

 
Bank of America Securities
 
3.05%
 
1/19
 
1,369

 
 
Collateralized by Par Value $1,355
 
 
 
 
 
 
 
 
U.S. Treasury Note, Coupon 2.75%,
 
 
 
 
 
 
 
 
Maturity Date 4/23
 
 
 
 
 
 
957

 
Morgan Stanley
 
(2.15)%
 
1/19
 
957

 
 
Collateralized by Par Value $1,000
 
 
 
 
 
 
 
 
Exchange-Traded Corporate Debt, Coupon 5.95%,
 
 
 
 
 
 
 
 
Maturity Date 12/26
 
 
 
 
 
 

See Notes to Consolidated Financial Statements
157

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONTINUED)

Current Principal
 
Description
 
Rate
 
Maturity
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
Expressed in U.S.
Dollars
(continued)
 
 
 
 
 
 
 
 
$
797

 
Barclays Capital Inc
 
(0.75)%
 
1/19
 
$
797

 
 
Collateralized by Par Value $1,200
 
 
 
 
 
 
 
 
Exchange-Traded Corporate Debt, Coupon 9.88%,
 
 
 
 
 
 
 
 
Maturity Date 2/24
 
 
 
 
 
 
531

 
Barclays Capital Inc
 
(1.25)%
 
1/19
 
531

 
 
Collateralized by Par Value $800
 
 
 
 
 
 
 
 
Exchange-Traded Corporate Debt, Coupon 9.88%,
 
 
 
 
 
 
 
 
Maturity Date 2/24
 
 
 
 
 
 
525

 
RBC Capital Markets LLC
 
2.05%
 
1/19
 
525

 
 
Collateralized by Par Value $500
 
 
 
 
 
 
 
 
Exchange-Traded Corporate Debt, Coupon 5.75%,
 
 
 
 
 
 
 
 
Maturity Date 10/22
 
 
 
 
 
 
469

 
Bank of America Securities
 
3.05%
 
1/19
 
469

 
 
Collateralized by Par Value $463
 
 
 
 
 
 
 
 
U.S. Treasury Note, Coupon 2.63%,
 
 
 
 
 
 
 
 
Maturity Date 6/23
 
 
 
 
 
 
87

 
Societe Generale
 
(1.85)%
 
1/19
 
87

 
 
Collateralized by Par Value $100
 
 
 
 
 
 
 
 
Exchange-Traded Corporate Debt, Coupon 5.95%,
 
 
 
 
 
 
 
 
Maturity Date 12/26
 
 
 
 
 
 
Total Repurchase Agreements (Cost $61,274)
 
 
 
 
 
$
61,274

Investments Sold Short (-142.91%) (a) (b)
 
 
 
 
 
 
TBA - Fixed Rate Agency Securities Sold Short (-129.87%) (p)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Mortgage-related—Residential
 
 
 
 
 
 
$
(156,590
)
 
Federal National Mortgage Association (30 year)
 
4.50%
 
1/19
 
$
(162,119
)
(117,590
)
 
Government National Mortgage Association (30 year)
 
4.50%
 
1/19
 
(121,637
)
(107,397
)
 
Federal Home Loan Mortgage Corporation (30 year)
 
4.00%
 
1/19
 
(109,465
)
(87,817
)
 
Federal National Mortgage Association (30 year)
 
5.00%
 
1/19
 
(91,971
)
(86,893
)
 
Government National Mortgage Association (30 year)
 
4.00%
 
1/19
 
(88,994
)
(76,912
)
 
Federal National Mortgage Association (30 year)
 
3.50%
 
1/19
 
(76,891
)
(32,260
)
 
Government National Mortgage Association (30 year)
 
3.50%
 
1/19
 
(32,484
)
(26,530
)
 
Federal National Mortgage Association (15 year)
 
3.50%
 
1/19
 
(26,859
)
(24,841
)
 
Federal Home Loan Mortgage Corporation (30 year)
 
4.50%
 
1/19
 
(25,707
)
(16,557
)
 
Federal National Mortgage Association (30 year)
 
3.00%
 
1/19
 
(16,153
)
(13,450
)
 
Federal National Mortgage Association (15 year)
 
3.00%
 
1/19
 
(13,426
)
(6,860
)
 
Federal National Mortgage Association (30 year)
 
5.50%
 
1/19
 
(7,258
)
Total TBA - Fixed Rate Agency Securities Sold Short (Proceeds -$766,777)
 
 
 
(772,964
)
 
 
 
 
 
 
 
 
 

See Notes to Consolidated Financial Statements
158

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONTINUED)

Current Principal/Number of Shares
 
Description
 
Rate
 
Maturity
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
Expressed in U.S.
Dollars
Government Debt Sold Short (-9.10%)
 
 
 
 
North America (-5.85%)
 
 
 
 
 
 
Government
 
 
 
 
 
 
$
(13,600
)
 
U.S. Treasury Note
 
2.88%
 
11/21
 
$
(13,754
)
(10,451
)
 
U.S. Treasury Note
 
2.88%
 
10/23
 
(10,631
)
(3,400
)
 
U.S. Treasury Note
 
3.13%
 
11/28
 
(3,528
)
(2,800
)
 
U.S. Treasury Note
 
2.88%
 
8/28
 
(2,844
)
(2,062
)
 
U.S. Treasury Note
 
2.88%
 
11/23
 
(2,098
)
(1,939
)
 
U.S. Treasury Note
 
2.75%
 
8/23
 
(1,962
)
Total North America (Proceeds -$34,410)
 
 
 
 
 
(34,817
)
Europe (-3.25%)
 
 
 
 
 
 
Government
 
 
 
 
 
 
(19,006
)
 
European Sovereign Bond
 
0.75% - 2.75%
 
4/19 - 7/21
 
(19,334
)
Total Europe (Proceeds -$19,545)
 
 
 
 
 
(19,334
)
Total Government Debt Sold Short (Proceeds -$53,955)
 
 
 
(54,151
)
Common Stock Sold Short (-2.84%)
 
 
 
 
North America
 
 
 
 
 
 
Financial
 
 
 
 
 
 
(277
)
 
Exchange Traded Equity
 
 
 
 
 
(16,933
)
Total Common Stock Sold Short (Proceeds -$17,164)
 
 
 
(16,933
)
Corporate Debt Sold Short (-1.10%)
 
 
 
 
 
 
North America
 
 
 
 
 
 
Communications
 
 
 
 
 
 
(1,730
)
 
Various
 
4.25%
 
9/23
 
(1,734
)
Consumer
 
 
 
 
 
 
(500
)
 
Various
 
5.75%
 
10/22
 
(500
)
Energy
 
 
 
 
 
 
(2,000
)
 
Various
 
9.88%
 
2/24
 
(1,230
)
Financial
 
 
 
 
 
 
(3,600
)
 
Various
 
4.70% - 5.95%
 
12/26 - 6/27
 
(2,810
)
Technology
 
 
 
 
 
 
(288
)
 
Various
 
4.95%
 
4/23
 
(255
)
Total Corporate Debt Sold Short (Proceeds -$6,708)
 
 
 
 
 
(6,529
)
Total Investments Sold Short (Proceeds -$844,604)
 
 
 
$
(850,577
)

See Notes to Consolidated Financial Statements
159

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONTINUED)

 
Primary Risk
Exposure
 
Notional Value
 
Range of
Expiration
Dates
 
Fair Value
(In thousands)
 
 
 
 
 
 
Expressed in U.S.Dollars
Financial Derivatives–Assets (3.36%) (a) (b)
 
 
 
 
 
 
 
Swaps (3.36%)
 
 
 
 
 
 
 
Long Swaps:
 
 
 
 
 
 
 
Credit Default Swaps on Corporate Bond Indices (q)
Credit
 
$
47,815

 
6/19 - 6/23
 
$
733

Credit Default Swaps on Asset-Backed Indices (q)
Credit
 
689

 
12/37
 
7

Interest Rate Swaps (r)
Interest Rates
 
29,198

 
1/19 - 2/19
 
61

North America
 
 
 
 
 
 
 
Credit Default Swaps on Corporate Bonds (q)
 
 
 
 
 
 
 
Basic Materials
Credit
 
4

 
12/22
 

Communications
Credit
 
3,090

 
12/20 - 12/23
 
18

Consumer
Credit
 
10,655

 
6/20 - 12/23
 
868

Financial
Credit
 
930

 
12/23
 
104

Industrial
Credit
 
485

 
12/23
 
13

Total Credit Default Swaps on Corporate Bonds
 
 
 
 
 
 
1,003

Short Swaps:
 
 
 
 
 
 
 
Credit Default Swaps on Asset-Backed Indices (s)
Credit
 
(56,207
)
 
5/46 - 11/59
 
8,085

Interest Rate Swaps (t)
Interest Rates
 
(353,741
)
 
3/20 - 12/45
 
7,163

North America
 
 
 
 
 
 
 
Credit Default Swaps on Asset-Backed Securities (s)
 
 
 
 
 
 
 
Mortgage-related—Residential
Credit
 
(3,186
)
 
6/35 - 12/35
 
1,472

Credit Default Swaps on Corporate Bonds (s)
 
 
 
 
 
 
 
Basic Materials
Credit
 
(2,074
)
 
12/21 - 12/23
 
25

Communications
Credit
 
(906
)
 
12/21 - 12/23
 
226

Consumer
Credit
 
(2,065
)
 
3/20
 
30

Energy
Credit
 
(7,610
)
 
6/19 - 6/23
 
950

Technology
Credit
 
(4,070
)
 
6/20 - 6/22
 
239

Total Credit Default Swaps on Corporate Bonds
 
 
 
 
 
 
1,470

Total Return Swaps (u)
 
 
 
 
 
 
 
Financial
Equity Market
 
(17,740
)
 
7/19 - 10/19
 
1

Total Total Return Swaps
 
 
 
 
 
 
1

Total Swaps (Net cost $22,524)
 
 
 
 
 
 
19,995

Options (0.00%)
 
 
 
 
 
 
 
Purchased Options:
 
 
 
 
 
 
 
Interest Rate Caps (w)
Interest Rates
 
51,545

 
5/19
 

Total Options (Cost $2)
 
 
 
 
 
 

 
 
 
 
 
 
 
 

See Notes to Consolidated Financial Statements
160

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONTINUED)

 
Primary Risk
Exposure
 
Notional Value
 
Range of
Expiration
Dates
 
Fair Value
(In thousands)
 
 
 
 
 
 
Expressed in U.S.Dollars
Futures (0.00%)
 
 
 
 
 
 
 
Short Futures:
 
 
 
 
 
 
 
U.S. Treasury Note Futures (x)
Interest Rates
 
$
(151,600
)
 
3/19
 
$

Total Futures
 
 
 
 
 
 

Forwards (0.00%)
 
 
 
 
 
 
 
Short Forwards:
 
 
 
 
 
 
 
Currency Forwards (aa)
Interest Rates
 
(802
)
 
3/19
 
6

Total Forwards
 
 
 
 
 
 
6

Total Financial Derivatives–Assets (Net cost $22,526)
 
 
 
 
 
 
$
20,001

Financial Derivatives–Liabilities (-3.50%) (a) (b)
 
 
 
 
 
 
 
Swaps (-3.42%)
 
 
 
 
 
 
 
Long Swaps:
 
 
 
 
 
 
 
Credit Default Swaps on Asset-Backed Indices (q)
Credit
 
$
14,838

 
3/49 - 11/60
 
$
(2,125
)
Credit Default Swaps on Corporate Bond Indices (q)
Credit
 
2,330

 
12/23
 
(1,467
)
Interest Rate Swaps (r)
Interest Rates
 
113,809

 
6/21 - 1/29
 
(1,987
)
North America
 
 
 
 
 
 
 
Credit Default Swaps on Corporate Bonds (q)
 
 
 
 
 
 
 
Basic Materials
Credit
 
2,000

 
12/23
 
(25
)
Communications
Credit
 
2,313

 
6/22 - 12/23
 
(396
)
Consumer
Credit
 
3,741

 
3/20 - 6/21
 
(62
)
Energy
Credit
 
5,144

 
6/20 - 6/23
 
(1,885
)
Technology
Credit
 
1,953

 
6/20 - 6/23
 
(114
)
Total Credit Default Swaps on Corporate Bonds
 
 
 
 
 
 
(2,482
)
Recovery Swaps (v)
 
 
 
 
 
 
 
Consumer
Credit
 
2,600

 
6/19
 
(8
)
Total Recovery Swaps
 
 
 
 
 
 
(8
)
 
 
 
 
 
 
 
 

See Notes to Consolidated Financial Statements
161

ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONTINUED)

 
Primary Risk
Exposure
 
Notional Value
 
Range of
Expiration
Dates
 
Fair Value
(In thousands)
 
 
 
 
 
 
Expressed in U.S.Dollars
Short Swaps:
 
 
 
 
 
 
 
Interest Rate Swaps (t)
Interest Rates
 
$
(71,672
)
 
5/20 - 11/28
 
$
(1,406
)
Interest Rate Basis Swaps (z)
Interest Rates
 
(12,900
)
 
6/19
 
(4
)
Credit Default Swaps on Corporate Bond Indices (s)
Credit
 
(279,163
)
 
6/19 - 12/23
 
(10,090
)
Total Return Swaps (ab)
Credit
 
(11,230
)
 
3/19
 
(6
)
North America
 
 
 
 
 
 
 
Credit Default Swaps on Corporate Bonds (s)
 
 
 
 
 
 
 
Basic Materials
Credit
 
(1,180
)
 
12/19
 
(57
)
Communications
Credit
 
(3,910
)
 
12/19 - 12/23
 
(11
)
Consumer
Credit
 
(12,830
)
 
6/19 - 12/23
 
(567
)
Financial
Credit
 
(930
)
 
12/23
 
(104
)
Industrial
Credit
 
(485
)
 
12/23
 
(13
)
Technology
Credit
 
(1,160
)
 
6/19
 
(4
)
Total Credit Default Swaps on Corporate Bonds
 
 
 
 
 
 
(756
)
Total Swaps (Net proceeds -$19,019)
 
 
 
 
 
 
(20,331
)
Futures (-0.06%)
 
 
 
 
 
 
 
Short Futures:
 
 
 
 
 
 
 
Eurodollar Futures (ac)
Interest Rates
 
(98,000
)
 
3/19 - 6/20
 
(53
)
Currency Futures (y)
Interest Rates
 
(47,931
)
 
3/19
 
(302
)
Total Futures
 
 
 
 
 
 
(355
)
Forwards (-0.02%)
 
 
 
 
 
 
 
Short Forwards:
 
 
 
 
 
 
 
Currency Forwards (aa)
Interest Rates
 
(16,497
)
 
3/19
 
(120
)
Total Forwards
 
 
 
 
 
 
(120
)
Total Financial Derivatives–Liabilities
(Net proceeds -$19,019)
 
 
 
 
 
 
$
(20,806
)

See Notes to Consolidated Financial Statements
162

Table of Contents         
ELLINGTON FINANCIAL LLC
CONSOLIDATED CONDENSED SCHEDULE OF INVESTMENTS
AT DECEMBER 31, 2018 (CONCLUDED)

(a)
See Note 2 and Note 3 in Notes to Consolidated Financial Statements.
(b)
Classification percentages are based on Total Equity.
(c)
At December 31, 2018, the Company's long investments guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Government National Mortgage Association, represented 93.99%, 42.12%, and 107.55% of Total Equity, respectively.
(d)
Private trust 100% backed by interest in Government National Mortgage Association collateralized mortgage obligation certificates.
(e)
Includes investment in collateralized loan obligation notes in the amount of $50.8 million that were issued and are managed by related parties of the Company. See Note 9 to the Notes to Consolidated Financial Statements.
(f)
Loans and real estate owned are beneficially owned by the Company through participation certificates in the various trusts that hold such investments. See Note 9 to the Notes to Consolidated Financial Statements.
(g)
Includes investments in participation certificates related to loans titled in the name of a related party of Ellington Management Group, L.L.C. Through its participation certificates, the Company has beneficial interests in the loan cash flows, net of servicing-related fees and expenses. At December 31, 2018 loans for which the Company has beneficial interests in the net cash flows, totaled $21.9 million. See Note 9 to the Notes to Consolidated Financial Statements.
(h)
Includes investments in participation certificates related to loans held in a trust owned by a related party of Ellington Management Group, L.L.C. Through its participation certificates, the Company participates in the cash flows of the underlying loans held by the trust. At December 31, 2018 loans held in the related party trust for which the Company has participating interests in the cash flows, totaled $181.5 million. See Note 9 to the Notes to Consolidated Financial Statements.
(i)
Represents the Company's beneficial interest in an entity, which is co-owned by an affiliate of Ellington Management Group, L.L.C. The entity owns subordinated notes issued by, as well as trust certificates representing ownership of, a securitization trust. See Note 6 and Note 9 to the Notes to Consolidated Financial Statements.
(j)
Includes non-performing commercial mortgage loans in the amount of $47.3 million whereby principal and/or interest is past due and a maturity date is not applicable.
(k)
As of December 31, 2018, the Company had residential mortgage loans that were in the process of foreclosure with a fair value of $9.1 million.
(l)
Number of properties not shown in thousands, represents actual number of properties owned.
(m)
Includes $314.2 million of non-qualified mortgage loans that have been securitized and are held in a consolidated securitization trusts. See Note 6 to the Notes to Consolidated Financial Statements.
(n)
Represents the Company's investment in a related party. See Note 9 to the Notes to Consolidated Financial Statements.
(o)
In general, securities received pursuant to repurchase agreements were delivered to counterparties in short sale transactions.
(p)
At December 31, 2018, the Company's short investments guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Government National Mortgage Association, represented 66.31%, 22.71%, and 40.85% of Total Equity, respectively.
(q)
For long credit default swaps, the Company sold protection.
(r)
For long interest rate swap contracts, the Company pays a floating rate and receives a fixed rate.
(s)
For short credit default swaps, the Company purchased protection.
(t)
For short interest rate swap contracts, the Company pays a fixed rate and receives a floating rate.
(u)
Notional value represents number of underlying shares multiplied by the closing price of the underlying security.
(v)
For long recovery swaps the Company receives a specified recovery rate in exchange for the actual recovery rate on the underlying.
(w)
Notional value represents the amount on which interest payments are calculated to the extent the market interest rate exceeds the rate cap on the contract.
(x)
Notional value represents the total face amount of U.S. Treasury securities underlying all contracts held. As of December 31, 2018, a total of 1,516 contracts were held.
(y)
Notional value represents the total face amount of foreign currency underlying all contracts held; as of December 31, 2018, 411 contracts were held.
(z)
Represents interest rate "basis" swaps whereby the Company pays one floating rate and receives a different floating rate.
(aa)
Notional value represents U.S. Dollars to be received by the Company at the maturity of the forward contract.
(ab)
Notional value represents the number of underlying index units multiplied by the reference price.
(ac)
Every $1,000,000 in notional value represents one contract.
(ad)
The table below shows the Company's long investment ratings from Moody's, Standard and Poor's, or Fitch, as well as the Company's long investments that were unrated but guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Government National Mortgage Association. Ratings tend to be a lagging credit indicator; as a result, the credit quality of the Company's long investment holdings may be lower than the credit quality implied based on the ratings listed below. In situations where an investment has a split rating, the lowest provided rating is used. The ratings descriptions include ratings qualified with a "+," "-," "1," "2," or "3."
Rating Description
 
Percent of Equity
Unrated but Agency-Guaranteed
 
243.66
%
Aaa/AAA/AAA
 
0.01
%
Aa/AA/AA
 
0.63
%
A/A/A
 
4.73
%
Baa/BBB/BBB
 
1.84
%
Ba/BB/BB or below
 
46.34
%
Unrated
 
196.65
%


See Notes to Consolidated Financial Statements
163


ELLINGTON FINANCIAL LLC
CONSOLIDATED STATEMENT OF OPERATIONS

 
 
Year Ended
December 31, 2018
(In thousands except per share amounts)
 
 
INVESTMENT INCOME
 
 
Interest income(1)
 
$
131,027

Other income
 
4,014

Total investment income
 
135,041

EXPENSES
 
 
Base management fee to affiliate (Net of fee rebates of $1,380)(2)
 
7,573

Incentive fee to affiliate
 
715

Interest expense(1)
 
56,707

Other investment related expenses
 
 
Servicing expense
 
7,715

Debt issuance costs related to Other secured borrowings, at fair value
 
1,647

Other
 
7,592

Professional fees
 
3,902

Administration fees
 
734

Compensation expense
 
2,233

Insurance expense
 
487

Directors' fees and expenses
 
298

Share-based long term incentive plan unit expense
 
415

Other expenses
 
1,898

Total expenses
 
91,916

NET INVESTMENT INCOME
 
43,125

NET REALIZED AND CHANGE IN NET UNREALIZED GAIN (LOSS) ON INVESTMENTS, FINANCIAL DERIVATIVES, AND FOREIGN CURRENCY TRANSACTIONS/TRANSLATION
 
 
Net realized gain (loss) on:
 
 
Investments
 
25,421

Financial derivatives, excluding currency hedges
 
(2,639
)
Financial derivatives—currency hedges
 
4,475

Foreign currency transactions
 
4,131

 
 
31,388

Change in net unrealized gain (loss) on:
 
 
Investments
 
(25,947
)
Other secured borrowings
 
758

Financial derivatives, excluding currency hedges
 
7,093

Financial derivatives—currency hedges
 
565

Foreign currency translation
 
(7,071
)
 
 
(24,602
)
NET REALIZED AND CHANGE IN NET UNREALIZED GAIN (LOSS) ON INVESTMENTS, OTHER SECURED BORROWINGS, FINANCIAL DERIVATIVES, AND FOREIGN CURRENCY TRANSACTIONS/TRANSLATION
 
6,786

 
 
 


See Notes to Consolidated Financial Statements
164


ELLINGTON FINANCIAL LLC
CONSOLIDATED STATEMENT OF OPERATIONS (CONTINUED)
 
 
 
 
 
 
 
 
Year Ended
December 31, 2018
 
 
 
NET INCREASE IN EQUITY RESULTING FROM OPERATIONS
 
$
49,911

LESS: NET INCREASE IN EQUITY RESULTING FROM OPERATIONS ATTRIBUTABLE TO NON-CONTROLLING INTERESTS
 
3,235

NET INCREASE IN SHAREHOLDERS' EQUITY RESULTING FROM OPERATIONS
 
$
46,676

NET INCREASE IN SHAREHOLDERS' EQUITY RESULTING FROM OPERATIONS PER SHARE:
 
 
Basic and Diluted
 
$
1.52


(1)
Includes interest income and interest expense of a consolidated securitization trust of $6.0 million and $3.6 million, respectively, for the year ended December 31, 2018. See Note 6 for further details on the Company's consolidated securitization trust.
(2)
See Note 9 for further details on management fee rebates.

See Notes to Consolidated Financial Statements
165


ELLINGTON FINANCIAL LLC
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

 
 
Year Ended
December 31, 2018
 
 
Shareholders' Equity
 
Non-controlling Interest
 
Total
Equity
(In thousands)
 
Expressed in U.S. Dollars
BEGINNING EQUITY (December 31, 2017)
 
$
600,099

 
$
20,862

 
$
620,961

CHANGE IN EQUITY RESULTING FROM OPERATIONS
 
 
 
 
 
 
Net investment income
 
 
 
 
 
43,125

Net realized gain (loss) on investments, financial derivatives, and foreign currency transactions
 
 
 
 
 
31,388

Change in net unrealized gain (loss) on investments, other secured borrowings, financial derivatives, and foreign currency translation
 
 
 
 
 
(24,602
)
Net increase (decrease) in equity resulting from operations
 
46,676

 
3,235

 
49,911

CHANGE IN EQUITY RESULTING FROM TRANSACTIONS
 
 
 
 
 
 
Shares issued in connection with incentive fee payment
 
71

 
 
 
71

Contributions from non-controlling interests
 
 
 
21,532

 
21,532

Dividends(1)
 
(50,388
)
 
(348
)
 
(50,736
)
Distributions to non-controlling interests
 
 
 
(23,853
)
 
(23,853
)
Adjustment to non-controlling interest
 
(369
)
 
369

 

Share-based long term incentive plan unit redemption and distribution
 
(9,537
)
 
9,537

 

Shares repurchased
 
(23,131
)
 
 
 
(23,131
)
Share-based long term incentive plan unit awards
 
412

 
3

 
415

Net increase (decrease) in equity from transactions
 
(82,942
)
 
7,240

 
(75,702
)
Net increase (decrease) in equity
 
(36,266
)
 
10,475

 
(25,791
)
ENDING EQUITY (December 31, 2018)
 
$
563,833

 
$
31,337

 
$
595,170


(1)
For the year ended December 31, 2018, dividends totaling $1.64 per common share and convertible unit outstanding, were declared.

See Notes to Consolidated Financial Statements
166


ELLINGTON FINANCIAL LLC
CONSOLIDATED STATEMENT OF CASH FLOWS

 
Year Ended
December 31, 2018
(In thousands)
Expressed in U.S. Dollars
INCREASE (DECREASE) IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH:
 
NET INCREASE IN EQUITY RESULTING FROM OPERATIONS
$
49,911

Cash flows provided by (used in) operating activities:
 
Reconciliation of the net increase (decrease) in equity resulting from operations to net cash provided by (used in) operating activities:
 
Net realized (gain) loss on investments, financial derivatives, and foreign currency transactions
(25,368
)
Change in net unrealized (gain) loss on investments, other secured borrowings, financial derivatives, and foreign currency translation
26,318

Amortization of premiums and accretion of discounts (net)
45,895

Purchase of investments
(3,350,398
)
Proceeds from disposition of investments
1,868,532

Proceeds from principal payments of investments
497,858

Proceeds from investments sold short
2,674,841

Repurchase of investments sold short
(2,457,148
)
Payments on financial derivatives
(119,490
)
Proceeds from financial derivatives
121,904

Amortization of deferred debt issuance costs
263

Shares issued in connection with incentive fee payment
71

Share-based long term incentive plan unit expense
415

Interest income related to consolidated securitization trust(1)
(4,697
)
Interest expense related to consolidated securitization trust(1)
4,313

Debt issuance costs related to Other secured borrowings, at fair value(1)
1,647

Repurchase agreements
94,675

(Increase) decrease in assets:
 
Receivable for securities sold and financial derivatives
(304,826
)
Due from brokers
68,610

Interest and principal receivable
(7,988
)
Other assets
28,234

Increase (decrease) in liabilities:
 
Due to brokers
3,832

Payable for securities purchased and financial derivatives
285,708

Accounts payable and accrued expenses
1,838

Other liabilities
(17
)
Interest and dividends payable
1,255

Base management fee payable to affiliate
(369
)
Net cash provided by (used in) operating activities
(494,181
)
 
 


See Notes to Consolidated Financial Statements
167


ELLINGTON FINANCIAL LLC
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
 
 
 
 
 
Year Ended
December 31, 2018
(In thousands)
Expressed in U.S. Dollars
Cash flows provided by (used in) financing activities:
 
Contributions from non-controlling interests
$
21,532

Shares repurchased
(23,131
)
Dividends paid
(50,736
)
Distributions to non-controlling interests
(23,853
)
Proceeds from issuance of Other secured borrowings
100,010

Principal payments on Other secured borrowings
(43,819
)
Proceeds from issuance of Other secured borrowings, at fair value
102,706

Debt issuance costs related to Other secured borrowings, at fair value
(775
)
Borrowings under reverse repurchase agreements
8,078,468

Repayments of reverse repurchase agreements
(7,668,798
)
Net cash provided by (used in) financing activities
491,604

NET INCREASE (DECREASE) IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH
(2,577
)
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH, BEGINNING OF PERIOD
47,658

CASH, CASH EQUIVALENTS, AND RESTRICTED CASH, END OF PERIOD
$
45,081

Supplemental disclosure of cash flow information:
 
Interest paid
$
55,649

Shares issued in connection with incentive fee payment
71

Share-based long term incentive plan unit awards (non-cash)
415

Aggregate TBA trade activity (buys + sells) (non-cash)
29,752,907

Purchase of investments (non-cash)
(17,424
)
Proceeds from principal payments of investments (non-cash)
49,731

Proceeds from the disposition of investments (non-cash)
17,424

Proceeds received from Other secured borrowings, at fair value (non-cash)
120,625

Principal payments on Other secured borrowings, at fair value (non-cash)
(49,731
)
Repayments of reverse repurchase agreements (non-cash)
(120,136
)
Expenses from issuance of other secured borrowings at fair value (non-cash)
(872
)
Share-based long term incentive plan unit redemption (non-cash)
(9,537
)
Contribution from non-controlling interests (non-cash)
9,537


(1)
Related to non-qualified mortgage securitization transactions. See Note 6 for further details.

See Notes to Consolidated Financial Statements
168


ELLINGTON FINANCIAL LLC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2018
1. Organization and Investment Objective
Ellington Financial LLC was formed as a Delaware limited liability company on July 9, 2007 and commenced operations on August 17, 2007. Ellington Financial Operating Partnership LLC (the "Operating Partnership"), a 97.6% owned consolidated subsidiary of Ellington Financial LLC, was formed as a Delaware limited liability company on December 14, 2012 and commenced operations on January 1, 2013. All of the Company's operations and business activities are conducted through the Operating Partnership. Ellington Financial LLC, the Operating Partnership, and their consolidated subsidiaries are hereafter collectively referred to as the "Company." All intercompany accounts are eliminated in consolidation.
The Company invests in a diverse array of financial assets, including residential mortgage-backed securities, or "RMBS," commercial mortgage-backed securities, or "CMBS," residential and commercial mortgage loans, consumer loans and asset-backed securities, or "ABS," backed by consumer loans, collateralized loan obligations, or "CLOs," non-mortgage and mortgage-related derivatives, equity investments in loan origination companies, and other strategic investments.
Ellington Financial Management LLC ("EFM" or the "Manager") is an SEC-registered investment adviser and a registered commodity pool operator that serves as the Manager to the Company pursuant to the terms of its seventh amended and restated management agreement (the "Management Agreement"). EFM is an affiliate of Ellington Management Group, L.L.C., ("Ellington") an investment management firm that is registered as both an investment adviser and a commodity pool operator. In accordance with the terms of the Management Agreement, the Manager implements the investment strategy and manages the business and operations on a day-to-day basis for the Company and performs certain services for the Company, subject to oversight by the Company's Board of Directors ("Board of Directors").
2. Significant Accounting Policies
(A) Basis of Presentation: The Company's consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America, or "U.S. GAAP," for investment companies, ASC 946, Financial Services—Investment Companies ("ASC 946"). The Company has determined that it meets the definition of an investment company under ASC 946. ASC 946 requires, among other things, that investments be reported at fair value in the financial statements. Additionally under ASC 946 the Company generally will not consolidate its interest in any company other than in its subsidiaries that qualify as investment companies under ASC 946. The consolidated financial statements include the accounts of the Company, the Operating Partnership, and its subsidiaries. They also include certain securitization trusts which are designed to facilitate specific financing activities of the Company and represent a direct extension of the Company's business activities. All intercompany balances and transactions have been eliminated. The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and those differences could be material.
(B) Valuation: The Company applies ASC 820-10, Fair Value Measurement ("ASC 820-10"), to its holdings of financial instruments. ASC 820-10 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the observability of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
Level 1—inputs to the valuation methodology are observable and reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Currently, the types of financial instruments the Company generally includes in this category are listed equities, exchange-traded derivatives, and cash equivalents;
Level 2—inputs to the valuation methodology other than quoted prices included in Level 1 are observable for the asset or liability, either directly or indirectly. Currently, the types of financial instruments that the Company generally includes in this category are Agency RMBS, U.S. Treasury securities and sovereign debt, certain non-Agency RMBS and CMBS, CLOs, and corporate debt, and actively traded derivatives, such as interest rate swaps and foreign currency forwards, and certain other over-the-counter derivatives; and
Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement. The types of financial instruments that the Company generally includes in this category are certain RMBS, CMBS, and CLOs, ABS, credit default swaps, or "CDS," on individual ABS, distressed corporate debt, and total return swaps on distressed corporate debt, in each case where there is less price transparency. Also included in this category are residential and commercial mortgage loans, consumer loans, non-listed equities, private corporate debt and equity investments, secured notes, and Other secured borrowings, at fair value.


169


For certain financial instruments, the various inputs that management uses to measure fair value for such financial instrument may fall into different levels of the fair value hierarchy. In such cases, the determination of which category within the fair value hierarchy is appropriate for such financial instrument is based on the lowest level of input that is significant to the fair value measurement. ASC 820 prioritizes the various inputs that management uses to measure fair value with the highest priority to inputs that are observable and reflect quoted prices (unadjusted) for identical assets or liabilities in active markets (Level 1) and the lowest priority to inputs that are unobservable and significant to the fair value measurement (Level 3). The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. The Company may use valuation techniques consistent with the market and income approaches to measure the fair value of its assets and liabilities. The market approach uses third-party valuations and information obtained from market transactions involving identical or similar assets or liabilities. The income approach uses projections of the future economic benefit of an instrument to determine its fair value, such as in the discounted cash flow methodology. The inputs or methodology used for valuing financial instruments are not necessarily an indication of the risk associated with investing in these financial instruments. The leveling of each financial instrument is reassessed at the end of each period.
Summary Valuation Techniques
For financial instruments that are traded in an "active market," the best measure of fair value is the quoted market price. However, many of the Company's financial instruments are not traded in an active market. Therefore, management generally uses third-party valuations when available. If third-party valuations are not available, management uses other valuation techniques, such as the discounted cash flow methodology. The following are summary descriptions, for various categories of financial instruments, of the valuation methodologies management uses in determining fair value of the Company's financial instruments in such categories. Management utilizes such methodologies to assign a good faith fair value (the estimated price that, in an orderly transaction at the valuation date, would be received to sell an asset, or paid to transfer a liability, as the case may be) to each such financial instrument.
For mortgage-backed securities, or "MBS," including To Be Announced MBS, or "TBAs," CLOs, and distressed and non-distressed corporate debt and equity, management seeks to obtain at least one third-party valuation, and often obtains multiple valuations when available. Management has been able to obtain third-party valuations on the vast majority of these instruments and expects to continue to solicit third-party valuations in the future. Management generally values each financial instrument at the average of third-party valuations received and not rejected as described below. Third-party valuations are not binding, and while management generally does not adjust the valuations it receives, management may challenge or reject a valuation when, based on its validation criteria, management determines that such valuation is unreasonable or erroneous. Furthermore, based on its validation criteria, management may determine that the average of the third-party valuations received for a given instrument does not result in what management believes to be the fair value of such instrument, and in such circumstances management may override this average with its own good faith valuation. The validation criteria may take into account output from management's own models, recent trading activity in the same or similar instruments, and valuations received from third parties. The use of proprietary models requires the use of a significant amount of judgment and the application of various assumptions including, but not limited to, assumptions concerning future prepayment rates and default rates. Valuations for fixed-rate RMBS pass-throughs issued by a U.S. government agency or government-sponsored enterprise are typically based on observable pay-up data (pay-ups are price premiums for specified categories of fixed-rate pools relative to their TBA counterparts) or models that use observable market data, such as interest rates and historical prepayment speeds, and are validated against third-party valuations. Given their relatively high level of price transparency, Agency RMBS pass-throughs are typically designated as Level 2 assets. Non-Agency MBS, Agency interest only and inverse interest only RMBS, and CLOs are generally classified as either Level 2 or Level 3 based on analysis of available market data and/or third-party valuations. The Company's investments in distressed corporate debt can be in the form of loans as well as total return swaps on loans. These investments, as well as related non-listed equity investments, are generally designated as Level 3 assets. Valuations for total return swaps are typically based on prices of the underlying loans received from widely used third-party pricing services. Investments in non-distressed corporate bonds are generally also valued based on prices received from third-party pricing services, and many of these bonds, because they are very liquid with readily observable data, are generally classified as Level 2 holdings. Furthermore, the methodology used by the third-party valuation providers is reviewed at least annually by management, so as to ascertain whether such providers are utilizing observable market data to determine the valuations that they provide.
For residential and commercial mortgage loans, consumer loans, and real estate owned properties, or "REO," management determines fair value by taking into account both external pricing data, when available, and internal pricing models. Non-performing mortgage loans and REO are typically valued based on management's estimates of the value of the underlying real estate, using information including general economic data, broker price opinions, or "BPOs," recent sales, property appraisals, and bids. Performing mortgage loans and consumer loans are typically valued using discounted cash flows based on market assumptions. Cash flow assumptions typically include projected default and prepayment rates and loss


170


severities, and may include adjustments based on appraisals and BPOs. Mortgage and consumer loans and REO properties are classified as Level 3 assets.
Securitized mortgage loans that are not deemed "qualified mortgage," or "QM," loans under the rules of the Consumer Financial Protection Bureau, or "non-QM loans," are held as part of a collateralized financing entity, or "CFE." A CFE is a variable interest entity, or "VIE," that holds financial assets, issues beneficial interests in those assets, and has no more than nominal equity, and for which the issued beneficial interests have contractual recourse only to the related assets of the CFE. ASC 810, Consolidation ("ASC 810"), allows the Company to elect to measure both the financial assets and financial liabilities of the CFE using the more observable of the fair value of the financial assets and the fair value of the financial liabilities of the CFE. The Company has elected the fair value option for initial and subsequent recognition of the debt issued by its consolidated securitization trust and has determined such trust meets the definition of a CFE; see Note 6 for further discussion on the Company's securitization trusts. The Company has determined the inputs to the fair value measurement of the financial liabilities of its CFE to be more observable than those of the financial assets and, as a result, has used the fair value of the financial liabilities of the CFE to measure the fair value of the financial assets of the CFE. The fair value of the debt issued by the CFE is typically valued using discounted cash flows and other market data. The securitized non-QM loans, which are assets of the CFE, are included in Investments, at fair value on the Company's Consolidated Statement of Assets, Liabilities, and Equity. The debt issued by the CFE is included in Other secured borrowings, at fair value, on the Company's Consolidated Statement of Assets, Liabilities, and Equity. The securitized non-QM loans and the debt issued by the Company's CFE are both designated as Level 3 financial instruments.
For financial derivatives with greater price transparency, such as CDS on asset-backed indices, CDS on corporate indices, certain options on the foregoing, and total return swaps on publicly traded equities, market-standard pricing sources are used to obtain valuations; these financial derivatives are generally designated as Level 2 instruments. Interest rate swaps, swaptions, and foreign currency forwards are typically valued based on internal models that use observable market data, including applicable interest rates and foreign currency rates in effect as of the measurement date; the model-generated valuations are then typically compared to counterparty valuations for reasonableness. These financial derivatives are also generally designated as Level 2 instruments. Financial derivatives with less price transparency, such as CDS on individual ABS, are generally valued based on internal models, and are typically designated as Level 3 instruments. In the case of CDS on individual ABS, the valuation process typically starts with an estimation of the value of the underlying ABS. In valuing its derivatives, the Company also considers the creditworthiness of both the Company and its counterparties, along with collateral provisions contained in each derivative agreement.
Investments in private operating entities, such as loan originators, are valued based on available metrics, such as relevant market multiples and comparable company valuations, company specific-financial data including actual and projected results and independent third party valuation estimates. These investments are designated as Level 3 assets.
The Company's repurchase agreements are carried at fair value based on their contractual amounts as the debt is short-term in nature. The Company's reverse repurchase agreements are carried at cost, which approximates fair value. Repurchase and reverse repurchase agreements are classified as Level 2 assets and liabilities based on the adequacy of the collateral and their short term nature.
The Company's valuation process, including the application of validation criteria, is overseen by the Manager's Valuation Committee ("Valuation Committee"). The Valuation Committee includes senior level executives from various departments within the Manager, and each quarter, the Valuation Committee reviews and approves the valuations of the Company's investments. The valuation process also includes a monthly review by the Company's third-party administrator. The goal of this review is to replicate various aspects of the Company's valuation process based on the Company's documented procedures.
Because of the inherent uncertainty of valuation, the estimated fair value of the Company's financial instruments may differ significantly from the values that would have been used had a ready market for the financial instruments existed, and the differences could be material to the Company's consolidated financial statements.
(C) Purchase and Sales of Investments and Investment Income: Purchases and sales of investments are generally recorded on trade date, and realized and unrealized gains and losses are calculated based on identified cost. The Company amortizes premiums and accretes discounts on its debt investments. Coupon interest income on fixed-income investments is generally accrued based on the outstanding principal balance or notional value and the current coupon interest rate.
For Agency RMBS and debt securities that are deemed to be of high credit quality at the time of purchase, premiums and discounts are amortized into interest income over the life of such securities using the effective interest method. For securities whose cash flows vary depending on prepayments, an effective yield retroactive to the time of purchase is periodically recomputed based on actual prepayments and changes in projected prepayment activity, and a catch-up adjustment is made to amortization to reflect the cumulative impact of the change in effective yield.


171


For debt securities (including non-Agency MBS) that are deemed not to be of high credit quality at the time of purchase, interest income is recognized based on the effective interest method. For purposes of determining the effective interest rate, management estimates the future expected cash flows of its investment holdings based on assumptions including, but not limited to, assumptions for future prepayment rates, default rates, and loss severities (each of which may in turn incorporate various macro-economic assumptions, such as future housing prices). These assumptions are re-evaluated not less than quarterly. Principal write-offs are generally treated as realized losses. Changes in projected cash flows, as applied to the current amortized cost of the security, may result in a prospective change in the yield/interest income recognized on such securities.
For each loan purchased with the expectation that both interest and principal will be paid in full, the Company generally amortizes or accretes any premium or discount over the life of the loan utilizing the effective interest method. However, on at least a quarterly basis based on current information and events, the Company re-assesses the collectibility of interest and principal, and designates a loan as impaired either when any payments have become 90 or more days past due, or when, in the opinion of management, it is probable that the Company will be unable to collect either interest or principal in full. Once a loan is designated as impaired, as long as principal is still expected to be collectible in full, interest payments are recorded as interest income only when received (i.e., under the cash basis method); accruals of interest income are only resumed when the loan becomes contractually current and performance is demonstrated to be resumed. However, if principal is not expected to be collectible in full, the cost recovery method is used (i.e., no interest income is recognized, and all payments received—whether contractually interest or principal—are applied to cost).
For each loan purchased with evidence of credit deterioration since origination and the expectation that either principal or interest will not be paid in full, interest income is generally recognized using the effective interest method for as long as the cash flows can be reasonably estimated. Here, instead of amortizing the purchase discount (i.e., the excess of the unpaid principal balance over the purchase price) over the life of the loan, the Company effectively amortizes the accretable yield (i.e., the excess of the Company's estimate of the total cash flows to be collected over the life of the loan over the purchase price). Not less than quarterly, the Company updates its estimate of the cash flows expected to be collected over the life of the loan, and revised yields are prospectively applied. To the extent that cash flows cannot be reasonably estimated, these loans are generally accounted for under the cost recovery method.
For certain groups of consumer loans that the Company considers as having sufficiently homogeneous characteristics, the Company aggregates such loans into pools, and accounts for each such pool as a single asset. The pool is then treated analogously to a debt security deemed not to be of high credit quality, in that (i) the aggregate premium or discount for the pool is amortized or accreted into interest income based on the pool's effective interest rate; (ii) the effective interest rate is determined based on the net expected cash flows of the pool, taking into account estimates of prepayments, defaults, and loss severities; and (iii) estimates are updated not less than quarterly and revised yields are prospectively applied.
In estimating future cash flows on the Company's debt investments, there are a number of assumptions that will be subject to significant uncertainties and contingencies, including, in the case of MBS, assumptions relating to prepayment rates, default rates, loan loss severities, and loan repurchases. These estimates require the use of a significant amount of judgment.
The Company receives dividend income on certain of its equity investments and rental income on certain of its REO properties. These items of income are included on the Consolidated Statement of Operations in, "Other income."
(D) Cash and Cash Equivalents: Cash and cash equivalents include cash and short term investments with original maturities of three months or less at the date of acquisition. Cash and cash equivalents typically include amounts held in an interest bearing overnight account and amounts held in money market funds, and these balances generally exceed insured limits. The Company holds its cash at institutions that it believes to be highly creditworthy. Restricted cash represents cash that the Company can use only for specific purposes. The Company's investments in money market funds are included in the Consolidated Condensed Schedule of Investments. See Note 15 for further discussion of restricted cash balances.
(E) Financial Derivatives: The Company enters into various types of financial derivatives. The Company's financial derivatives are predominantly subject to bilateral collateral arrangements or clearing in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Company may be required to deliver or receive cash or securities as collateral upon entering into derivative transactions. In addition, changes in the relative value of derivative transactions may require the Company or the counterparty to post or receive additional collateral. In the case of cleared derivatives, the clearinghouse becomes the Company's counterparty and a futures commission merchant acts as an intermediary between the Company and the clearinghouse with respect to all facets of the related transaction, including the posting and receipt of required collateral. Cash collateral received by the Company is reflected on the Consolidated Statement of Assets, Liabilities, and Equity as "Due to Brokers." Conversely, cash collateral posted by the Company is reflected as "Due from Brokers" on the Consolidated Statement of Assets, Liabilities, and Equity. The major types of derivatives utilized by the Company are swaps, futures, options, and forwards.


172


Swaps: The Company may enter into various types of swaps, including interest rate swaps, credit default swaps, and total return swaps. The primary risk associated with the Company's interest rate swap activity is interest rate risk. The primary risk associated with the Company's credit default swaps is credit risk and the primary risks associated with the Company's total return swap activity are equity market risk and credit risk.
The Company is subject to interest rate risk exposure in the normal course of pursuing its investment objectives. Primarily to help mitigate interest rate risk, the Company enters into interest rate swaps. Interest rate swaps are contractual agreements whereby one party pays a floating interest rate on a notional principal amount and receives a fixed-rate payment on the same notional principal, or vice versa, for a fixed period of time. Interest rate swaps change in value with movements in interest rates.
The Company enters into credit default swaps. A credit default swap is a contract under which one party agrees to compensate another party for the financial loss associated with the occurrence of a "credit event" in relation to a "reference amount" or notional value of a credit obligation (usually a bond, loan, or a basket of bonds or loans). The definition of a credit event may vary from contract to contract. A credit event may occur (i) when the underlying reference asset(s) fails to make scheduled principal or interest payments to its holders, (ii) with respect to credit default swaps referencing mortgage/asset-backed securities and indices, when the underlying reference obligation is downgraded below a certain rating level, or (iii) with respect to credit default swaps referencing corporate entities and indices, upon the bankruptcy of the underlying reference obligor. The Company typically writes (sells) protection to take a "long" position or purchases (buys) protection to take a "short" position with respect to underlying reference assets or to hedge exposure to other investment holdings.
The Company enters into total return swaps in order to take a "long" or "short" position with respect to an underlying reference asset. The Company is subject to market price volatility of the underlying reference asset. A total return swap involves commitments to pay interest in exchange for a market-linked return based on a notional value. To the extent that the total return of the corporate debt, security, group of securities or index underlying the transaction exceeds or falls short of the offsetting interest obligation, the Company will receive a payment from or make a payment to the counterparty.
Swaps change in value with movements in interest rates, credit quality, or total return of the reference securities. During the term of swap contracts, changes in value are recognized as unrealized gains or losses. When a contract is terminated, the Company realizes a gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Company's basis in the contract, if any. Periodic payments or receipts required by swap agreements are recorded as unrealized gains or losses when accrued and realized gains or losses when received or paid. Upfront payments paid and/or received by the Company to open swap contracts are recorded as an asset and/or liability on the Consolidated Statement of Assets, Liabilities, and Equity and are recorded as a realized gain or loss on the termination date.
Futures Contracts: A futures contract is an exchange-traded agreement to buy or sell an asset for a set price on a future date. The Company enters into Eurodollar and/or U.S. Treasury security futures contracts to hedge its interest rate risk. The Company may also enter into various other futures contracts, including equity index futures and foreign currency futures. Initial margin deposits are made upon entering into futures contracts and can generally be either in the form of cash or securities. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by marking-to-market to reflect the current market value of the contract. Variation margin payments are made or received periodically, depending upon whether unrealized losses or gains are incurred. When the contract is closed, the Company records a realized gain or loss equal to the difference between the proceeds of the closing transaction and the Company's basis in the contract.
Options: The Company may purchase or write put or call options contracts or enter into swaptions. The Company enters into options contracts typically to help mitigate overall market, credit, or interest rate risk depending on the type of options contract. However, the Company also enters into options contracts from time to time for speculative purposes. When the Company purchases an options contract, the option asset is initially recorded at an amount equal to the premium paid, if any, and is subsequently marked-to-market. Premiums paid for purchasing options contracts that expire unexercised are recognized on the expiration date as realized losses. If an options contract is exercised, the premium paid is subtracted from the proceeds of the sale or added to the cost of the purchase to determine whether the Company has realized a gain or loss on the related transaction. When the Company writes an options contract, the option liability is initially recorded at an amount equal to the premium received, if any, and is subsequently marked-to-market. Premiums received for writing options contracts that expire unexercised are recognized on the expiration date as realized gains. If an options contract is exercised, the premium received is subtracted from the cost of the purchase or added to the proceeds of the sale to determine whether the Company has realized a gain or loss on the related investment transaction. When the Company enters into a closing transaction, the Company will realize a gain or loss depending upon whether the amount from the closing transaction is greater or less than the premiums paid or received. The Company may also enter into options contracts that contain forward-settling premiums. In this case, no money


173


is exchanged upfront. Instead the agreed-upon premium is paid by the buyer upon expiration of the option, regardless of whether or not the option is exercised.
Forward Currency Contracts: A forward currency contract is an agreement between two parties to purchase or sell a specific quantity of currency with the delivery and settlement at a specific future date and exchange rate. During the period the forward currency contract is open, changes in the value of the contract are recognized as unrealized gains or losses. When the contract is settled, the Company records a realized gain or loss equal to the difference between the proceeds of the closing transaction and the Company's basis in the contract.
Commitments to Purchase Residential Mortgage Loans: The Company has entered into forward purchase commitments under flow agreements, whereby the Company commits to purchasing the loans based on pre-defined underwriting guidelines and at stated interest rates. Actual loan purchases are contingent upon successful loan closings. These commitments to purchase mortgage loans are classified as derivatives on the Company's Consolidated Statement of Assets, Liabilities, and Equity and are, therefore, recorded as assets or liabilities measured at fair value. Until the purchase commitment expires or the underlying loan closes, changes in the estimated fair value of such commitments are recognized as unrealized gains or losses in the Consolidated Statement of Operations.
Financial derivatives disclosed on the Consolidated Condensed Schedule of Investments include: credit default swaps on asset-backed securities, credit default swaps on asset-backed indices, credit default swaps on corporate bond indices, credit default swaps on corporate bonds, interest rate swaps, total return swaps, futures contracts, foreign currency forwards, options contracts.
Financial derivative assets are included in Financial derivatives—assets, at fair value on the Consolidated Statement of Assets, Liabilities, and Equity. Financial derivative liabilities are included in Financial derivatives—liabilities, at fair value on the Consolidated Statement of Assets, Liabilities, and Equity. In addition, financial derivative contracts are summarized by type on the Consolidated Condensed Schedule of Investments.
(F) Investments Sold Short: When the Company sells securities short, it typically satisfies its security delivery settlement obligation by obtaining the security sold short from the same or a different counterparty. The Company generally is required to deliver cash or securities as collateral to the counterparty for the Company's obligation to return the borrowed security. The amount by which the market value of the obligation falls short of or exceeds the proceeds from the short sale is treated as an unrealized gain or loss, respectively. A realized gain or loss will be recognized upon the termination of a short sale if the market price is less or greater than the proceeds originally received.
(G) Reverse Repurchase Agreements: The Company enters into reverse repurchase agreements with third-party broker-dealers whereby it sells securities under agreements to be repurchased at an agreed-upon price and date. The Company accounts for reverse repurchase agreements as collateralized borrowings, with the initial sale price representing the amount borrowed, and with the future repurchase price consisting of the amount borrowed plus interest, at the implied interest rate of the reverse repurchase agreement, on the amount borrowed over the term of the reverse repurchase agreement. The interest rate on a reverse repurchase agreement is based on competitive rates (or competitive market spreads, in the case of agreements with floating interest rates) at the time such agreement is entered into. When the Company enters into a reverse repurchase agreement, the lender establishes and maintains an account containing cash and/or securities having a value not less than the repurchase price, including accrued interest, of the reverse repurchase agreement. Reverse repurchase agreements are carried at their contractual amounts, which approximate fair value as the debt is short-term in nature.
(H) Repurchase Agreements: The Company enters into repurchase agreement transactions whereby it purchases securities under agreements to resell at an agreed-upon price and date. In general, securities received pursuant to repurchase agreements are delivered to counterparties of short sale transactions. The interest rate on a repurchase agreement is based on competitive rates (or competitive market spreads, in the case of agreements with floating interest rates) at the time such agreement is entered into. Assets held pursuant to repurchase agreements are reflected as assets on the Consolidated Statement of Assets, Liabilities, and Equity. Repurchase agreements are carried at fair value based on their contractual amounts as the debt is short-term in nature.
Repurchase and reverse repurchase agreements that are conducted with the same counterparty may be reported on a net basis if they meet the requirements of ASC 210-20, Balance Sheet Offsetting. There are no repurchase and reverse repurchase agreements reported on a net basis in the Company's consolidated financial statements.
(I) Transfers of Financial Assets: The Company enters into transactions whereby it transfers financial assets to third parties. Upon such a transfer of financial assets, the Company will sometimes retain or acquire interests in the related assets. The Company evaluates transferred assets pursuant to ASC 860-10, Transfers of Financial Assets, or "ASC 860-10," which requires that a determination be made as to whether a transferor has surrendered control over transferred financial assets. That


174


determination must consider the transferor's continuing involvement in the transferred financial asset, including all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer, even if they were not entered into at the time of the transfer. When a transfer of financial assets does not qualify as a sale, ASC 860-10 requires the transfer to be accounted for as a secured borrowing with a pledge of collateral. ASC 860-10 is a standard that requires the Company to exercise significant judgment in determining whether a transaction should be recorded as a "sale" or a "financing."
(J) When-Issued/Delayed Delivery Securities: The Company may purchase or sell securities on a when-issued or delayed delivery basis. Securities purchased or sold on a when-issued basis are traded for delivery beyond the normal settlement date at a stated price or yield, and no income accrues to the purchaser prior to settlement. Purchasing or selling securities on a when-issued or delayed delivery basis involves the risk that the market price or yield at the time of settlement may be lower or higher than the agreed-upon price or yield, in which case a realized loss may be incurred.
The Company transacts in the forward settling TBA market. The Company typically does not take delivery of TBAs, but rather settles the associated receivable and payable with its trading counterparties on a net basis. Transactions with the same counterparty for the same TBA that result in a reduction of the position are treated as extinguished. The market value of the securities that the Company is required to purchase pursuant to a TBA transaction may decline below the agreed-upon purchase price. Conversely, the market value of the securities that the Company is required to sell pursuant to a TBA transaction may increase above the agreed upon sale price. As part of its TBA activities, the Company may "roll" its TBA positions, whereby the Company may sell (buy) securities for delivery (receipt) in an earlier month and simultaneously contract to repurchase (sell) similar, but not identical, securities at an agreed-upon price on a fixed date in a later month (with the later-month price typically lower than the earlier-month price). The Company accounts for its TBA transactions (including those related to TBA rolls) as purchases and sales.
(K) REO: When the Company obtains possession of real property in connection with a foreclosure or similar action, the Company de-recognizes the associated mortgage loan according to ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure ("ASU 2014-04"). Under the provisions of ASU 2014-04, the Company is deemed to have received physical possession of real estate property collateralizing a mortgage loan when it obtains legal title to the property upon completion of a foreclosure or when the borrower conveys all interest in the property to it through a deed in lieu of foreclosure or similar legal agreement. The Company holds all REO at fair value.
(L) Investments in Operating Entities: The Company has made and may in the future make non-controlling investments in operating entities such as loan originators. Investments in such operating entities may be in the form of preferred and/or common equity, debt, or some other form of investment. The Company carries its investments in such entities at fair value. In cases where the operating entity provides services to the Company, the Company is required to use the equity method of accounting.
(M) Variable Interest Entities: VIEs are entities in which: (i) the equity investors do not have the characteristics of a controlling financial interest, or (ii) there is insufficient equity to permit the entity to finance its activities without additional subordinated financial support from other parties. The Company holds beneficial interests in securitization trusts that are considered VIEs. The beneficial interests in these securitization trusts are represented by certificates issued by the trusts. The securitization trusts have been structured as pass-through entities that receive principal and interest payments on the underlying collateral and distribute those payments to the certificate holders, which include both third-party investors and the Company. The certificates held by the Company typically include some or all of the most subordinated tranches. The assets held by the trusts are restricted in that they can only be used to fulfill the obligations of the related trust. In certain cases the design and structure of the securitization trust is such that the Company effectively retains control of the assets as well as the activities that most significantly impact the economic performance of the trust; in such cases the trust is considered a direct extension of the Company's business, and the Company consolidates the trust. In cases where the Company does not effectively retain control of the assets of, or the activities that most significantly impact the economic performance of, the related trust, it does not consolidate the trust. See Note 6 for further discussion of the Company's securitization trusts.
(N) Offering Costs/Underwriters' Discount: Offering costs and underwriters' discount are charged against shareholders' equity. Offering costs typically include legal, accounting, printing, and other fees associated with the cost of raising capital.
(O) Debt Issuance Costs: Debt issuance costs associated with debt for which the Company has elected the fair value option are expensed at the issuance of the debt, and are included in Other investment related expenses on the Consolidated Statement of Operations. Costs associated with the issuance of debt for which the Company has not elected the fair value option are amortized over the life of the debt, which approximates the effective interest rate method, and are included in Interest expense on the Consolidated Statement of Operations. Deferred debt issuance costs are presented on the Consolidated Statement of Assets, Liabilities, and Equity as a direct deduction from the related debt liability, unless such deferred debt issuance costs are associated with borrowing facilities that are expected to have a future benefit, such as giving the Company


175


the ability to access additional borrowings over the contractual term of the debt, in which case such deferred debt issuance costs are included in Other Assets on Consolidated Statement of Assets, Liabilities, and Equity. Debt issuance costs include legal and accounting fees, purchasers' or underwriters' discount, as well as other fees associated with the cost of the issuance of the related debt.
(P) Expenses: Expenses are recognized as incurred on the Consolidated Statement of Operations.
(Q) Other Investment Related Expenses: Other investment related expenses consist of expenses directly related to specific financial instruments. Such expenses generally include dividend expense on common stock sold short, servicing fees and corporate and escrow advances on mortgage and consumer loans, and various other expenses and fees related directly to the Company's financial instruments. Other investment related expenses are recognized as incurred on the Consolidated Statement of Operations; dividend expense on common stock sold short is recognized on the ex-dividend date.
(R) LTIP Units: Long term incentive plan units of the Company ("LTIP Units") and long term incentive plan units of the Operating Partnership ("OP LTIP Units") have been issued to the Company's dedicated or partially dedicated personnel and certain of its directors as well as the Manager. Costs associated with LTIP Units and OP LTIP Units issued to dedicated or partially dedicated personnel, or to its directors, are measured as of the grant date based on the closing stock price on the New York Stock Exchange and are amortized over the vesting period in accordance with ASC 718-10, Compensation—Stock Compensation. The vesting periods for LTIP Units and OP LTIP Units are typically one year from issuance for directors, and are typically one year to two years from issuance for dedicated or partially dedicated personnel.
(S) Non-controlling interests: Non-controlling interests include interests in the Operating Partnership represented by units convertible into the Company's common shares ("Convertible Non-controlling Interests"). Convertible Non-controlling Interests include both the OP LTIP Units and those common units ("OP Units") of the Operating Partnership not held by the Company. Non-controlling interests also include the interests of joint venture partners in certain of our consolidated subsidiaries. The joint venture partners' interests are not convertible into the Company's common shares. The Company adjusts the Convertible Non-controlling Interests to align their carrying value with their share of total outstanding Operating Partnership units, including both the OP Units held by the Company and the Convertible Non-controlling Interests. Any such adjustments are reflected in "Adjustment to non-controlling interest" on the Consolidated Statement of Changes in Equity. See Note 11 for further discussion of non-controlling interests.
(T) Dividends: Dividends payable by the Company are recorded on the ex-dividend date. Dividends are typically declared and paid on a quarterly basis in arrears.
(U) Shares Repurchased: Common shares that are repurchased by the Company subsequent to issuance are immediately retired upon settlement and decrease the total number of shares outstanding and issued.
(V) Earnings Per Share ("EPS"): Basic EPS is computed using the two class method by dividing net increase (decrease) in shareholders' equity resulting from operations after adjusting for the impact of LTIP Units which are participating securities, by the weighted average number of common shares outstanding calculated including LTIP Units. Because the Company's LTIP Units are participating securities, they are included in the calculation of basic and diluted EPS. Convertible Non-controlling Interests are also participating securities and, accordingly, are included in the calculation of both basic and diluted EPS.
(W) Foreign Currency: Assets and liabilities denominated in foreign currencies are translated into U.S. dollars at current exchange rates at the following dates: (i) assets, liabilities, and unrealized gains/losses—at the valuation date; and (ii) income, expenses, and realized gains/losses—at the accrual/transaction date. The Company isolates the portion of realized and change in unrealized gain (loss) resulting from changes in foreign currency exchange rates on investments and financial derivatives from the fluctuations arising from changes in fair value of investments and financial derivatives held. Changes in realized and change in unrealized gain (loss) due to foreign currency are included in Foreign currency transactions and Foreign currency translation, respectively, on the Consolidated Statement of Operations.
(X) Income Taxes: The Company is treated as a partnership for U.S. federal income tax purposes. Certain of the Company's subsidiaries are not consolidated for U.S. federal income tax purposes, but are also treated as partnerships. In general, partnerships are not subject to entity-level tax on their income, but the income of a partnership is taxable to its owners on a flow-through basis. In addition, certain subsidiaries of the Company have elected to be treated as corporations for U.S. federal income tax purposes, and one has elected to be taxed as a real estate investment trust, or "REIT."
The Company follows the authoritative guidance on accounting for and disclosure of uncertainty on tax positions, which requires management to determine whether a tax position of the Company is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. For uncertain tax positions, the tax benefit to be recognized is measured as the largest amount


176


of benefit that is greater than 50% likely of being realized upon ultimate settlement. The Company did not have any additions to unrecognized tax benefits resulting from tax positions related either to the current period or to 2017, 2016, or 2015 (its open tax years), and no reductions resulting from tax positions of prior years or due to settlements, and thus had no unrecognized tax benefits or reductions since inception. The Company does not expect any change in unrecognized tax benefits within the next fiscal year. There were no amounts accrued for tax penalties or interest as of or during the periods presented in these consolidated financial statements.
The Company may take positions with respect to certain tax issues which depend on legal interpretation of facts or applicable tax regulations. Should the relevant tax regulators successfully challenge any of such positions, the Company might be found to have a tax liability that has not been recorded in the accompanying consolidated financial statements. Also, management's conclusions regarding ASC 740-10 may be subject to review and adjustment at a later date based on factors including, but not limited to, further implementation guidance from the Financial Accounting Standards Board, or "FASB," and ongoing analyses of tax laws, regulations and interpretations thereof.
(Y) Recent Accounting Pronouncements: In August 2018, the Financial Accounting Standards Board, or "FASB," issued ASU 2018-13, Fair Value Measurement—Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"). This amends ASC 820, Fair Value Measurement, to remove or modify various current disclosure requirements related to fair value measurement. Additionally ASU 2018-13 requires certain additional disclosures around fair value measurement. ASU 2018-13 is effective for annual periods beginning after December 15, 2019 and interim periods within those years, with early adoption permitted. Entities are permitted to early adopt any removed or modified disclosures and delay adoption of the additional disclosures until their effective date. The Company has elected to early adopt the removal and modification of various disclosure requirements in accordance with ASU 2018-13; early adoption has not had a material impact on the Company's consolidated financial statements. The Company has elected not to early adopt the additional disclosure requirements. The adoption of additional disclosures, as required under ASU 2018-13, is not expected to have a material impact on the Company's consolidated financial statements.
In June 2018, the FASB issued ASU 2018-07, Compensation—Stock Compensation—Improvements to Nonemployee Share-Based Payment Accounting ("ASU 2018-07"). This amends ASC 718, Compensation—Stock Compensation, to simplify several aspects of accounting for nonemployee share-based payment transactions. ASU 2018-07 is effective for annual periods beginning after December 15, 2019 and interim periods beginning after December 15, 2020, with early adoption permitted. The adoption of ASU 2018-07 is not expected to have a material impact on the Company's consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows—Restricted Cash ("ASU 2016-18"). This amends ASC 230, Statement of Cash Flows, to require that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash and restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 became effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The adoption of ASU 2016-18 did not have a material impact on the Company's consolidated financial statements.


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3. Valuation
The table below reflects the value of the Company's Level 1, Level 2, and Level 3 financial instruments at December 31, 2018:
Description
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In thousands)
Assets:
 
 
 
 
 
 
 
 
Cash equivalents
 
$
12,460

 
$

 
$

 
$
12,460

Investments, at fair value-
 
 
 
 
 
 
 
 
Agency residential mortgage-backed securities
 
$

 
$
1,442,924

 
$
7,293

 
$
1,450,217

U.S. Treasury securities
 

 
76

 

 
76

Private label residential mortgage-backed securities
 

 
211,348

 
91,291

 
302,639

Private label commercial mortgage-backed securities
 

 
33,105

 
803

 
33,908

Commercial mortgage loans
 

 

 
211,185

 
211,185

Residential mortgage loans
 

 

 
496,830

 
496,830

Collateralized loan obligations
 

 
108,978

 
14,915

 
123,893

Consumer loans and asset-backed securities backed by consumer loans
 

 

 
206,761

 
206,761

Corporate debt
 

 
16,074

 
6,318

 
22,392

Secured notes
 

 

 
10,917

 
10,917

Real estate owned
 

 

 
34,500

 
34,500

Common stock
 
2,200

 

 

 
2,200

Corporate equity investments
 

 

 
43,793

 
43,793

Total investments, at fair value
 
2,200

 
1,812,505

 
1,124,606

 
2,939,311

Financial derivatives–assets, at fair value-
 
 
 
 
 
 
 
 
Credit default swaps on asset-backed securities
 

 

 
1,472

 
1,472

Credit default swaps on corporate bond indices
 

 
733

 

 
733

Credit default swaps on corporate bonds
 

 
2,473

 

 
2,473

Credit default swaps on asset-backed indices
 

 
8,092

 

 
8,092

Total return swaps
 

 
1

 

 
1

Interest rate swaps
 

 
7,224

 

 
7,224

Forwards
 

 
6

 

 
6

Total financial derivatives–assets, at fair value
 

 
18,529

 
1,472

 
20,001

Repurchase agreements, at fair value
 

 
61,274

 

 
61,274

Total investments, financial derivatives–assets, and repurchase agreements, at fair value
 
$
2,200

 
$
1,892,308

 
$
1,126,078

 
$
3,020,586

Liabilities:
 
 
 
 
 
 
 
 
Investments sold short, at fair value-
 
 
 
 
 
 
 
 
Agency residential mortgage-backed securities
 
$

 
$
(772,964
)
 
$

 
$
(772,964
)
Government debt
 

 
(54,151
)
 

 
(54,151
)
Corporate debt
 

 
(6,529
)
 

 
(6,529
)
Common stock
 
(16,933
)
 

 

 
(16,933
)
Total investments sold short, at fair value
 
(16,933
)
 
(833,644
)
 

 
(850,577
)
 
 
 
 
 
 
 
 
 



178


Description
 
Level 1
 
Level 2
 
Level 3
 
Total
(continued)
 
(In thousands)
Financial derivatives–liabilities, at fair value-
 
 
 
 
 
 
 
 
Credit default swaps on corporate bond indices
 
$

 
$
(11,557
)
 
$

 
$
(11,557
)
Credit default swaps on corporate bonds
 

 
(3,246
)
 

 
(3,246
)
Credit default swaps on asset-backed indices
 

 
(2,125
)
 

 
(2,125
)
Interest rate swaps
 

 
(3,397
)
 

 
(3,397
)
Total return swaps
 

 
(6
)
 

 
(6
)
Futures
 
(355
)
 

 

 
(355
)
Forwards
 

 
(120
)
 

 
(120
)
Total financial derivatives–liabilities, at fair value
 
(355
)
 
(20,451
)
 

 
(20,806
)
Other secured borrowings, at fair value
 

 

 
(297,948
)
 
(297,948
)
Total investments sold short, financial derivatives–liabilities, and other secured borrowings, at fair value
 
$
(17,288
)
 
$
(854,095
)
 
$
(297,948
)
 
$
(1,169,331
)

The following table identifies the significant unobservable inputs that affect the valuation of the Company's Level 3 assets and liabilities as of December 31, 2018:
 
 
Fair Value
 
Valuation 
Technique
 
Unobservable Input
 
Range
 
Weighted
Average
Description
 
 
 
 
Min
 
Max
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Private label residential mortgage-backed securities
 
$
36,945

 
Market Quotes
 
Non Binding Third-Party Valuation
 
$
17.42

 
$
178.00

 
$
78.31

Collateralized loan obligations
 
5,828

 
Market Quotes
 
Non Binding Third-Party Valuation
 
2.64

 
375.00

 
167.78

Corporate debt, non-exchange traded corporate equity, and secured notes
 
13,976

 
Market Quotes
 
Non Binding Third-Party Valuation
 
9.69

 
91.00

 
59.18

Private label commercial mortgage-backed securities
 
576

 
Market Quotes
 
Non Binding Third-Party Valuation
 
5.93

 
6.36

 
6.14

Agency interest only residential mortgage-backed securities
 
744

 
Market Quotes
 
Non Binding Third-Party Valuation
 
1.70

 
9.12

 
5.64

Private label residential mortgage-backed securities
 
54,346

 
Discounted Cash Flows
 
Yield
 
3.5
%
 
66.1
%
 
10.7
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
16.0
%
 
92.1
%
 
50.4
%
 
 
 
 
 
 
Projected Collateral Losses
 
0.0
%
 
23.1
%
 
8.7
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
1.5
%
 
14.6
%
 
7.3
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
6.1
%
 
61.8
%
 
33.6
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Private label commercial mortgage-backed securities
 
227

 
Discounted Cash Flows
 
Yield
 
3.4
%
 
3.4
%
 
3.4
%
 
 
 
 
 
 
Projected Collateral Losses
 
2.0
%
 
2.0
%
 
2.0
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
6.6
%
 
6.6
%
 
6.6
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
91.4
%
 
91.4
%
 
91.4
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Corporate debt and non-exchange traded corporate equity
 
4,793

 
Discounted Cash Flows
 
Yield
 
17.5
%
 
17.5
%
 
17.5
%



179


(continued)
 
Fair Value
 
Valuation 
Technique
 
Unobservable Input
 
Range
 
Weighted
Average
Description
 
 
 
 
Min
 
Max
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Collateralized loan obligations
 
$
9,087

 
Discounted Cash Flows
 
Yield
 
12.6
%
 
103.1
%
 
26.7
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
8.1
%
 
88.4
%
 
65.2
%
 
 
 
 
 
 
Projected Collateral Losses
 
3.7
%
 
40.8
%
 
13.5
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
4.2
%
 
38.0
%
 
11.9
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
3.5
%
 
13.5
%
 
9.4
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Consumer loans and asset-backed securities backed by consumer loans
 
206,761

 
Discounted Cash Flows
 
Yield
 
7.0
%
 
18.3
%
 
8.5
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
0.0
%
 
45.9
%
 
33.5
%
 
 
 
 
 
 
Projected Collateral Losses
 
2.6
%
 
84.8
%
 
9.1
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
15.2
%
 
96.6
%
 
57.4
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Performing commercial mortgage loans
 
163,876

 
Discounted Cash Flows
 
Yield
 
8.0
%
 
22.5
%
 
9.6
%
Non-performing commercial mortgage loans and commercial real estate owned
 
80,513

 
Discounted Cash Flows
 
Yield
 
9.6
%
 
27.4
%
 
13.2
%
 
 
 
 
 
 
Months to Resolution
 
3.0

 
16.0

 
7.9

Performing residential mortgage loans
 
171,367

 
Discounted Cash Flows
 
Yield
 
2.7
%
 
12.9
%
 
6.0
%
Securitized residential mortgage loans(1)
 
314,202

 
Discounted Cash Flows
 
Yield
 
4.3
%
 
4.6
%
 
4.6
%
Non-performing residential mortgage loans and residential real estate owned
 
12,557

 
Discounted Cash Flows
 
Yield
 
4.3
%
 
25.1
%
 
11.3
%
 
 
 
 
 
 
Months to Resolution(2)
 
1.9

 
42.2

 
27.8

Credit default swaps on asset-backed securities
 
1,472

 
Net Discounted Cash Flows
 
Projected Collateral Prepayments
 
33.6
%
 
42.0
%
 
36.5
%
 
 
 
 
 
 
Projected Collateral Losses
 
11.1
%
 
15.6
%
 
12.8
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
10.3
%
 
18.7
%
 
15.8
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
32.0
%
 
36.5
%
 
34.9
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Agency interest only residential mortgage-backed securities
 
6,549

 
Option Adjusted Spread ("OAS")
 
LIBOR OAS(3)
 
211

 
3,521

 
677

 
 
 
 
 
 
Projected Collateral Prepayments
 
37.7
%
 
100.0
%
 
66.2
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
0.0
%
 
62.3
%
 
33.8
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Non-exchange traded common equity investment in mortgage-related entity
 
6,750

 
Enterprise Value
 
Equity Price-to-Book(4)
 
3.3x
 
3.3x
 
3.3x
Non-exchange traded preferred equity investment in mortgage-related entity
 
27,317

 
Enterprise Value
 
Equity Price-to-Book(4)
 
1.1x
 
1.1x
 
1.1x
Non-exchange traded preferred equity investment in loan origination entity
 
3,000

 
Recent Transactions
 
Transaction Price
 
N/A
 
N/A
 
N/A
Non-controlling equity interest in limited liability company
 
5,192

 
Discounted Cash Flows
 
Yield(5)
 
12.9%
 
16.1%
 
15.4%
Other secured borrowings, at fair value(1)
 
(297,948
)
 
Discounted Cash Flows
 
Yield
 
3.9%
 
4.4%
 
4.3%

(1)
Securitized residential mortgage loans and Other secured borrowings, at fair value, represent financial assets and liabilities of the Company's CFE as discussed in Note 2.


180


(2)
Excludes certain loans that are re-performing.
(3)
Shown in basis points.
(4)
Represent an estimation of where market participants might value an enterprise on a price-to-book basis.
(5)
Represents the significant unobservable inputs used to fair value the financial instruments of the limited liability company. The fair value of such financial instruments is the largest component of the valuation of the limited liability company as a whole.
Third-party non-binding valuations are validated by comparing such valuations to internally generated prices based on the Company's models and to recent trading activity in the same or similar instruments.
For those instruments valued using discounted and net discounted cash flows, collateral prepayments, losses, recoveries, and scheduled amortization are projected over the remaining life of the collateral and expressed as a percentage of the collateral's current principal balance. Averages are weighted based on the fair value of the related instrument. In the case of credit default swaps on asset-backed securities, averages are weighted based on each instrument's bond equivalent value. Bond equivalent value represents the investment amount of a corresponding position in the reference obligation, calculated as the difference between the outstanding principal balance of the underlying reference obligation and the fair value, inclusive of accrued interest, of the derivative contract. For those assets valued using the LIBOR Option Adjusted Spread ("OAS") valuation methodology, cash flows are projected using the Company's models over multiple interest rate scenarios, and these projected cash flows are then discounted using the LIBOR rates implied by each interest rate scenario. The LIBOR OAS of an asset is then computed as the unique constant yield spread that, when added to all LIBOR rates in each interest rate scenario generated by the model, will equate (a) the expected present value of the projected asset cash flows over all model scenarios to (b) the actual current market price of the asset. LIBOR OAS is therefore model-dependent. Generally speaking, LIBOR OAS measures the additional yield spread over LIBOR that an asset provides at its current market price after taking into account any interest rate options embedded in the asset. The Company considers the expected timeline to resolution in the determination of fair value for its non-performing commercial and residential mortgage loans.
Material changes in any of the inputs above in isolation could result in a significant change to reported fair value measurements. Additionally, fair value measurements are impacted by the interrelationships of these inputs. For example, for instruments subject to prepayments and credit losses, such as non-Agency RMBS and consumer loans and ABS backed by consumer loans, a higher expectation of collateral prepayments will generally be accompanied by a lower expectation of collateral losses. Conversely, higher losses will generally be accompanied by lower prepayments. Because the Company's credit default swaps on asset-backed security holdings represent credit default swap contracts whereby the Company has purchased credit protection, such credit default swaps on asset-backed securities generally have the directionally opposite sensitivity to prepayments, losses, and recoveries as compared to the Company's long securities holdings. Prepayments do not represent a significant input for the Company's commercial mortgage-backed securities and commercial mortgage loans. Losses and recoveries do not represent a significant input for the Company's Agency RMBS interest only securities, given the guarantee of the issuing government agency or government-sponsored enterprise.


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The tables below include a roll-forward of the Company's financial instruments for the year ended December 31, 2018 (including the change in fair value), for financial instruments classified by the Company within Level 3 of the valuation hierarchy.
Level 3—Fair Value Measurement Using Significant Unobservable Inputs:
Year Ended December 31, 2018
(In thousands)
Ending
Balance as of 
December 31, 2017
 
Accreted
Discounts /
(Amortized
Premiums)
 
Net Realized
Gain/
(Loss)
 
Change in Net
Unrealized
Gain/(Loss)
 
Purchases/
Payments
 
Sales/
Issuances
 
Transfers Into Level 3
 
Transfers Out of Level 3
 
Ending
Balance as of 
December 31, 2018
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investments, at fair value-
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency residential mortgage-backed securities
$
6,173

 
$
(2,233
)
 
$
(10
)
 
$
175

 
$
2,753

 
$
(1,169
)
 
$
2,616

 
$
(1,012
)
 
$
7,293

Private label residential mortgage-backed securities
101,297

 
383

 
1,838

 
(2,135
)
 
75,685

 
(78,487
)
 
7,074

 
(14,364
)
 
91,291

Private label commercial mortgage-backed securities
12,347

 
(243
)
 
2,229

 
2,120

 
1,481

 
(16,896
)
 

 
(235
)
 
803

Commercial mortgage loans
108,301

 
790

 
1,146

 
1,944

 
149,053

 
(50,049
)
 

 

 
211,185

Residential mortgage loans
182,472

 
(1,965
)
 
1,011

 
(34
)
 
402,235

 
(86,889
)
 

 

 
496,830

Collateralized loan obligations
24,911

 
(351
)
 
317

 
(2,268
)
 
33,549

 
(33,115
)
 
3,959

 
(12,087
)
 
14,915

Consumer loans and asset-backed securities backed by consumer loans
135,258

 
(29,320
)
 
8,415

 
(1,092
)
 
228,354

 
(134,854
)
 

 

 
206,761

Corporate debt
23,947

 
56

 
241

 
(964
)
 
7,665

 
(17,688
)
 

 
(6,939
)
 
6,318

Secured notes

 
870

 

 
(1,221
)
 
11,268

 

 

 

 
10,917

Real estate owned
26,277

 

 
(653
)
 
(1,003
)
 
12,793

 
(2,914
)
 

 

 
34,500

Corporate equity investments
37,465

 

 
1,671

 
8,299

 
12,708

 
(16,350
)
 

 

 
43,793

Total investments, at fair value
658,448

 
(32,013
)
 
16,205

 
3,821

 
937,544

 
(438,411
)
 
13,649

 
(34,637
)
 
1,124,606

Financial derivatives–assets, at fair value-
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit default swaps on asset-backed securities
3,140

 

 
(687
)
 
715

 
102

 
(1,798
)
 

 

 
1,472

Total financial derivatives– assets, at fair value
3,140

 

 
(687
)
 
715

 
102

 
(1,798
)
 

 

 
1,472

Total investments and financial derivatives–assets, at fair value
$
661,588

 
$
(32,013
)
 
$
15,518

 
$
4,536

 
$
937,646

 
$
(440,209
)
 
$
13,649

 
$
(34,637
)
 
$
1,126,078

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other secured borrowings, at fair value
$
(125,105
)
 
$

 
$

 
$
758

 
$
49,731

 
$
(223,332
)
 
$

 
$

 
$
(297,948
)
Total other secured borrowings, at fair value
$
(125,105
)
 
$

 
$

 
$
758

 
$
49,731

 
$
(223,332
)
 
$

 
$

 
$
(297,948
)
All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at December 31, 2018, as well as Level 3 financial instruments disposed of by the Company during the year ended December 31, 2018. For Level 3 financial instruments held by the Company at December 31, 2018, change in net unrealized gain (loss) of $5.3 million, $(0.6) million, and $0.8 million, for the year ended December 31, 2018 relate to investments, financial derivatives–assets, and other secured borrowings, at fair value, respectively.
At December 31, 2018, the Company transferred $34.6 million of securities from Level 3 to Level 2 and $13.6 million from Level 2 to Level 3. Transfers between these hierarchy levels were based on the availability of sufficient observable inputs to meet Level 2 versus Level 3 criteria. The leveling of each financial instrument is reassessed at the end of each period, and is based on pricing information received from third-party pricing sources.
Not included in the disclosures above are the Company's other financial instruments, which are carried at cost and include, Cash, Due from brokers, Due to brokers, Reverse repurchase agreements, Other secured borrowings, and the


182


Company's unsecured long-term debt, or the "Senior Notes," which is reflected on the Consolidated Statement of Assets, Liabilities, and Equity in Senior notes, net. Cash includes cash held in various accounts including an interest bearing overnight account for which fair value equals the carrying value; such assets are considered Level 1 assets. Due from brokers and Due to brokers include collateral transferred to or received from counterparties, along with receivables and payables for open and/or closed derivative positions. These receivables and payables are short term in nature and any collateral transferred consists primarily of cash; carrying value of these items approximates fair value and such items are considered Level 1 assets and liabilities. The Company's reverse repurchase agreements and Other secured borrowings are carried at cost, which approximates fair value due to their short term nature. Reverse repurchase agreements and Other secured borrowings are considered Level 2 assets and liabilities based on the adequacy of the associated collateral and their short term nature. The Company estimates the fair value of the Senior Notes at $86.0 million as of December 31, 2018. The Senior Notes are considered Level 3 liabilities given the relative unobservability of the most significant inputs to valuation estimation as well as the lack of trading activity of these instruments.
4. To Be Announced RMBS
In addition to investing in pools of Agency RMBS, the Company transacts in the forward settling TBA market. Pursuant to these TBA transactions, the Company agrees to purchase or sell, for future delivery, Agency RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular Agency RMBS to be delivered is not identified until shortly before the TBA settlement date. TBAs are liquid and have quoted market prices and represent the most actively traded class of MBS. The Company accounts for its TBAs as purchases and sales and uses TBAs primarily for hedging purposes, typically in the form of short positions. However, the Company may also invest in TBAs for speculative purposes, including holding long positions. Overall, the Company typically holds a net short position.
The Company does not generally take delivery of TBAs; rather, it settles the associated receivable and payable with its trading counterparties on a net basis. Transactions with the same counterparty for the same TBA that result in a reduction of the position are treated as extinguished. The fair value of the Company's long positions in TBA contracts are reflected on the Consolidated Condensed Schedule of Investments under TBA–Fixed-Rate Agency Securities and the fair value of the Company's positions in TBA contracts sold short are reflected on the Consolidated Condensed Schedule of Investments under TBA–Fixed-Rate Agency Securities Sold Short. The payables and receivables related to the Company's TBA securities are included on the Consolidated Statement of Assets, Liabilities, and Equity in Payable for securities purchased and Receivable for securities sold, respectively.
The below table details TBA assets, liabilities, and the respective related payables and receivables as of December 31, 2018:
(In thousands)
 
As of
December 31, 2018
Assets:
 
 
TBA securities, at fair value (Current principal: $460,037)
 
$
474,860

Receivable for securities sold relating to unsettled TBA sales
 
766,574

Liabilities:
 
 
TBA securities sold short, at fair value (Current principal: -$753,697)
 
$
(772,964
)
Payable for securities purchased relating to unsettled TBA purchases
 
(473,386
)
Net short TBA securities, at fair value
 
(298,104
)



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5. Financial Derivatives
Gains and losses on the Company's derivative contracts for the year ended December 31, 2018 are summarized in the table below:
 
 
 
 
Year Ended December 31, 2018
Derivative Type
 
Primary Risk
Exposure
 
Net Realized
Gain/(Loss)
(1)
 
Change in Net Unrealized Gain/(Loss)(2)
(In thousands)
 
 
 
 
 
 
Credit default swaps on asset-backed securities
 
Credit
 
$
(687
)
 
$
715

Credit default swaps on asset-backed indices
 
Credit
 
(2,293
)
 
2,013

Credit default swaps on corporate bond indices
 
Credit
 
(1,983
)
 
3,540

Credit default swaps on corporate bonds
 
Credit
 
2,993

 
(2,648
)
Total return swaps
 
Equity Market/Credit
 
3,844

 
(5
)
Interest rate swaps
 
Interest Rate
 
(985
)
 
3,648

Futures
 
Interest Rate/Currency
 
162

 
108

Forwards
 
Currency
 
923

 
359

Options
 
Interest Rate/
Equity Market
 
(63
)
 
77

Total
 
 
 
$
1,911

 
$
7,807


(1)
Includes gain/(loss) on foreign currency transactions on derivatives in the amount of $0.1 million for the year ended December 31, 2018, which is included on the Consolidated Statement of Operations in Realized gain (loss) on foreign currency transactions.
(2)
Includes foreign currency translation on derivatives in the amount of $0.1 million for the year ended December 31, 2018, which is included on the Consolidated Statement of Operations in Change in net unrealized gain (loss) on foreign currency translation.
The table below details the average notional values of the Company's financial derivatives, using absolute value of month end notional values, for the year ended December 31, 2018:
Derivative Type
 
Year Ended
December 31, 2018
 
 
(In thousands)
Interest rate swaps
 
$
1,059,756

Credit default swaps
 
566,805

Total return swaps
 
53,603

Futures
 
201,295

Options
 
99,891

Forwards
 
45,522


From time to time the Company enters into credit derivative contracts for which the Company sells credit protection ("written credit derivatives"). As of December 31, 2018 all of the Company's open written credit derivatives were credit default swaps on either mortgage/asset-backed indices (ABX and CMBX indices) or corporate bond indices (CDX), collectively referred to as credit indices, or on individual corporate bonds, for which the Company receives periodic payments at fixed rates from credit protection buyers, and is obligated to make payments to the credit protection buyer upon the occurrence of a "credit event" with respect to underlying reference assets.


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Written credit derivatives held by the Company at December 31, 2018 are summarized below:
Credit Derivatives
 
December 31, 2018
(In thousands)
 
 
Fair Value of Written Credit Derivatives, Net
 
$
(4,339
)
Fair Value of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties (1)
 
(284
)
Notional Value of Written Credit Derivatives (2)
 
98,586

Notional Value of Purchased Credit Derivatives Offsetting Written Credit Derivatives with Third Parties (1)
 
(41,134
)
(1)
Offsetting transactions with third parties include purchased credit derivatives which have the same reference obligation.
(2)
The notional value is the maximum amount that a seller of credit protection would be obligated to pay, and a buyer of credit protection would receive, upon occurrence of a "credit event." Movements in the value of credit default swap transactions may require the Company or the counterparty to post or receive collateral. Amounts due or owed under credit derivative contracts with an International Swaps and Derivatives Association, or "ISDA," counterparty may be offset against amounts due or owed on other credit derivative contracts with the same ISDA counterparty. As a result, the notional value of written credit derivatives involving a particular underlying reference asset or index has been reduced (but not below zero) by the notional value of any contracts where the Company has purchased credit protection on the same reference asset or index with the same ISDA counterparty.
A credit default swap on a credit index or a corporate bond typically terminates at the stated maturity date in the case of corporate indices or bonds, or, in the case of ABX and CMBX indices, the date that all of the reference assets underlying the index are paid off in full, retired, or otherwise cease to exist. Implied credit spreads may be used to determine the market value of such contracts and are reflective of the cost of buying/selling credit protection. Higher spreads would indicate a greater likelihood that a seller will be obligated to perform (i.e., make protection payments) under the contract. In situations where the credit quality of the underlying reference assets has deteriorated, the percentage of notional values that would be paid up front to enter into a new such contract ("points up front") is frequently used as an indication of credit risk. Credit protection sellers entering the market in such situations would expect to be paid points up front corresponding to the approximate fair value of the contract. For the Company's written credit derivatives that were outstanding at December 31, 2018, implied credit spreads on such contracts ranged between 42.6 and 815.1 basis points. Excluded from this spread range are contracts outstanding for which the individual spread is greater than 2,000 basis points. The Company believes that these contracts would be quoted based on estimated points up front. The total fair value of contracts with individual implied credit spreads in excess of 2,000 basis points was $(1.0) million as of December 31, 2018. Estimated points up front on these contracts as of December 31, 2018 ranged between 36.9 and 75.2 points. Total net up-front payments (paid) or received relating to written credit derivatives outstanding at December 31, 2018 were $(2.0) million.
6. Securitization Transactions
Participation in Multi-Seller Consumer Loan Securitization
In August 2016, the Company participated in a securitization transaction whereby the Company, together with another entity managed by Ellington (the "co-participant"), sold consumer loans with an aggregate unpaid principal balance of approximately $124 million to a newly formed securitization trust (the "Issuer"). Of the $124 million in loans sold to the Issuer, the Company's share was 51% while the co-participant's share was 49%. The transfer was accounted for as a sale in accordance with ASC 860-10. As a result of the sale the Company recognized a realized loss in the amount of $(0.1) million. Pursuant to the securitization, the Issuer issued senior and subordinated notes in the principal amount of $87 million and $18.7 million, respectively. Trust certificates representing beneficial ownership of the Issuer were also issued. In connection with the transaction, and through a jointly owned newly formed entity (the "Acquiror"), the Company and the co-participant acquired all of the subordinated notes as well as the trust certificates in the Issuer. The Company and the co-participant acquired 51% and 49%, respectively, of the interests in the Acquiror. During 2017, at the co-participant's direction, the Acquiror sold the portion of the subordinated notes beneficially owned by the co-participant, and in 2018, the Acquiror sold the remaining portion of the subordinated notes which were beneficially owned by the Company, and as a result as of December 31, 2018, the Company's total interest in the Acquiror was approximately 62%. The Company's interest in the Acquiror is accounted for as a beneficial interest and is included on the Consolidated Condensed Schedule of Investments in Corporate Equity Investments.
The notes and trust certificates issued by the Issuer are backed by the cash flows from the underlying consumer loans. If there are breaches of representations and warranties with respect to any underlying consumer loans, the Company could, under certain circumstances, be required to purchase or replace such loans. Absent such breaches, the Company has no obligation to repurchase or replace any underlying consumer loans that become delinquent or otherwise default. Cash flows collected on the underlying consumer loans are distributed to service providers to the trust, noteholders, and trust certificate holders in accordance with the contractual priority of payments. In addition, another affiliate of Ellington (the "Administrator"), acts as the administrator for the securitization and is paid a monthly fee for its services.


185


While the Company retains credit risk in the securitization trust through its beneficial ownership of the most subordinated interests of the securitization trust, which are the first to absorb credit losses on the securitized assets, the Company does not retain control of these assets or the power to direct the activities of the Issuer that most significantly impact the Issuer's economic performance. See Note 9 for further details on the Company's participation in the multi-seller consumer loan securitization.
Participation in CLO Transactions
Since June 2017, an affiliate of Ellington sponsored three CLO securitization transactions (the "CLO I Securitization," the "CLO II Securitization," and the "CLO III Securitization"; collectively, the "Ellington-sponsored CLO Securitizations"), collateralized by corporate loans and managed by an affiliate of Ellington (the "CLO Manager"). Ellington, the Company, several other affiliates of Ellington, and, in the case of the CLO II Securitization and the CLO III Securitization, several third parties, participated in the Ellington-sponsored CLO Securitizations (collectively, the "CLO Co-Participants").
Pursuant to each Ellington-sponsored CLO Securitization, a newly formed securitization trust (the "CLO I Issuer," the "CLO II Issuer," and the "CLO III Issuer"; collectively, the "CLO Issuers") issued various classes of notes, which were in turn sold to unrelated third parties and the applicable CLO Co-Participants. The notes issued by each CLO Issuer are backed by the cash flows from the underlying corporate loans (including loans to be purchased during a reinvestment period); these cash flows are applied in accordance with the contractual priority of payments.
In the case of the CLO I Securitization, the Company and one CLO Co-Participant transferred corporate loans with a fair value of approximately $62.0 million and $141.7 million, respectively, to the CLO I Issuer in exchange for cash. The Company has no obligation to repurchase or replace securitized corporate loans that subsequently become delinquent or are otherwise in default, and the transfer by the Company was accounted for as a sale in accordance with ASC 860-10. As a result of the sale, the Company recognized a realized gain in the amount of $0.2 million.
In the case of the CLO II Securitization and the CLO III Securitization, the Company, along with certain other CLO Co-Participants, advanced funds in the form of loans (the "Advances") to the applicable CLO Issuers prior to the CLO pricing date to enable it to establish warehouse facilities for the purpose of acquiring the assets to be securitized. Pursuant to their terms, the Advances are required to be repaid at the closing of the respective securitization.
In each Ellington-sponsored CLO Securitization, the Company and each of the applicable CLO Co-Participants purchased various classes of notes issued by the corresponding CLO Issuer. In accordance with the Company's accounting policy for recording certain investment transactions on trade date, these purchases were recorded on the CLO pricing date rather than the CLO closing date. In addition, in the case of each of the CLO I Securitization and the CLO II Securitization, the Company and the CLO Co-Participants also funded a newly formed entity (the "CLO I Risk Retention Vehicle" and the "CLO II Risk Retention Vehicle") to purchase a sufficient portion of the unsecured subordinated notes issued by the applicable CLO Issuer so as to comply with risk retention rules (the "Risk Retention Rules") under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as further described below.
With respect to each Ellington-sponsored CLO Securitization, the Company subsequently sold a portion of the notes that it had originally purchased. As of December 31, 2018, the Company did not have an ownership interest in the CLO I Risk Retention Vehicle.
Under the Risk Retention Rules, sponsors of securitizations are generally required to retain at least 5% of the economic interest in the credit risk of the securitized assets. However, in February 2018, the U.S. Court of Appeals for the District of Columbia Circuit, or the "Court of Appeals," ruled that open-market CLO securitizations are exempt from the Risk Retention Rules, as long as certain requirements are met, and in April 2018 the Court of Appeals gave effect to this ruling. As a result, Risk Retention Rules no longer apply to managers of open-market CLOs, and those managers are now permitted to sell the interests in existing open-market CLOs that were originally retained in order to comply with the Risk Retention Rules, as long as those securitizations meet the requirements for exemption. After the decision by the Court of Appeals, the CLO Manager determined that the CLO II Securitization met the requirements for exemption from the Risk Retention Rules and subsequently distributed, in-kind, the subordinated notes held in the CLO II Risk Retention Vehicle to the CLO Co-Participants pro rata based on each CLO Co-Participant's respective ownership percentage of the CLO II Risk Retention Vehicle. The subordinated notes distributed to the Company from the CLO II Risk Retention Vehicle had a face amount of $5.6 million. Such notes had a fair value of $4.3 million as of December 31, 2018 and are included on the Company's Consolidated Condensed Schedule of Investments in Collateralized Loan Obligations and in the table below. The Manager of CLO III Securitization was not required to establish a risk retention vehicle because the transaction closed subsequent to the effectiveness of the ruling by the Court of Appeals.


186


In August 2018, the CLO I Issuer optionally redeemed all of the notes issued by the CLO I Securitization. Simultaneously with this optional redemption, the CLO I Issuer issued various classes of new notes, which were in turn sold to unrelated third parties and to the applicable CLO Co-Participants ("the Reset CLO I Securitization"). These new notes are backed by the cash flows from the underlying corporate loans (including loans to be purchased during a reinvestment period); these cash flows are applied in accordance with the contractual priority of payments. The CLO Manager determined that the Reset CLO I Securitization met the requirements for exemption from the Risk Retention Rules. As a result, the CLO Manager commenced liquidation of the CLO I Risk Retention Vehicle, and all of the liquidation proceeds have been distributed to the applicable CLO Co-Participants. As of December 31, 2018, the Company has received $5.7 million in liquidation proceeds from the CLO I Risk Retention Vehicle.
While the Company retains credit risk in each of the Ellington-sponsored CLO Securitizations through its beneficial ownership of the most subordinated interests of each of the securitization trusts, which are the first to absorb credit losses on the securitized assets, the Company does not retain control of these assets nor does it have the power to direct the activities of the CLO Issuers that most significantly impact the CLO Issuers' economic performance.
The following table details the Company's investments in notes issued by the Ellington-sponsored CLO Securitizations:
CLO Issuer(1)
 
CLO Pricing Date
 
CLO Closing Date
 
Total Face Amount of Notes Issued
 
Face Amount of Notes Initially Purchased
 
Aggregate Purchase Price
 
Notes Held(2) as of
 
 
 
 
 
 
December 31, 2018
($ in thousands)
 
 
 
 
 
 
 
 
 
 
CLO I Issuer(3)(4)
 
5/17
 
6/17
 
$
373,550

 
$
36,606

(5) 
 
$
35,926

 
$

 
CLO I Issuer(4)
 
8/18
 
8/18
 
461,840

 
36,579

(5) 
 
25,622

 
16,973

(6) 
CLO II Issuer
 
12/17
 
1/18
 
452,800

 
18,223

(7) 
 
16,621

 
14,721

(6) 
CLO III Issuer
 
6/18
 
7/18
 
407,100

 
35,480

(7) 
 
32,394

 
19,071

(8) 
(1)
The Company does not have the power to direct the activities of the CLO Issuers that most significantly impact their economic performance.
(2)
Included on the Company's Consolidated Condensed Schedule of Investments in Collateralized Loan Obligations.
(3)
Excludes the Company's equity investment in the CLO I Risk Retention Vehicle, as discussed above.
(4)
In August 2018, the notes originally issued by the CLO I Issuer in 2017 were fully redeemed, and the CLO I Issuer simultaneously issued new notes in conjunction with this full redemption.
(5)
The Company purchased secured and unsecured subordinated notes.
(6)
Includes secured and unsecured subordinated notes.
(7)
The Company purchased secured senior and secured and unsecured subordinated notes.
(8)
Includes secured senior and secured and unsecured subordinated notes.
See Note 9 for further details on the Company's participation in CLO transactions.
Residential Mortgage Loan Securitizations
Since November 2017, the Company, through its wholly owned subsidiary, Ellington Financial REIT TRS LLC (the "Sponsor"), has sponsored two securitizations of non-QM loans. In each case, the Sponsor transferred non-QM loans to a wholly owned, newly created entity (the "Depositor") and on the closing date such loans were deposited into newly created securitization trusts (Ellington Financial Mortgage Trust 2017-1 and Ellington Financial Mortgage Trust 2018-1, collectively the "Issuing Entities"). Pursuant to the securitizations, the Issuing Entities issued various classes of mortgage pass-through certificates (the "Certificates") which are backed by the cash flows from the underlying non-QM loans. As detailed further in the table below, in order to comply with the Risk Retention Rules, in each securitization the Sponsor purchased the two most subordinated classes of Certificates and the excess cash flow certificates. The Sponsor also purchased the Certificates entitled to excess servicing fees in each securitization, while the remaining classes of Certificates were purchased by unrelated parties.
The Certificates issued in November 2017 and 2018 have final scheduled distribution dates of October 25, 2047 and October 25, 2058, respectively. However, the Depositor may, with respect to each securitization, at its sole option, purchase all of the outstanding Certificates (an "Optional Redemption") following the earlier of (1) the two year anniversary of the closing date of such securitization or (2) the date on which the aggregate unpaid principal balance of the underlying non-QM loans has declined below 30% of the aggregate unpaid principal balance of the underlying non-QM loans as of the date as of which such loans were originally transferred to the applicable Issuing Entity. The purchase price that the Depositor is required to pay in connection with an Optional Redemption is equal to the sum of the unpaid principal balance of each class of Certificates as of the redemption date and any accrued and unpaid interest thereon. In light of these Optional Redemption rights held by the Depositor, the transfers of non-QM loans to each of the Issuing Entities do not qualify as sales under ASC 860, Transfers and Servicing.


187


In the event that certain breaches of representations or warranties are discovered with respect to any underlying non-QM loans, the Company could be required to repurchase or replace such loans.
The Sponsor also serves as the servicing administrator of each securitization and as such, is entitled to receive a monthly fee equal to one-twelfth of the product of (a) 0.03% and (b) the unpaid principal balance of the underlying non-QM loans as of the first day of the related due period. The Sponsor in its role as servicing administrator provides direction and consent for certain loss mitigation activities to the third-party servicer of the underlying non-QM loans. In certain circumstances, the servicing administrator will be required to reimburse the servicer for principal and interest advances and servicing advances made by the servicer.
In light of the Company's retained interests in each of the securitizations, together with the Optional Redemption rights and the Company's ability to direct the third-party servicer regarding certain loss mitigation activities, the Issuing Entities are deemed to be an extension of the Company's business. The non-QM loans held by the Issuing Entities are included on the Consolidated Condensed Schedule of Investments in Mortgage Loans. Interest income from these loans and the expenses related to the servicing of these loans are included in Interest income and Other investment related expenses—Servicing expense, respectively, on the Consolidated Statement of Operations.
The Issuing Entities each meet the definition of a CFE as defined in Note 2, and as a result the assets of the Issuing Entities have been valued using the fair value of the liabilities of the Issuing Entities, as such liabilities have been assessed to be more observable than such assets.
The debt of the Issuing Entities is included in Other secured borrowings, at fair value on the Consolidated Statement of Assets, Liabilities, and Equity and is shown net of the Certificates held by the Company.
The following table details the residential mortgage loan securitizations:
Issuing Entity
 
Closing Date
 
Principal Balance of Loans Transferred to the Depositor
 
Total Face Amount of Certificates Issued
 
 
 
 
(In thousands)
Ellington Financial Mortgage Trust 2017-1
 
11/15/2017
 
$
141,233

 
$
141,233

(1) 
Ellington Financial Mortgage Trust 2018-1
 
11/13/2018
 
232,518

 
232,518

(2) 
(1)
In order to comply with the Risk Retention Rules, the Sponsor purchased the two most subordinated classes of Certificates and the excess cash flow certificates, with an aggregate value equal to 5.1% of the fair value of all Certificates issued. The Sponsor also purchased, for an aggregate purchase price of $0.7 million, the Certificates entitled to excess servicing fees, while the remaining classes of Certificates were purchased by unrelated third parties.
(2)
In order to comply with the Risk Retention Rules, the Sponsor purchased the two most subordinated classes of Certificates and the excess cash flow certificates, with an aggregate value equal to 5.7% of the fair value of all Certificates issued. The Sponsor also purchased, for an aggregate purchase price of $1.3 million, the Certificates entitled to excess servicing fees, while the remaining classes of Certificates were purchased by unrelated third parties.
The following table details the assets and liabilities of the consolidated securitization trusts included in the Company's Consolidated Statement of Assets, Liabilities, and Equity as of December 31, 2018:
 
 
As of
(In thousands)
 
December 31, 2018
Assets:
 
 
Investments, at fair value
 
$
314,202

Interest and dividends receivable
 
3,527

Liabilities:
 
 
Interest and dividends payable
 
103

Other secured borrowings, at fair value
 
297,948




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7. Borrowings
Secured Borrowings
The Company's secured borrowings consist of reverse repurchase agreements, Other secured borrowings, and Other secured borrowings, at fair value. As of December 31, 2018 the Company's total secured borrowings were $1.911 billion.
Reverse Repurchase Agreements
The Company enters into reverse repurchase agreements. A reverse repurchase agreement involves the sale of an asset to a counterparty together with a simultaneous agreement to repurchase the transferred asset or similar asset from such counterparty at a future date. The Company accounts for its reverse repurchase agreements as collateralized borrowings, with the transferred assets effectively serving as collateral for the related borrowing. The Company's reverse repurchase agreements typically range in term from 30 to 180 days, although the Company also has reverse repurchase agreements that provide for longer or shorter terms. The principal economic terms of each reverse repurchase agreement—such as loan amount, interest rate, and maturity date—are typically negotiated on a transaction-by-transaction basis. Other terms and conditions, such as those relating to events of default, are typically governed under the Company's master repurchase agreements. Absent an event of default, the Company maintains beneficial ownership of the transferred securities during the term of the reverse repurchase agreement and receives the related principal and interest payments. Interest rates on these borrowings are generally fixed based on prevailing rates corresponding to the terms of the borrowings, and for most reverse repurchase agreements, interest is generally paid at the termination of the reverse repurchase agreement, at which time the Company may enter into a new reverse repurchase agreement at prevailing market rates with the same counterparty, repay that counterparty and possibly negotiate financing terms with a different counterparty, or choose to no longer finance the related asset. Some reverse repurchase agreements provide for periodic payments of interest, such as monthly payments. In response to a decline in the fair value of the transferred securities, whether as a result of changes in market conditions, security paydowns, or other factors, reverse repurchase agreement counterparties will typically make a margin call, whereby the Company will be required to post additional securities and/or cash as collateral with the counterparty in order to re-establish the agreed-upon collateralization requirements. In the event of increases in fair value of the transferred securities, the Company can generally require the counterparty to post collateral with it in the form of cash or securities. The Company is generally permitted to sell or re-pledge any securities posted by the counterparty as collateral; however, upon termination of the reverse repurchase agreement, or other circumstance in which the counterparty is no longer required to post such margin, the Company must return to the counterparty the same security that had been posted.
At any given time, the Company seeks to have its outstanding borrowings under reverse repurchase agreements with several different counterparties in order to reduce the exposure to any single counterparty. The Company had outstanding borrowings under reverse repurchase agreements with 23 counterparties as of December 31, 2018.
At December 31, 2018, approximately 21% of open reverse repurchase agreements were with one counterparty. As of December 31, 2018 remaining days to maturity on the Company's open reverse repurchase agreements ranged from 2 days to 871 days. Interest rates on the Company's open reverse repurchase agreements ranged from 0.23% to 6.07% as of December 31, 2018.


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The following table details the Company's outstanding borrowings under reverse repurchase agreements for Agency RMBS, credit assets (which include non-Agency MBS, CLOs, consumer loans, corporate debt, residential mortgage loans, and commercial mortgage loans and REO), and U.S. Treasury securities, by remaining maturity as of December 31, 2018:
(In thousands)
 
December 31, 2018
 
 
 
 
Weighted Average
Remaining Maturity
 
Outstanding
Borrowings
 
Interest Rate
 
Remaining Days to Maturity
Agency RMBS:
 
 
 
 
 
 
30 Days or Less
 
$
245,956

 
2.46
%
 
17
31-60 Days
 
415,379

 
2.58
%
 
46
61-90 Days
 
255,421

 
2.74
%
 
76
91-120 Days
 
506

 
3.31
%
 
91
Total Agency RMBS
 
917,262

 
2.59
%
 
47
Credit:
 
 
 
 
 
 
30 Days or Less
 
30,426

 
2.55
%
 
22
31-60 Days
 
189,937

 
3.32
%
 
48
61-90 Days
 
93,202

 
3.21
%
 
74
121-150 Days
 
26,222

 
4.60
%
 
123
151-180 Days
 
9,491

 
4.64
%
 
166
181-360 Days
 
91,730

 
4.54
%
 
316
> 360 Days
 
140,306

 
5.15
%
 
636
Total Credit Assets
 
581,314

 
3.98
%
 
240
U.S. Treasury Securities:
 
 
 
 
 
 
30 Days or Less
 
273

 
3.10
%
 
2
Total U.S. Treasury Securities
 
273

 
3.10
%
 
2
Total
 
$
1,498,849

 
3.13
%
 
122

Reverse repurchase agreements involving underlying investments that the Company sold prior to period end, for settlement following period end, are shown using their original maturity dates even though such reverse repurchase agreements may be expected to be terminated early upon settlement of the sale of the underlying investment.
As of December 31, 2018, the fair value of investments transferred as collateral under outstanding borrowings under reverse repurchase agreements was $1.79 billion. Collateral transferred under outstanding borrowings as of December 31, 2018 include investments in the amount of $86.7 million that were sold prior to period end but for which such sale had not yet settled. In addition the Company posted net cash collateral of $17.0 million and additional securities with a fair value of $0.2 million as of December 31, 2018 to its counterparties.
As of December 31, 2018, there were no counterparties for which the amount at risk relating to our repurchase agreements was greater than 10% of total equity.
Other Secured Borrowings
In February 2018, the Company entered into agreements to finance a portfolio of unsecured loans through a recourse secured borrowing facility. The facility includes a one year revolving period (or earlier following an early amortization event or event of default), whereby the Company can vary its borrowings based on the size of its portfolio, subject to certain maximum limits. After the revolving period ends, the facility has a two-year term ending in February 2021. The facility accrues interest on a floating rate basis. As of December 31, 2018, the Company had outstanding borrowings under this facility in the amount of $13.2 million which is included under the caption Other secured borrowings, on the Company's Consolidated Statement of Assets, Liabilities, and Equity, and the effective interest rate, inclusive of related deferred financing costs, was 4.72%. As of December 31, 2018, the fair value of unsecured loans collateralizing this borrowing was $20.3 million.
In December 2017, the Company amended its non-recourse secured borrowing facility that is used to finance a portfolio of unsecured loans. The facility includes a reinvestment period ending in December 2019 (or earlier following an early amortization event), whereby the Company can vary its borrowings based on the size of its portfolio, subject to certain maximum limits. Following the reinvestment period, the facility will begin to amortize based on the collections from the underlying loans. The facility accrues interest on a floating rate basis. As of December 31, 2018 the Company had outstanding


190


borrowings under this facility in the amount of $101.0 million which is included under the caption Other secured borrowings, on the Company's Consolidated Statement of Assets, Liabilities, and Equity, and the effective interest rate on this facility, inclusive of related deferred financing costs, was 4.68% as of December 31, 2018. As of December 31, 2018 the fair value of unsecured loans collateralizing this borrowing was $149.0 million.
The Company has completed securitization transactions, as discussed in Note 6, whereby it financed portfolios of non-QM loans. As of December 31, 2018 the fair value of the Company's outstanding liabilities associated with these securitization transactions were $297.9 million, representing the fair value of the securitization trust certificates held by third parties as of such date, and is included on Company's Consolidated Statement of Assets, Liabilities, and Equity in Other Secured Borrowings, at fair value. The weighted average coupon on the Certificates held by third parties was 3.72% as of December 31, 2018. As of December 31, 2018 the fair value of non-QM loans held in the securitization trusts were $314.2 million.
Unsecured Borrowings
Senior Notes
On August 18, 2017, the Company issued $86.0 million in aggregate principal amount of Senior Notes. The total net proceeds to the Company from the issuance of the Senior Notes was approximately $84.7 million, after deducting debt issuance costs. The Senior Notes bear an interest rate of 5.25%, subject to adjustment based on changes in the ratings, if any, of the Senior Notes. Interest on the Senior notes is payable semi-annually in arrears on March 1 and September 1 of each year. The Senior Notes mature on September 1, 2022. The Company may redeem the Senior Notes, at its option, in whole or in part, prior to March 1, 2022 at a price equal to 100% of the principal amount thereof, plus the applicable "make-whole" premium as of the applicable date of redemption. At any time on or after March 1, 2022, the Company may redeem the Senior Notes, in whole or in part, at a redemption price equal to 100% of the aggregate principal amount of the Senior Notes to be redeemed, plus accrued and unpaid interest. The Senior Notes are carried at amortized cost. There are a number of covenants, including several financial covenants, associated with the Senior Notes. As of December 31, 2018 the Company was in compliance with all of its covenants.
The Company amortizes debt issuance costs over the life of the associated debt; the amortized portion of debt issuance costs is included in Interest expense on the Consolidated Statement of Operations. The Senior Notes have an effective interest rate of 5.55%, inclusive of debt issuance costs.
The Senior Notes are unsecured and are effectively subordinated to secured indebtedness of the Company, to the extent of the value of the collateral securing such indebtedness.
Schedule of Principal Repayments
The following table details the Company's principal repayment schedule for outstanding borrowings as of December 31, 2018:
Year
 
Reverse Repurchase Agreements(1)
 
Other
Secured Borrowings(2)
 
Senior Notes(1)
 
Total
(In thousands)
 
 
 
 
 
 
 
 
2019
 
$
1,358,542

 
$
194,135

 
$

 
$
1,552,677

2020
 
78,530

 
205,198

 

 
283,728

2021
 
61,776

 
13,150

 

 
74,926

2022
 

 

 
86,000

 
86,000

2023
 

 

 

 

Total
 
$
1,498,848

 
$
412,483

 
$
86,000

 
$
1,997,331

(1)
Reflects the Company's contractual principal repayment dates.
(2)
Reflects the Company's expected principal repayment dates.
8. Income Taxes
The Company has certain subsidiaries that have elected to be treated as corporations for U.S. federal, state, and local income tax purposes. The Company accounts for income taxes in accordance with ASC 740, Income Taxes. Deferred income taxes reflect the net tax effects of temporary differences that may exist between the carrying amounts of assets and liabilities under U.S. GAAP and the amounts used for income tax purposes. As of December 31, 2018, one of the Company's domestic TRS's had a net operating loss carry-forward, resulting in a gross deferred tax asset, which has been fully reserved through a valuation allowance.


191


9. Related Party Transactions
The Company is party to a Management Agreement (which may be amended from time to time), pursuant to which the Manager manages the assets, operations, and affairs of the Company, in consideration of which the Company pays the Manager management and incentive fees. Effective March 13, 2018, the Board of Directors approved a Seventh Amended and Restated Management Agreement between the Company and the Manager. The descriptions of the Base Management Fees and Incentive Fees are detailed below.
Base Management Fees
The Operating Partnership pays the Manager 1.50% per annum of total equity of the Operating Partnership calculated in accordance with U.S. GAAP as of the end of each fiscal quarter (before deductions for base management fees and incentive fees payable with respect to such fiscal quarter), provided that total equity is adjusted to exclude one-time events pursuant to changes in U.S. GAAP, as well as non-cash charges after discussion between the Manager and the Company's independent directors, and approval by a majority of the Company's independent directors in the case of non-cash charges.
Pursuant to the Company's management agreement, if the Company invests at issuance in the equity of any collateralized debt obligation that is managed, structured, or originated by Ellington or one of its affiliates, or if the Company invests in any other investment fund or other investment for which Ellington or one of its affiliates receives management, origination, or structuring fees, then, unless agreed otherwise by a majority of the Company's independent directors, the base management and incentive fees payable by the Company to its Manager will be reduced by an amount equal to the applicable portion (as described in the management agreement) of any such management, origination, or structuring fees.
Summary information—For the year ended December 31, 2018 the total base management fee incurred, net of fee rebates, was $7.6 million.
Incentive Fees
The Manager is entitled to receive a quarterly incentive fee equal to the positive excess, if any, of (i) the product of (A) 25% and (B) the excess of (1) Adjusted Net Income (described below) for the Incentive Calculation Period (which means such fiscal quarter and the immediately preceding three fiscal quarters) over (2) the sum of the Hurdle Amounts (described below) for the Incentive Calculation Period, over (ii) the sum of the incentive fees already paid or payable for each fiscal quarter in the Incentive Calculation Period preceding such fiscal quarter.
For purposes of calculating the incentive fee, "Adjusted Net Income" for the Incentive Calculation Period means the net increase in equity from operations of the Operating Partnership, after all base management fees but before any incentive fees for such period, and excluding any non-cash equity compensation expenses for such period, as reduced by any Loss Carryforward (as described below) as of the end of the fiscal quarter preceding the Incentive Calculation Period.
For purposes of calculating the incentive fee, the "Loss Carryforward" as of the end of any fiscal quarter is calculated by determining the excess, if any, of (1) the Loss Carryforward as of the end of the immediately preceding fiscal quarter over (2) the Company's net increase in equity from operations (expressed as a positive number) or net decrease in equity from operations (expressed as a negative number) of the Operating Partnership for such fiscal quarter. As of December 31, 2018, there was a Loss Carryforward of $2.1 million.
For purposes of calculating the incentive fee, the "Hurdle Amount" means, with respect to any fiscal quarter, the product of (i) one-fourth of the greater of (A) 9% and (B) 3% plus the 10-year U.S. Treasury rate for such fiscal quarter, (ii) the sum of (A) the weighted average gross proceeds per share of all common share and OP Unit issuances since inception of the Company and up to the end of such fiscal quarter, with each issuance weighted by both the number of shares and OP Units issued in such issuance and the number of days that such issued shares and OP Units were outstanding during such fiscal quarter, using a first-in first-out basis of accounting (i.e. attributing any share and OP Unit repurchases to the earliest issuances first) and (B) the result obtained by dividing (I) retained earnings attributable to common shares and OP Units at the beginning of such fiscal quarter by (II) the average number of common shares and OP Units outstanding for each day during such fiscal quarter, (iii) the sum of (x) the average number of common shares and LTIP Units outstanding for each day during such fiscal quarter, and (y) the average number of OP Units and OP LTIP Units outstanding for each day during such fiscal quarter. For purposes of determining the Hurdle Amount, issuances of common shares, OP LTIP Units, and OP Units (a) as equity incentive awards, (b) to the Manager as part of its base management fee or incentive fee and (c) to the Manager or any of its affiliates in privately negotiated transactions, are excluded from the calculation. The payment of the incentive fee will be in a combination of common shares and cash, provided that at least 10% of any quarterly payment will be made in common shares.
Summary information—Total incentive fee incurred for the year ended December 31, 2018 was $0.7 million.


192


Termination Fees
The Management Agreement requires the Company to pay a termination fee to the Manager in the event of (1) the Company's termination or non-renewal of the Management Agreement without cause or (2) the Company's termination of the Management Agreement based on unsatisfactory performance by the Manager that is materially detrimental to the Company or (3) the Manager's termination of the Management Agreement upon a default by the Company in the performance of any material term of the Management Agreement. Such termination fee will be equal to the amount of three times the sum of (i) the average annual Quarterly Base Management Fee Amounts paid or payable with respect to the two 12-month periods ending on the last day of the latest fiscal quarter completed on or prior to the date of the notice of termination or non-renewal and (ii) the average annual Quarterly Incentive Fee Amounts paid or payable with respect to the two 12-month periods ending on the last day of the latest fiscal quarter completed on or prior to the date of the notice of termination or non-renewal.
Expense Reimbursement
Under the terms of the Management Agreement the Company is required to reimburse the Manager for operating expenses related to the Company that are incurred by the Manager, including expenses relating to legal, accounting, due diligence, other services, and all other costs and expenses. The Company's reimbursement obligation is not subject to any dollar limitation. Expenses will be reimbursed in cash within 60 days following delivery of the expense statement by the Manager; provided, however, that such reimbursement may be offset by the Manager against amounts due to the Company from the Manager. The Company will not reimburse the Manager for the salaries and other compensation of the Manager's personnel except that the Company will be responsible for expenses incurred by the Manager in employing certain dedicated or partially dedicated personnel as further described below.
The Company reimburses the Manager for the allocable share of the compensation, including, without limitation, wages, salaries, and employee benefits paid or reimbursed, as approved by the Compensation Committee of the Board of Directors to certain dedicated or partially dedicated personnel who spend all or a portion of their time managing the Company's affairs, based upon the percentage of time devoted by such personnel to the Company's affairs. In their capacities as officers or personnel of the Manager or its affiliates, such personnel will devote such portion of their time to the Company's affairs as is necessary to enable the Company to operate its business.
For the year ended December 31, 2018 the Company reimbursed the Manager $6.5 million for previously incurred operating and compensation expenses.
Equity Investments in Certain Mortgage Originators
As of December 31, 2018, the mortgage originators in which the Company holds equity investments represent related parties. Transactions that have been entered into with these related party mortgage originators are summarized below.
The Company is a party to a mortgage loan purchase and sale flow agreement, with a mortgage originator in which the Company holds an investment in common stock, whereby the Company purchases residential mortgage loans that satisfy certain specified criteria. The Company has also provided a $5.0 million line of credit to the mortgage originator. Under the terms of this line of credit, the Company has agreed to make advances to the mortgage originator solely for the purpose of funding specifically identified residential mortgage loans designated for sale to the Company. To the extent the advances are drawn by the mortgage originator, it must pay interest, at a rate of 15% per annum, on the outstanding balance of each advance from the date the advance is made until such advance is repaid in full. The mortgage originator is required to repay advances in full no later than two business days following the date the Company purchases the related residential mortgage loans from the mortgage originator. As of December 31, 2018, there were no advances outstanding. The Company has also entered into two agreements whereby it guarantees the performance of such mortgage originator under third-party borrowing arrangements. See Note 17, Commitments and Contingencies, for further information on the Company's guarantees of the third-party borrowing arrangements.
Consumer, Residential, and Commercial Loan Transactions with Affiliates
The Company, through a related party of Ellington, or the "Loan Purchaser," is a beneficiary to a consumer loan purchase and sale flow agreement whereby the Loan Purchaser purchases consumer loans that satisfy certain specified criteria. The Company has investments in participation certificates related to consumer loans titled in the name of the Loan Purchaser. Through its participation certificates, the Company has beneficial interests in the loan cash flows, net of servicing-related fees and expenses. The total fair value of the Company's beneficial interests in the net cash flows was $21.9 million as of December 31, 2018 and is included on the Company's Consolidated Condensed Schedule of Investments in Consumer Loans and Asset-backed Securities backed by Consumer Loans. In addition, the Company also holds an investment in preferred stock


193


and warrants to purchase additional preferred stock of the consumer loan originator that sells consumer loans to the Loan Purchaser.
The Company purchases certain of its consumer loans through an affiliate, or the "Purchasing Entity." The Purchasing Entity has entered into purchase agreements, open-ended in duration, with third party consumer loan originators whereby it has agreed to purchase eligible consumer loans. The amount of loans purchased under these purchase agreements is dependent on, among other factors, the amount of loans originated in any given period by the selling originators. The Company and other affiliates of Ellington have entered into agreements with the Purchasing Entity whereby the Company and each of the affiliates have agreed to purchase their allocated portion (subject to monthly determination based on available capital and other factors) of the eligible loans acquired by the Purchasing Entity under each purchase agreement. Immediately after the Purchasing Entity purchases beneficial interests in the loans, the Company and other affiliates purchase such beneficial interests from the Purchasing Entity, at the same price paid by the Purchasing Entity. During the year ended December 31, 2018, the Company purchased loans under these agreements with an aggregate principal balance of $166.3 million. As of December 31, 2018, the estimated remaining contingent purchase obligations of the Company under these purchase agreements was approximately $263.5 million in principal balance.
The Company's beneficial interests in the consumer loans purchased through the Purchasing Entity are evidenced by participation certificates issued by trusts that hold legal title to the loans. These trusts are owned by a related party of Ellington and were established to hold such loans. Through its participation certificates, the Company participates in the cash flows of the underlying loans held by each trust. The total amount of consumer loans held in the related party trusts, for which the Company has participating interests in the net cash flows, was $181.5 million as of December 31, 2018 and is included on the Company's Consolidated Condensed Schedule of Investments in Consumer Loans and Asset-backed Securities backed by Consumer Loans.
The Company has investments in participation certificates related to residential mortgage loans and REO held in a trust owned by another related party of Ellington. Through its participation certificates, the Company participates in the cash flows of the underlying loans held by such trust. The total amount of residential mortgage loans and REO held in the related party trust, for which the Company has participating interests in the net cash flows, and the residential mortgage loans previously held in the related party trust that now reside in the securitization trusts as described in Note 6 was $498.1 million as of December 31, 2018 and is included on the Company's Consolidated Condensed Schedule of Investments in Mortgage Loans as well as Real Estate Owned.
The Company is a co-investor in certain small balance commercial mortgage loans with several other investors, including an unrelated third party and various affiliates of Ellington. These loans are beneficially owned by a consolidated subsidiary of the Company. As of December 31, 2018, the aggregate fair value of these loans was $25.3 million and the non-controlling interests held by the unrelated third party and the various Ellington affiliates were $1.4 million and $4.1 million, respectively.
The Company is also a co-investor in certain small balance commercial mortgage loans with other investors, including unrelated third parties and various affiliates of Ellington. Each co-investor has an interest in a limited liability company that owns the loans. As of December 31, 2018 the Company's ownership percentage of the jointly owned limited liability company was approximately 15% and had a fair value of $1.1 million, which is included on the Company's Consolidated Condensed Schedule of Investments in Corporate Equity Investments.
The Company is also a co-investor, together with other affiliates of Ellington, in the parent of an entity (the "Holding Entity"), that holds a call right to a securitization. The Holding Entity issued notes to the Company and its affiliates, and to an unrelated third party. As of December 31, 2018 the notes held by the Company had a fair value of $10.9 million, which are included on the Company's Consolidated Condensed Schedule of Investments in Secured Notes.
Participation in Multi-Borrower Financing Facilities
The Company is a co-participant with certain other entities managed by Ellington (the "Affiliated Entities") in two entities (each, a "Jointly Owned Entity"), which were formed in order to facilitate the financing of small balance commercial mortgage loans and REO (collectively, "SBC Assets"). Each Jointly Owned Entity has a reverse repurchase agreement with a particular financing counterparty.
From time to time, when the Company and/or the Affiliated Entities wish to finance an SBC Asset through one of the Jointly Owned Entities, Ellington submits such SBC Asset for approval to the financing counterparty for such Jointly Owned Entity. Upon obtaining such approval, the Company and/or the Affiliated Entities, as the case may be, transfers such SBC Assets to the Jointly Owned Entity in exchange for its pro rata share of the financing proceeds that the Jointly Owned Entity receives from the financing counterparty. While the Company transferred certain SBC Assets to the Jointly Owned Entities, such SBC Assets and the related debt were not derecognized for financial reporting purposes, in accordance with ASC 860-10,


194


because the Company continued to retain the risks and rewards of ownership of its SBC Assets. As of December 31, 2018 , the Jointly Owned Entities have outstanding issued debt under the reverse repurchase agreements in the amount of $149.0 million. The Company's portion of this debt as of December 31, 2018 was $77.0 million and is included under the caption Reverse repurchase agreements on the Company's Consolidated Statement of Assets, Liabilities, and Equity. To the extent that there is a default under one of these reverse repurchase agreements, all of the assets of the applicable Jointly Owned Entity, including those assets beneficially owned by any non-defaulting owners of such Jointly Owned Entity, could be used to satisfy the outstanding obligations under such reverse repurchase agreement. As of December 31, 2018, no party to either of the reverse repurchase agreements was in default. There was no receivable from the Jointly Owned Entities as of December 31, 2018.
Multi-Seller Consumer Loan Securitization
In December 2016, in order to facilitate the financing of the Company's share of the subordinated note held by the Acquiror, the Company entered into a repurchase agreement with the Acquiror (the "Acquiror Repurchase Agreement") whereby the Company's share of the subordinated note held by the Acquiror was transferred to the Company as collateral under the Acquiror Repurchase Agreement. The Company then re-hypothecated this collateral to a third-party lending institution pursuant to a reverse repurchase agreement (the "Reverse Agreement"). The Acquiror Repurchase Agreement is included on the Company's Consolidated Statement of Assets, Liabilities and Equity under the caption, Repurchase agreements, at fair value and on its Consolidated Condensed Schedule of Investments. The Company's obligation under the Reverse Agreement is included on its Consolidated Statement of Assets, Liabilities and Equity under the caption, Reverse repurchase agreements. In December 2018, the Acquiror sold the Company's share of the subordinated note, and as a result as of December 31, 2018 there were no amounts outstanding amounts under the Acquiror Repurchase Agreement or the Reverse Agreement. See Note 6 for details of the Company's participation in the multi-seller consumer loan securitization.
Participation in CLO Transactions
As discussed in Note 6, the Company participated in various CLO securitization transactions, all managed by the CLO Manager.
The CLO Manager is entitled to receive management and incentive fees in accordance with the respective management agreements between the CLO Manager and the respective CLO Issuers. In accordance with the Company's Management Agreement, the Manager rebates to the Company the portion of the management fees payable by each CLO Issuer to the CLO Manager that are allocable to the Company's participating interest in the unsecured subordinated notes issued by such CLO Issuer. For the year ended December 31, 2018 the amount of such fee rebates was $1.4 million, respectively.
In addition, from time to time, the Company along with various other affiliates of Ellington, and in certain cases various third parties, advance funds in the form of loans ("Initial Funding Loans") to securitization vehicles to enable them to establish warehouse facilities for the purpose of acquiring the assets to be securitized. Pursuant to the terms of the warehouse facilities and the Initial Funding Loans, the applicable securitization trust is required, at the closing of each respective CLO securitization, first to repay the warehouse facility, then to repay the Initial Funding Loans, and then to distribute interest earned, net of any necessary reserves and/or interest expense, and the aggregate realized or unrealized gains, if any, on assets purchased into the warehouse facility. In the event that such CLO securitization fails to close, the assets held by the respective securitization vehicle would, subject to a cure period, be liquidated. As of December 31, 2018 the Company's loan receivable related to the warehouse facility in operation at such time was in the amount of $11.6 million and is included on the Consolidated Statement of Assets, Liabilities and Equity in Other assets. Each loan receivable from these warehouse facilities is considered a Level 3 asset and its carrying value approximates fair value due to its short term nature and the adequacy of the assets acquired into the warehouse.
In July 2018, the Company purchased two loans from the CLO I Securitization, at the fair market price. The loans purchased by the Company had a face amount of $2.9 million. The Company subsequently sold one of the loans and the remaining loan had a fair value of $1.6 million at December 31, 2018 and is included on the Company's Consolidated Condensed Schedule of Investments in Corporate Debt.
10. Long-Term Incentive Plan Units
LTIP Units and OP LTIP Units held pursuant to the Company's incentive plans are generally exercisable by the holder at any time after vesting. Each LTIP Unit is convertible into one common share. Each OP LTIP Unit is convertible into an OP Unit on a one-for-one basis. Subject to certain conditions, the OP Units are redeemable by the holder for an equivalent number of common shares of the Company or for the cash value of such common shares, at the Company's election. Costs associated with the LTIP Units and the OP LTIP Units issued under the Company's incentive plans are measured as of the grant date and expensed ratably over the vesting period. Total expense associated with LTIP Units and OP LTIP Units issued under the Company's incentive plans for the year ended December 31, 2018 was $0.4 million.


195


On March 7, 2018, the Company's Board of Directors authorized the issuance of 1,723 LTIP Units to certain of its partially dedicated employees pursuant to the Company's 2017 Equity Incentive Plan. These LTIP Units will vest and become non-forfeitable on March 7, 2019.
On September 12, 2018, the Company's Board of Directors authorized the issuance of 14,440 LTIP Units to certain of its directors pursuant to the Company's 2017 Equity Incentive Plan. These LTIP Units will vest and become non-forfeitable on September 11, 2019.
On December 11, 2018, the Company's Board of Directors authorized the issuance of 17,383 OP LTIP Units to certain of its partially dedicated employees pursuant to the Company's 2017 Equity Incentive Plan. These OP LTIP Units will vest and become non-forfeitable on December 11, 2019 with respect to 8,692 OP LTIP Units and December 11, 2020 with respect to 8,691 OP LTIP Units.
On December 31, 2018, the Company redeemed all 503,988 outstanding LTIP Units which it had originally issued under its incentive plans, with each LTIP unitholder receiving in exchange an equal number of OP LTIP Units (the "Redemption Transaction").
The below table details unvested OP LTIP Units as of December 31, 2018:
Grant Recipient
 
Number of OP LTIP Units
 
Grant Date
 
Vesting Date(1)
Directors:
 
 
 
 
 
 
 
 
14,440

 
September 12, 2018
 
September 11, 2019
Partially dedicated employees:
 
 
 
 
 
 
 
 
8,692

 
December 11, 2018
 
December 11, 2019
 
 
8,691

 
December 11, 2018
 
December 11, 2020
 
 
1,723

 
March 7, 2018
 
March 7, 2019
 
 
5,886

 
December 12, 2017
 
December 12, 2019
Total unvested OP LTIP Units at December 31, 2018
 
39,432

 
 
 
 
(1)
Date at which such OP LTIP Units will vest and become non-forfeitable.
The following table summarizes issuance and exercise activity of LTIP Units and OP LTIP Units for the year ended December 31, 2018:
 
Year Ended December 31, 2018
 
Manager
 
Director/
Employee
 
Total
LTIP Units and OP LTIP Units Outstanding (December 31, 2017)
375,000

 
116,159

 
491,159

Granted

 
33,546

 
33,546

Exercised

 
(3,334
)
 
(3,334
)
LTIP Units and OP LTIP Units Outstanding (December 31, 2018)
375,000

 
146,371

 
521,371

LTIP Units and OP LTIP Units Vested and Outstanding (December 31, 2018)
375,000

 
106,939

 
481,939


As of December 31, 2018, there were an aggregate of 1,874,223 common shares underlying awards, including OP LTIP Units, available for future issuance under the Company's 2017 Equity Incentive Plan.
11. Non-controlling Interests
Operating Partnership
Non-controlling interests include the Convertible Non-controlling Interests in the Operating Partnership owned by an affiliate of our Manager, our directors, and certain current and former Ellington employees and their related parties. These interests consist of OP Units and OP LTIP Units. On January 1, 2013, 212,000 OP Units were purchased by the initial non-controlling interest member. On December 11, 2018, the Company issued 17,383 OP LTIP Units to certain officers of the Company. On December 31, 2018, the Company redeemed 503,988 LTIP Units and distributed 503,988 OP LTIP Units to non-controlling interest members pursuant to the Redemption Transaction. Income allocated to these non-controlling interests is based on the non-controlling interest owners' ownership percentage of the Operating Partnership during the quarter, calculated


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using a daily weighted average of all common shares and convertible units outstanding during the quarter. Holders of OP Units and OP LTIP Units are entitled to receive the same distributions that holders of common shares receive, and OP Units are convertible into common shares on a one-for-one basis, subject to specified limitations. Each OP LTIP Unit is convertible into an OP Unit on a one-for-one basis. OP Units and OP LTIP Units are non-voting with respect to matters as to which common shareholders are entitled to vote. As December 31, 2018, the Convertible Non-controlling Interests consisted of the outstanding 521,371 OP LTIP Units and 212,000 OP Units, and represented an interest of approximately 2.4% in the Operating Partnership. As of December 31, 2018 non-controlling interests related to the outstanding 521,371 OP LTIP Units and the outstanding 212,000 OP Units was $13.9 million.
Joint Venture Interests
Non-controlling interests also include the interests of joint venture partners in various consolidated subsidiaries of the Company. The subsidiaries hold the Company's investments in certain commercial mortgage loans and REO. These joint venture partners participate in the income, expense, gains and losses of such subsidiaries as set forth in the related operating agreements of the subsidiaries. These joint venture partners make capital contributions to the subsidiaries as new approved investments are purchased by the subsidiaries, and are generally entitled to distributions when investments are sold or otherwise disposed of. As of December 31, 2018 these joint venture partners' interests in subsidiaries of the Company were $17.3 million.
These joint venture partners' interests are not convertible into common shares of the Company or OP Units, nor are these joint venture partners entitled to receive distributions that holders of common shares of the Company receive.
12. Common Share Capitalization
During the year ended December 31, 2018 the Board of Directors authorized dividends totaling $1.64 per share. Total dividends paid during the year ended December 31, 2018 were $50.7 million, respectively.
The following table summarizes issuance, repurchase, and other activity with respect to the Company's common shares for the year ended December 31, 2018:
 
 
Year Ended
December 31, 2018
Common Shares Outstanding (December 31, 2017)
 
31,335,938

Share Activity:
 
 
Shares repurchased
 
(1,547,148
)
Director LTIP Units exercised
 
3,334

Shares issued in connection with incentive fee payment
 
4,477

Common Shares Outstanding (December 31, 2018)
 
29,796,601


If all LTIP Units, OP LTIP Units, and OP Units that have been previously issued were to become fully vested and exchanged for common shares as of December 31, 2018 the Company's issued and outstanding common shares would increase to 30,529,972.
On June 13, 2018, the Company's Board of Directors approved the adoption of a share repurchase program under which the Company is authorized to repurchase up to 1.55 million common shares. The program, which is open-ended in duration, allows the Company to make repurchases from time to time on the open market or in negotiated transactions, including under Rule 10b5-1 plans. Repurchases are at the Company's discretion, subject to applicable law, share availability, price and its financial performance, among other considerations. This program superseded the program that was previously adopted on February 6, 2018. During the year ended December 31, 2018, the Company repurchased 1,547,148 common shares at an average price per share of $14.95 and a total cost of $23.1 million. As of December 31, 2018, the Company had repurchased 361,090 common shares at an average price per share of $15.34 and a total cost of $5.5 million under the current share repurchase program.


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13. Earnings Per Share
The components of the computation of basic and diluted EPS were as follows:
 
 
Year Ended December 31, 2018
(In thousands except share amounts)
 
 
Net increase (decrease) in shareholders' equity resulting from operations
 
$
46,676

Add: Net increase (decrease) in equity resulting from operations attributable to participating non-controlling interests(1)
 
319

Net increase (decrease) in equity resulting from operations related to common shares, LTIP Unit holders, and participating non-controlling interests
 
46,995

Net increase (decrease) in shareholders' equity resulting from operations available to common share and LTIP Unit holders:
 
 
Net increase (decrease) in shareholders' equity resulting from operations–common shares
 
45,922

Net increase (decrease) in shareholders' equity resulting from operations–LTIP Units
 
753

Dividends Paid:
 
 
Common shareholders
 
(49,576
)
LTIP Unit holders
 
(812
)
Non-controlling interests
 
(348
)
Total dividends paid to common shareholders, LTIP Unit holders, and non-controlling interests
 
(50,736
)
Undistributed (Distributed in excess of) earnings:
 
 
Common shareholders
 
(3,653
)
LTIP Unit holders
 
(59
)
Non-controlling interests
 
(29
)
Total undistributed (distributed in excess of) earnings attributable to common shareholders, LTIP Unit holders, and non-controlling interests
 
$
(3,741
)
Weighted average shares outstanding (basic and diluted):
 
 
Weighted average common shares outstanding
 
30,297,401

Weighted average participating LTIP Units
 
496,962

Weighted average non-controlling interest units
 
212,000

Basic earnings per common share:
 
 
Distributed
 
$
1.64

Undistributed (Distributed in excess of)
 
(0.12
)
 
 
$
1.52

Diluted earnings per common share:
 
 
Distributed
 
$
1.64

Undistributed (Distributed in excess of)
 
(0.12
)
 
 
$
1.52

(1)
For the year ended December 31, 2018, excludes net increase (decrease) in equity resulting from operations of $2.9 million attributable to joint venture partners, which have non-participating interests as described in Note 11.
14. Counterparty Risk
As of December 31, 2018, investments with an aggregate value of approximately $1.79 billion were held with dealers as collateral for various reverse repurchase agreements. The investments held as collateral include securities in the amount of $86.7 million that were sold prior to period end but for which such sale had not yet settled as of December 31, 2018.
The following table details the percentage of such collateral held by counterparties who hold greater than 15% of the aggregate $1.79 billion in collateral for various reverse repurchase agreements as of December 31, 2018. In addition to the below, unencumbered investments, on a settlement date basis, of approximately $13.3 million were held in custody at the Bank of New York Mellon Corporation as of December 31, 2018.


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Dealer
 
% of Total Collateral on Reverse Repurchase Agreements
Royal Bank of Canada
 
19%
The following table details the percentage of collateral amounts held by dealers who hold greater than 15% of the Company's Due from Brokers, included as of December 31, 2018:
Dealer
 
% of Total Due
from Brokers
Morgan Stanley
 
37%
J.P. Morgan Securities LLC
 
30%

The following table details the percentage of amounts held by dealers who hold greater than 15% of the Company's Receivable for securities sold as of December 31, 2018:
Dealer
 
% of Total Receivable
for Securities Sold
J.P. Morgan Securities LLC
 
25%
Bank of America Securities
 
26%
CS First Boston Limited
 
34%

In addition, the Company held cash and cash equivalents of $44.7 million as of December 31, 2018. The below table details the concentration of cash and cash equivalents held by each counterparty:
Counterparty
 
As of
December 31, 2018
Bank of New York Mellon Corporation
 
64%
Deutsche Bank Securities
 
5%
Bank of America Securities
 
2%
Morgan Stanley Institutional Liquidity Fund—Government Portfolio
 
10%
BlackRock Liquidity Funds FedFund Portfolio
 
9%
Goldman Sachs Financial Square Funds—Government Fund
 
9%
Lakeland Bank Inc.
 
1%

15. Restricted Cash
The Company is required to maintain certain cash balances with counterparties and/or unrelated third parties for various activities and transactions.
The Company is required to maintain a specific cash balance in a segregated account pursuant to a flow consumer loan purchase and sale agreement. The Company is also required to maintain a specific minimum cash balance in connection with its subsidiary that holds various state mortgage origination licenses.
The below table details the Company's restricted cash balances included in Restricted cash on the Consolidated Statement of Assets, Liabilities, and Equity as of December 31, 2018.
 
 
December 31, 2018
 
 
(In thousands)
Restricted cash balance related to:
 
 
Minimum account balance required for regulatory purposes
 
$
250

Flow consumer loan purchase and sale agreement
 
175

Total
 
$
425




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16. Offsetting of Assets and Liabilities
The Company records financial instruments at fair value as described in Note 2. All financial instruments are recorded on a gross basis on the Consolidated Statement of Assets, Liabilities, and Equity. In connection with the vast majority of its derivative, repurchase and reverse repurchase agreements, and the related trading agreements, the Company and its counterparties are required to pledge collateral. Cash or other collateral is exchanged as required with each of the Company's counterparties in connection with open derivative positions, and repurchase and reverse repurchase agreements.
The following tables present information about certain assets and liabilities representing financial instruments as of December 31, 2018. The Company has not entered into master netting agreements with any of its counterparties. Certain of the Company's repurchase and reverse repurchase agreements and financial derivative transactions are governed by underlying agreements that generally provide a right of offset in the event of default or in the event of a bankruptcy of either party to the transaction.
December 31, 2018:
Description
 
Amount of Assets (Liabilities) Presented in the Consolidated Statements of Assets, Liabilities, and Equity(1)
 
Financial Instruments Available for Offset
 
Financial Instruments Transferred or Pledged as Collateral(2)(3)
 
Cash Collateral (Received) Pledged(2)(3)
 
Net Amount
(In thousands)
 
 
 
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
 
 
 
Financial derivatives–assets
 
$
20,001

 
$
(10,910
)
 
$

 
$
(2,514
)
 
$
6,577

Repurchase agreements
 
61,274

 
(61,274
)
 

 

 

Liabilities
 
 
 
 
 

 
 
 
 
Financial derivatives–liabilities
 
(20,806
)
 
10,910

 

 
9,896

 

Reverse repurchase agreements
 
(1,498,849
)
 
61,274

 
1,420,601

 
16,974

 

(1)
In the Company's Consolidated Statement of Assets, Liabilities, and Equity, all balances associated with repurchase agreements, reverse repurchase agreements, and financial derivatives are presented on a gross basis.
(2)
For the purpose of this presentation, for each row the total amount of financial instruments transferred or pledged and cash collateral (received) or pledged may not exceed the applicable gross amount of assets or (liabilities) as presented here. Therefore, the Company has reduced the amount of financial instruments transferred or pledged as collateral related to the Company's reverse repurchase agreements and cash collateral pledged on the Company's financial derivative liabilities. Total financial instruments transferred or pledged as collateral on the Company's reverse repurchase agreements as of December 31, 2018 were $1.79 billion. As of December 31, 2018 total cash collateral on financial derivative assets excludes excess net cash collateral pledged of $0.1 million. As of December 31, 2018 total cash collateral on financial derivative liabilities excludes excess cash collateral pledged of $16.4 million.
(3)
When collateral is pledged to or pledged by a counterparty, it is often pledged or posted with respect to all positions with such counterparty, and in such cases such collateral cannot be specifically identified as relating to a specific asset or liability. As a result, in preparing the above tables, the Company has made assumptions in allocating pledged or posted collateral among the various rows.
17. Commitments and Contingencies
The Company provides current directors and officers with a limited indemnification against liabilities arising in connection with the performance of their duties to the Company.
In the normal course of business the Company may also enter into contracts that contain a variety of representations, warranties, and general indemnifications. The Company's maximum exposure under these arrangements, including future claims that may be made against the Company that have not yet occurred, is unknown. The Company has not incurred any costs to defend lawsuits or settle claims related to these indemnification agreements. As of December 31, 2018, the Company has no liabilities recorded for these agreements.
Commitments and Contingencies Related to Investments in Residential Mortgage Loans
In connection with certain of the Company's investments in residential mortgage loans, the Company has unfunded commitments in the amount of $1.0 million as of December 31, 2018.
Commitments and Contingencies Related to Investments in Mortgage Originators
In connection with certain of its investments in mortgage originators, the Company has outstanding commitments and contingencies as described below.
As described in Note 9, Related Party Transactions, the Company is party to a flow mortgage loan purchase and sale


200


agreement with a mortgage originator. The Company has entered into two agreements whereby it guarantees the performance of this mortgage originator under master repurchase agreements. The Company's maximum guarantees are capped at $25.0 million. As of December 31, 2018 the mortgage originator had $2.9 million outstanding borrowings under these agreements guaranteed by the Company. The Company's obligation under these arrangements are deemed to be guarantees under ASC 460-10 and are carried at fair value and included in Other Liabilities on the Consolidated Statement of Assets, Liabilities, and Equity. As of December 31, 2018 the estimated fair value of such guarantees was zero.
18. Financial Highlights
Results of Operations for a Share Outstanding Throughout the Periods:
 
 
Year Ended December 31, 2018
Beginning Shareholders' Equity Per Share (December 31, 2017)
 
$
19.15

Net Investment Income
 
1.42

Net Realized/Unrealized Gains (Losses)
 
0.23

Results of Operations Attributable to Equity
 
1.65

Less: Results of Operations Attributable to Non-controlling Interests
 
(0.11
)
Results of Operations Attributable to Shareholders' Equity(1)
 
1.54

Dividends Paid to Common Shareholders
 
(1.64
)
Weighted Average Share Impact on Dividends Paid (2)
 
(0.03
)
Accretive (Dilutive) Effect of Share Issuances (Net of Offering Costs), Share Repurchases, and Adjustments to Non-controlling Interest
 
(0.10
)
Ending Shareholders' Equity Per Share (December 31, 2018)(3)
 
$
18.92

Shares Outstanding, end of period
 
29,796,601

(1)
Calculated based on average common shares outstanding and can differ from the calculation for EPS (See Note 13).
(2)
Per share impact on dividends paid relating to share issuances/repurchases during the period as well as dividends paid to LTIP and OP Unit holders.
(3)
If all LTIP Units and OP Units previously issued were vested and exchanged for common shares as of December 31, 2018 shareholders' equity per share would be $18.92.
Total Return:
The Company calculates its total return two ways, one based on its reported net asset value and the other based on its publicly traded share price.
The following table illustrates the Company's total return for the periods presented based on net asset value:
Net Asset Value Based Total Return for a Shareholder: (1) 
 
 
Year Ended December 31, 2018(2)
Total Return
 
7.38%
(1)
Total return is calculated assuming reinvestment of distributions at shareholders' equity per share during the period.
(2)
The Company redeemed all 503,988 of its outstanding LTIP Units which it had originally issued under its incentive plans, with each LTIP unitholder receiving in exchange an equal number of OP LTIP Units. While this activity did not affect fully diluted net asset value per common share, it did cause a 1.66% decline in net asset value per common share. The Company's total return for the year ended December 31, 2018 before the effect of this activity was 9.19%.
Market Based Total Return for a Shareholder:
For the year ended December 31, 2018 the Company's market based total return based on the closing price as reported by the New York Stock Exchange was 17.30%. Calculation of market based total return assumes the reinvestment of dividends at the closing price as reported by the New York Stock Exchange as of the ex-date.


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Net Investment Income Ratio to Average Equity: (1) 
 
 
Year Ended December 31, 2018
Net Investment Income
 
7.04%
(1)
Average equity is calculated using month end values.
Expense Ratios to Average Equity: (1) 
 
 
Year Ended December 31, 2018
Operating expenses, before interest expense and other investment related expenses
 
(2.86)%
Incentive fee
 
(0.12)%
Interest expense and other investment related expenses
 
(12.03)%
Total Expenses
 
(15.01)%
(1)
Average equity is calculated using month end values.


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19. Condensed Quarterly Financial Data (Unaudited)
Detailed below is unaudited quarterly financial data for the year ended December 31, 2018.
 
Three Month Period Ended
 
March 31,
2018
 
June 30,
2018
 
September 30, 2018
 
December 31, 2018
(In thousands except per share amounts)
 
 
 
 
 
 
 
INVESTMENT INCOME
 
 
 
 
 
 
 
Interest income(1)
$
28,092

 
$
31,941

 
$
35,300

 
$
35,694

Other income
716

 
1,094

 
1,046

 
1,157

Total investment income
28,808

 
33,035

 
36,346

 
36,851

EXPENSES
 
 
 
 
 
 
 
Base management fee to affiliate(2)
1,978

 
2,021

 
1,830

 
1,744

Incentive fee to affiliate

 
291

 
424

 

Interest expense(1)
11,562

 
13,383

 
15,678

 
16,083

Other investment related expenses
2,952

 
3,771

 
4,384

 
4,201

Other operating expenses
2,074

 
2,578

 
2,352

 
4,609

Total expenses
18,566

 
22,044

 
24,668

 
26,637

NET INVESTMENT INCOME
10,242

 
10,991

 
11,678

 
10,214

NET REALIZED AND CHANGE IN NET UNREALIZED GAIN (LOSS) ON INVESTMENTS, OTHER SECURED BORROWINGS, FINANCIAL DERIVATIVES, AND FOREIGN CURRENCY TRANSACTIONS/TRANSLATION
 
 
 
 
 
 
 
Net realized gain (loss) on investments, financial derivatives, and foreign currency transactions
13,051

 
(1,343
)
 
10,102

 
9,578

Change in net unrealized gain (loss) on investments, other secured borrowings, financial derivatives, and foreign currency translation
(1,969
)
 
12,536

 
(14,306
)
 
(20,862
)
NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS, OTHER SECURED BORROWINGS, FINANCIAL DERIVATIVES, AND FOREIGN CURRENCY
11,082

 
11,193

 
(4,204
)
 
(11,284
)
NET INCREASE (DECREASE) IN EQUITY RESULTING FROM OPERATIONS
21,324

 
22,184

 
7,474

 
(1,070
)
LESS: NET INCREASE IN EQUITY RESULTING FROM OPERATIONS ATTRIBUTABLE TO NON-CONTROLLING INTERESTS
285

 
991

 
813

 
1,147

NET INCREASE (DECREASE) IN SHAREHOLDERS' EQUITY RESULTING FROM OPERATIONS
$
21,039

 
$
21,193

 
$
6,661

 
$
(2,217
)
NET INCREASE (DECREASE) IN SHAREHOLDERS' EQUITY RESULTING FROM OPERATIONS PER SHARE:
 
 
 
 
 
 
 
Basic and Diluted (3)
$
0.67

 
$
0.69

 
$
0.22

 
$
(0.07
)
(1)
Includes interest income and interest expense of a consolidated securitization trust of $1.3 million and $0.9 million, respectively, for the three-month period ended March 31, 2018. Includes interest income and interest expense of a consolidated securitization trust of $1.3 million and $0.8 million, respectively, for the three-month period ended June 30, 2018. Includes interest income and interest expense of a consolidated securitization trust of $1.3 million and $0.7 million, respectively, for the three-month period ended September 30, 2018. Includes interest income and interest expense of a consolidated securitization trust of $2.1 million and $1.2 million, respectively, for the three-month period ended December 31, 2018. See Note 6 for further details on the Company's consolidated securitization trusts.
(2)
Net of management fee rebate of $0.3 million, $0.3 million, $0.4 million, and $0.4 million, for the each of the three-month periods ended March 31, 2018, June 30, 2018, September 30, 2018, and December 31, 2018, respectively. See Note 9 for further details on management fee rebates.
(3)
For the year ended December 31, 2018 the sum of EPS for the four quarters of the year does not equal EPS as calculated for the entire year (see Note 13) as a result of changes in shares during the year due to repurchases of common shares, as EPS is calculated using average shares outstanding during the period.


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20. Subsequent Events
On February 13, 2019, the Company announced that it will elect to be taxed as a REIT for U.S. federal income tax purposes for the taxable year ending December 31, 2019. To facilitate this planned election, it has elected to be taxed as a corporation for U.S. federal income tax purposes effective January 1, 2019.
Also on February 13, 2019, the Company exchanged $86 million of 5.50% Senior Notes due 2022 (the "New Senior Notes") for its existing 5.25% senior notes due 2022 (the "Existing Senior Notes"). The New Senior Notes were jointly and severally issued by two of the Company's subsidiaries and fully guaranteed by the Company. The indenture governing the New Senior Notes contains a number of covenants, including several financial covenants.
On February 14, 2019, the Company's Board of Directors approved a dividend in the amount of $0.41 per share payable on March 15, 2019 to shareholders of record as of March 1, 2019.
On February 28, 2019, the Company filed a certificate of conversion with the Secretary of State of the State of Delaware (the "Secretary of State") to convert from a Delaware limited liability company to a Delaware corporation (the "Conversion") and change its name to Ellington Financial Inc. (the "Corporation"). The Conversion became effective on March 1, 2019, and upon effectiveness, each of the Company's existing common shares representing limited liability company interests, no par value, converted into one issued and outstanding, fully paid and nonassessable share of common stock, $0.001 par value per share, of the Corporation. In connection with the Conversion, the Board approved the Company's Certificate of Incorporation, which the Company also filed with the Secretary of State, and the Company's Bylaws.
On March 11, 2019, the Company's Board of Directors approved a dividend in the amount of $0.14 per share payable on April 25, 2019 to stockholders of record as of March 29, 2019.
In connection with the Conversion and the Company's plan to qualify as a REIT for the year ending December 31, 2019, effective January 1, 2019 the Company no longer qualifies for investment company accounting in accordance with ASC 946 and will discontinue its use prospectively. The Company will continue to measure its qualifying assets and liabilities at fair value by electing the fair value option where applicable.


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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosures. An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of December 31, 2019. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2019.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management's Annual Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Our internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of assets that could have a material effect on our financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of our internal control over financial reporting using the criteria set forth in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment and those criteria, our management concluded that our internal control over financial reporting was effective as of December 31, 2019.
The Company's independent registered public accounting firm, PricewaterhouseCoopers LLP, has audited the Company's internal control over financial reporting as of December 31, 2019. Their report appears on page 89 of this Annual Report on Form 10-K.


205


PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information required by Item 10 is incorporated by reference to information to be included in our definitive Proxy Statement for our 2020 annual stockholders' meeting.
Our Board of Directors has established a Code of Business Conduct and Ethics that applies to our officers and directors and to our Manager's and certain of its affiliates' officers, directors and employees when such individuals are acting for us or on our behalf which is available on our website at www.ellingtonfinancial.com. Any waiver of our Code of Business Conduct and Ethics of our executive officers or directors may be made only by our Board or one of its committees.
We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K relating to amendments to or waivers from any provision of our Code of Business Conduct and Ethics applicable to our principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions and that relates to any element of the code of ethics definition enumerated in Item 406(b) of Regulation S-K by posting such information on our website at www.ellingtonfinancial.com under the, "For Our Shareholders—Corporate Governance" section of the website.
Item 11. Executive Compensation
The information required by Item 11 is incorporated by reference to information to be included in our definitive Proxy Statement for our 2020 annual stockholders' meeting.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
The information required by Item 12 is incorporated by reference to information to be included in our definitive Proxy Statement for our 2020 annual stockholders' meeting.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is incorporated by reference to information to be included in our definitive Proxy Statement for our 2020 annual stockholders' meeting.
Item 14. Principal Accountant Fees and Services
The information required by Item 14 is incorporated by reference to information to be included in our definitive Proxy Statement for our 2020 annual stockholders' meeting.


206


PART IV
Item 15. Exhibits, Financial Statement Schedules
(a) Documents filed as part of this report:
1. Financial Statements:
See Index to consolidated financial statements, included in Part II, Item 8 of this Annual Report on Form 10-K.
2. Schedules to Financial Statements:
All financial statement schedules not included have been omitted because they are either inapplicable or the information required is provided in our Financial Statements and Notes thereto, included in Part II, Item 8, of this Annual Report on Form 10-K.
3. Exhibits:
Exhibit
 
Description
3.1
 
 
 
 
3.2
 
 
 
 
3.3
 
 
 
 
4.1
 
 
 
 
4.2
 
 
 
 
4.3
 
 
 
 
10.1
 
 
 
 
10.2
 
 
 
 
10.3
 
 
 
 
10.4†
 
 
 
 
10.5†
 
 
 
 
10.6†
 
 
 
 
10.7†
 
 
 
 
10.8†
 
 
 
 
10.9†
 
 
 
 
10.10†
 
 
 
 
10.11†
 
 
 
 


207


Exhibit
 
Description
(continued)
10.12†
 
 
 
 
10.13†
 
 
 
 
21.1
 
 
 
 
23.1
 
 
 
 
24.1
 
 
 
 
31.1
 
 
 
 
31.2
 
 
 
 
32.1*
 
 
 
 
32.2*
 
 
 
 
101
 
The following financial information from Ellington Financial Inc.'s Annual Report on Form 10-K for the year ended December 31, 2019, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statement of Assets, Liabilities, and Equity, (ii) Consolidated Statement of Operations, (iii) Consolidated Statements of Changes in Equity, (iv) Consolidated Statements of Cash Flows and (v) Notes to Consolidated Financial Statements.
*
Furnished herewith. These certifications are not deemed "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
Compensatory plan or arrangement.
Item 16. Form 10-K Summary
None.


208


SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
ELLINGTON FINANCIAL INC.
Date:
March 13, 2020
 
By:
/s/ LAURENCE PENN
 
 
 
 
Laurence Penn
Chief Executive Officer
(Principal Executive Officer)
POWER OF ATTORNEY
We, the undersigned officers and directors of Ellington Financial Inc., hereby severally constitute Laurence Penn, Daniel Margolis, Jason Frank and JR Herlihy, and each of them singly, our true and lawful attorneys with full power to them, and each of them singly, to sign for us and in our names in the capacities indicated below, any and all amendments to this Annual Report on Form 10-K, and generally to do all such things in our names and in our capacities as officers and directors to enable Ellington Financial Inc. to comply with the provisions of the Securities Exchange Act of 1934, as amended, and all requirements of the SEC, hereby ratifying and confirming our signatures as they may be signed by our said attorneys, or any of them, to said Annual Report on Form 10-K and any and all amendments thereto.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and dates indicated.
Signature
 
Title
 
Date
 
 
 
 
 
/s/ LAURENCE PENN
 
Chief Executive Officer, President and Director
(Principal Executive Officer)
 
March 13, 2020
LAURENCE PENN
 
 
 
 
 
 
 
 
/s/ JR HERLIHY
 
Chief Financial Officer (Principal Financial and Accounting Officer)
 
March 13, 2020
JR HERLIHY
 
 
 
 
 
 
 
 
/s/ LISA MUMFORD
 
Director
 
March 13, 2020
LISA MUMFORD
 
 
 
 
 
 
 
 
 
/s/ THOMAS F. ROBARDS
 
Chairman of the Board
 
March 13, 2020
THOMAS F. ROBARDS
 
 
 
 
 
 
 
 
 
/s/ RONALD I. SIMON PH.D
 
Director
 
March 13, 2020
RONALD I. SIMON PH.D
 
 
 
 
 
 
 
 
 
/s/ EDWARD RESENDEZ
 
Director
 
March 13, 2020
EDWARD RESENDEZ
 
 
 
 
 
 
 
 
 
 
 
 
 
 


209
Exhibit 4.3

DESCRIPTION OF THE REGISTRANT’S SECURITIES
REGISTERED PURSUANT TO SECTION 12 OF THE
SECURITIES EXCHANGE ACT OF 1934
As of December 31, 2019, Ellington Financial Inc. had two classes of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”):
common stock, par value $0.001 per share (“common stock”); and
6.750% Series A Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, $0.001 par value per share (“Series A Preferred Stock”).
Each of our securities registered under Section 12 of the Exchange Act are listed on the New York Stock Exchange (the “NYSE”).
Except where the context suggests otherwise, “we,” “us,” "our" and “our company” refer to Ellington Financial Inc. and its consolidated subsidiaries, including Ellington Financial Operating Partnership LLC, our operating partnership subsidiary. On March 1, 2019, we completed our conversion (the “Conversion”) from a Delaware limited liability company named Ellington Financial LLC into a Delaware corporation named Ellington Financial Inc. Our “Manager” refers to Ellington Financial Management LLC, our external manager.

1


DESCRIPTION OF COMMON STOCK
Our certificate of incorporation provides for the issuance of our shares of common stock, as well as certain terms of our common stock. The following is a summary of some of the terms of our common stock, our certificate of incorporation and the Delaware General Corporation Law (the “DGCL”), and is not complete and is subject to, and qualified in its entirety by reference to, all of the provisions of our certificate of incorporation and the DGCL. As used herein, the “company,” “our company,” “we,” “us” and “our” mean Ellington Financial Inc., a Delaware corporation.
Authorized Shares
We are authorized to issue, pursuant to action by our Board of Directors and subject to limitations prescribed by the DGCL, up to 100,000,000 shares of common stock, par value $0.001 per share.
Conversion
At 11:59 P.M. Eastern Time on March 1, 2019 (the “Effective Time”) and pursuant to a plan of conversion, each common share representing a limited liability company interest in Ellington Financial LLC outstanding immediately prior to the Effective Time converted into one issued and outstanding, fully paid and nonassessable share of common stock.
Our certificate of incorporation and our bylaws provide our stockholders following the Conversion with substantially the same rights and obligations of limited liability company members pursuant to the operating agreement of Ellington Financial LLC immediately prior to the Conversion.
Voting Rights
The holders of common stock are entitled to one vote per share held of record on all matters submitted to a vote of our stockholders. Generally, all matters to be voted on by our stockholders must be approved by a majority (or, in the case of election of directors, by a plurality) of the votes entitled to be cast by all holders of common stock present in person or represented by proxy, voting together as a group.
Economic Rights
Dividends. In general, holders of common stock will share ratably (based on the number of shares of common stock held) in any dividend declared by our Board of Directors out of funds legally available therefor, subject to any statutory or contractual restrictions on the payment of distributions and to any restrictions on the payment of distributions imposed by the terms of any outstanding preferred stock.
Liquidation. Upon our dissolution, liquidation or winding up, after payment in full of all amounts required to be paid to creditors and to the holders of preferred stock having liquidation preferences, if any, the holders of our common stock will be entitled to receive our remaining assets available for distribution.
Restrictions on Transfer
See “Certain Provisions of Delaware Law and Our Certificate of Incorporation and Bylaws” for a description of restrictions on transfers of our shares including our common stock and for a description of other provisions of the certificate of incorporation and bylaws.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is American Stock Transfer & Trust Company, LLC. The transfer agent and registrar’s address is 6201 15th Avenue, Brooklyn, New York 11219, and its telephone number is (718) 921-8300.
Listing
Our common stock is listed on the NYSE under the ticker symbol “EFC.”

2


DESCRIPTION OF THE SERIES A PREFERRED STOCK
This description of certain terms of the Series A Preferred Stock does not purport to be complete and is in all respects subject to, and qualified in its entirety by references to the relevant provisions of our certificate of incorporation, the certificate of designations designating the Series A Preferred Stock, our bylaws and Delaware law. 
General
Shares of the Series A Preferred Stock represent a single series of our authorized preferred stock. We may elect from time to time to issue additional shares of the Series A Preferred Stock without notice to, or consent from, the existing holders of the Series A Preferred Stock, and all such additional shares of Series A Preferred Stock would be deemed to form a single series with the currently outstanding shares of the Series A Preferred Stock.
Pursuant to our certificate of incorporation, we are currently authorized to designate and issue up to 100,000,000 shares of preferred stock, par value $0.001 per share, in one or more classes or series and, subject to the limitations prescribed by our certificate of incorporation and Delaware law, to fix the designations, powers, rights, preferences, qualifications, limitations, restrictions and the number of shares constituting any class or series as our board of directors may determine, without any vote or action by our stockholders. As of December 31, 2019, there are 4,600,000 shares of Series A Preferred Stock issued and outstanding. Our board of directors may, without the approval of holders of the Series A Preferred Stock or our common stock, designate additional series of authorized preferred stock ranking junior to or on parity with the Series A Preferred Stock or designate additional shares of the Series A Preferred Stock and authorize the issuance of such shares.
The registrar and transfer agent in respect of the Series A Preferred Stock is American Stock Transfer & Trust Company, LLC. The principal business address for American Stock Transfer & Trust Company, LLC is 6201 15th Avenue, Brooklyn, NY 11219. The certificate of designations designating the Series A Preferred Stock provides that we will maintain an office or agency where shares of the Series A Preferred Stock may be surrendered for payment (including redemption), registration of transfer or exchange, or conversion.
Maturity
The Series A Preferred Stock has no stated maturity and is not subject to any sinking fund or mandatory redemption. Shares of the Series A Preferred Stock will remain outstanding indefinitely unless we decide to redeem or otherwise repurchase them or they become convertible and are converted as described below under “-Conversion Rights.” We are not required to set aside funds to redeem the Series A Preferred Stock.
Ranking
The Series A Preferred Stock ranks, with respect to rights to the payment of dividends and the distribution of assets upon our liquidation, dissolution or winding up:
1.
senior to all classes or series of our common stock and to all other classes or series of stock that we may issue in the future with terms specifically providing that such stock ranks junior to the Series A Preferred Stock with respect to rights to the payment of dividends and the distribution of assets upon our liquidation, dissolution or winding up (together with the common stock, the “Junior Stock”);
2.
on a parity with all classes or series of stock that we may issue in the future with terms specifically providing that such stock ranks on a parity with the Series A Preferred Stock with respect to rights to the payment of dividends and the distribution of assets upon our liquidation, dissolution or winding up (the “Parity Stock”);
3.
junior to all classes or series of stock that we may issue in the future with terms specifically providing that such stock ranks senior to the Series A Preferred Stock with respect to rights to the payment of dividends and the distribution of assets upon our liquidation, dissolution or winding up (the “Senior Stock”); and
4.
effectively junior to all of our existing and future indebtedness (including indebtedness convertible into or exchangeable for our common stock or preferred stock) and other liabilities and to all liabilities and preferred equity of our existing subsidiaries and any future subsidiaries.
Dividends
Holders of shares of the Series A Preferred Stock are entitled to receive, when, as and if declared by our board of directors, out of funds legally available for the payment of dividends, cumulative cash dividends. The initial dividend rate for the Series A Preferred Stock from and including the original issue date to, but excluding, October 30, 2024 (the “Fixed Rate Period”) is at

3


the fixed rate equal to 6.750% per annum of the $25.00 per share liquidation preference of the Series A Preferred Stock (equivalent to $1.6875 per annum per share of the Series A Preferred Stock). From and including October 30, 2024 (the “Floating Rate Period”), dividends on the Series A Preferred Stock will accumulate at a percentage of the $25.00 per share liquidation preference of the Series A Preferred Stock equal to an annual floating rate of the Three-Month LIBOR Rate (as defined herein) plus a spread of 5.196% per annum. Dividends on the Series A Preferred Stock shall accumulate daily and be cumulative from, and including, the original issue date and shall be payable quarterly in arrears on or about the 30th day of January, April, July and October of each year (each, a “dividend payment date”), when and as declared, provided that if any dividend payment date is not a business day, as defined in the certificate of designations, then the dividend which would otherwise have been payable on that dividend payment date may be paid on the next succeeding business day and no interest, additional dividends or other sums will accrue on the amount so payable for the period from and after that dividend payment date to that next succeeding business day. Dividends payable for any Dividend Period during the Fixed Rate Period will be calculated on the basis of a 360-day year consisting of twelve 30-day months, and dividends payable for any Dividend Period during the Floating Rate Period will be calculated on the basis of a 360-day year and the number of days actually elapsed in such Dividend Period. Dividends will be payable to holders of record as they appear in our stock transfer records for the Series A Preferred Stock at the close of business on the applicable dividend record date, which will be no fewer than ten days and no more than 35 days prior to the applicable dividend payment date, as shall be fixed by the board of directors (each, a “dividend record date”). The dividends payable on any dividend payment date shall include dividends accumulated to, but excluding, such dividend payment date. No holder of any shares of the Series A Preferred Stock will be entitled to receive any dividends paid or payable on the Series A Preferred Stock with a dividend record date before the date such shares of the Series A Preferred Stock are issued.
For each Dividend Period during the Floating Rate Period, LIBOR (the London interbank offered rate) (“Three-Month LIBOR Rate”) will be determined by us or a Calculation Agent (as defined herein) as of the applicable Dividend Determination Date, in accordance with the following provisions:
LIBOR will be the rate (expressed as a percentage per year) for deposits in U.S. dollars having an index maturity of three months, in amounts of at least $1,000,000, as such rate appears on “Reuters Page LIBOR01” at approximately 11:00 a.m. (London time) on the relevant Dividend Determination Date; or
if no such rate appears on “Reuters Page LIBOR01” or if the “Reuters Page LIBOR01” is not available at approximately 11:00 a.m. (London time) on the relevant Dividend Determination Date, then we will select four nationally recognized banks in the London interbank market and request that the principal London offices of those four selected banks provide us with their offered quotation for deposits in U.S. dollars for a period of three months, commencing on the first day of the applicable Dividend Period, to prime banks in the London interbank market at approximately 11:00 a.m. (London time) on that Dividend Determination Date for the applicable Dividend Period. Offered quotations must be based on a principal amount equal to an amount that, in our discretion, is representative of a single transaction in U.S. dollars in the London interbank market at that time. If at least two quotations are provided, the Three-Month LIBOR Rate for such Dividend Period will be the arithmetic mean (rounded upward if necessary, to the nearest 0.00001 of 1%) of those quotations. If fewer than two quotations are provided, the Three-Month LIBOR Rate for such Dividend Period will be the arithmetic mean (rounded upward if necessary, to the nearest 0.00001 of 1%) of the rates quoted at approximately 11:00 a.m. (New York City time) on that Dividend Determination Date for such Dividend Period by three nationally recognized banks in New York, New York selected by us, for loans in U.S. dollars to nationally recognized European banks (as selected by us), for a period of three months commencing on the first day of such Dividend Period. The rates quoted must be based on an amount that, in our discretion, is representative of a single transaction in U.S. dollars in that market at that time. If no quotation is provided as described above, then if a Calculation Agent has not been appointed at such time, we will appoint a Calculation Agent who shall, after consulting such sources as it deems comparable to any of the foregoing quotations or display page, or any such source as it deems reasonable from which to estimate LIBOR or any of the foregoing lending rates or display page, shall determine LIBOR for the second London Business Day (as defined herein) immediately preceding the first day of the applicable Dividend Period in its sole discretion. If the Calculation Agent is unable or unwilling to determine LIBOR as provided in the immediately preceding sentence, then LIBOR will be equal to Three-Month LIBOR for the then current Dividend Period, or, in the case of the first Dividend Period in the Floating Rate Period, the most recent dividend rate that would have been determined based on the last available Reuters Page LIBOR01 had the Floating Rate Period been applicable prior to the first Dividend Period in the Floating Rate Period.
Notwithstanding the foregoing, if we determine on the relevant Dividend Determination Date that LIBOR has been discontinued, then we will appoint a Calculation Agent and the Calculation Agent will consult with an investment bank of national standing to determine whether there is an industry accepted substitute or successor base rate to Three-Month LIBOR Rate. If, after such consultation, the Calculation Agent determines that there is an industry accepted substitute or successor base rate, the Calculation Agent shall use such substitute or successor base rate. In such case, the Calculation Agent in its sole

4


discretion may (without implying a corresponding obligation to do so) also implement changes to the business day convention, the definition of business day, the Dividend Determination Date and any method for obtaining the substitute or successor base rate if such rate is unavailable on the relevant business day, in a manner that is consistent with industry accepted practices for such substitute or successor base rate. Unless the Calculation Agent determines that there is an industry accepted substitute or successor base rate as so provided above, the Calculation Agent will, in consultation with us, follow the steps specified in the second bullet point in the immediately preceding paragraph in order to determine Three-Month LIBOR Rate for the applicable Dividend Period.
“Calculation Agent” means a third party independent financial institution of national standing with experience providing such services, which has been selected by us.
“Dividend Determination Date” means the second London Business Day immediately preceding the first date of the applicable Dividend Period.
“Dividend Period” means the period from, and including, the immediately preceding dividend payment date to, but excluding, the applicable dividend payment date.
“London Business Day” means any day on which dealings in deposits in U.S. dollars are transacted in the London interbank market.
“Reuters Page LIBOR01” means the display so designated on the Reuters 3000 Xtra (or such other page as may replace the LIBOR01 page on that service, or such other service as may be nominated by the ICE Benchmark Administration Limited, or ICE, or its successor, or such other entity assuming the responsibility of ICE or its successor in the event ICE or its successor no longer does so, as the successor service, for the purpose of displaying London interbank offered rates for U.S. dollar deposits).
No dividends on shares of the Series A Preferred Stock shall be declared by our board of directors or paid or set apart for payment by us at any time when the terms and provisions of any agreement of ours, including any agreement relating to our indebtedness, prohibit the declaration, payment or setting apart for payment thereof or provide that the declaration, payment or setting apart for payment thereof would constitute a breach of the agreement or a default under the agreement, or if the declaration, payment or setting apart for payment is restricted or prohibited by law.
Notwithstanding the foregoing, dividends on the Series A Preferred Stock will accumulate whether or not we have earnings, whether or not there are funds legally available for the payment of those dividends and whether or not those dividends are declared. No interest, or sum in lieu of interest, will be payable in respect of any dividend payment or payments on the Series A Preferred Stock which may be in arrears, and holders of the Series A Preferred Stock will not be entitled to any dividends in excess of full cumulative dividends described above. Any dividend payment made on the Series A Preferred Stock will first be credited against the earliest accumulated but unpaid dividend due with respect to those shares.
Future distributions on our common stock and preferred stock, including the Series A Preferred Stock, will be at the discretion of our board of directors and will depend on, among other things, our results of operations, cash flow from operations, financial condition and capital requirements, the annual distribution requirements under the real estate investment trust, or “REIT,” provisions of the Internal Revenue Code of 1986, as amended (the “Code”), any debt service requirements, financial covenants and any other factors our board of directors deems relevant. Accordingly, we cannot guarantee that we will be able to make cash distributions on the Series A Preferred Stock or what the actual distributions will be for any future period.
Except as noted below, unless full cumulative dividends on the Series A Preferred Stock have been or contemporaneously are declared and paid or declared and a sum sufficient for the payment thereof is set apart for payment for all past Dividend Periods, no dividends or other distributions (other than in shares of common stock or other Junior Stock we may issue) may be declared or paid or set aside for payment upon shares of our common stock or other Junior Stock or Parity Stock we may issue. In addition, any shares of our common stock or other Junior Stock or Parity Stock we may issue may not be redeemed, purchased or otherwise acquired for any consideration (or any moneys be paid to or made available for a sinking fund for the redemption of any such shares) by us (except by conversion into or exchange for shares of, or options, warrants or rights to purchase or subscribe for, our common stock or other Junior Stock we may issue and except for transfers made pursuant to the provisions of our certificate of incorporation relating to restrictions on ownership and transfers of our capital stock). The foregoing will not, however, prevent the redemption, purchase or acquisition by us of shares of any class or series of stock for the purpose of enforcing restrictions on transfer and ownership of our stock contained in our certificate of incorporation, including in order to qualify and maintain our qualification as a REIT, or the redemption, purchase or acquisition by us of shares of our common stock for purposes of and in compliance with any incentive or benefit plan of ours.

5


When dividends are not paid in full (or a sum sufficient for such full payment is not so set apart) upon the Series A Preferred Stock and any Parity Stock that we may issue, all dividends declared upon the Series A Preferred Stock and any Parity Stock that we may issue shall be declared pro rata so that the amount of dividends declared per share of the Series A Preferred Stock and such Parity Stock that we may issue shall in all cases bear to each other the same ratio that accumulated dividends per share on the Series A Preferred Stock and accumulated dividends per share on such Parity Stock that we may issue (which shall not include any accumulation in respect of undeclared and unpaid dividends for past Dividend Periods if such stock does not have a cumulative dividend) bear to each other. No interest, or sum of money in lieu of interest, shall be payable in respect of any dividend payment or payments on the Series A Preferred Stock which may be in arrears.
Liquidation Preference
In the event of our voluntary or involuntary liquidation, dissolution or winding up, the holders of shares of the Series A Preferred Stock will be entitled to be paid out of the assets we have legally available for distribution to our stockholders, subject to the preferential rights of the holders of any Senior Stock, a liquidation preference of $25.00 per share, plus an amount equal to any accumulated and unpaid dividends thereon (whether or not authorized or declared) to, but excluding, the date of payment, before any distribution of assets is made to holders of our common stock or any other Junior Stock we may issue.
In the event that, upon any such voluntary or involuntary liquidation, dissolution or winding up, our available assets are insufficient to pay the amount of the liquidating distributions on all outstanding shares of the Series A Preferred Stock and the corresponding amounts payable on all shares of Parity Stock that we may issue, the holders of the Series A Preferred Stock and all such Parity Stock shall share ratably in any such distribution of assets in proportion to the full liquidating distributions to which they would otherwise be respectively entitled.
Holders of the Series A Preferred Stock will be entitled to written notice of any such liquidation no fewer than 30 days and no more than 60 days prior to the payment date. After payment of the full amount of the liquidating distributions to which they are entitled, the holders of the Series A Preferred Stock will have no right or claim to any of our remaining assets. The consolidation or merger of us with or into any other corporation, trust or entity or of any other entity with or into us, or the sale, lease, transfer or conveyance of all or substantially all of our property or business, individually or in a series of related transactions, shall not be deemed to constitute a liquidation, dissolution or winding up of us (although such events may give rise to the special optional redemption and contingent conversion rights described below).
Redemption
The Series A Preferred Stock is not redeemable by us prior to October 30, 2024, except as described below under “-Special Optional Redemption” and except under circumstances where it is necessary to allow us to qualify and maintain our qualification as a REIT for U.S. federal income tax purposes. Please see the section entitled “Certain Provisions of Delaware Law and Our Certificate of Incorporation and Bylaws-Restrictions on Ownership and Transfer”.
Optional Redemption. On or after October 30, 2024, we may, at our option, upon not less than 30 nor more than 60 days’ written notice, redeem the Series A Preferred Stock, in whole or in part, at any time or from time to time, for cash at a redemption price equal to $25.00 per share of the Series A Preferred Stock, plus any accumulated and unpaid dividends thereon (whether or not authorized or declared) to, but excluding, the redemption date, without interest. If we elect to redeem any shares of the Series A Preferred Stock as described in this paragraph, we may use any available cash to pay the redemption price, and we will not be required to pay the redemption price only out of the proceeds from the issuance of other stock or any other specific source.
Special Optional Redemption. Upon the occurrence of a Change of Control, we may, at our option, upon not less than 30 nor more than 60 days’ written notice, redeem the Series A Preferred Stock, in whole or in part, within 120 days after the first date on which such Change of Control occurred, for cash at a redemption price of $25.00 per share of the Series A Preferred Stock, plus any accumulated and unpaid dividends thereon (whether or not authorized or declared) to, but excluding, the redemption date, without interest. If, prior to the Change of Control Conversion Date, we have provided notice of our election to redeem some or all of the shares of the Series A Preferred Stock (whether pursuant to our optional redemption right described above under “-Optional Redemption” or this special optional redemption right), the holders of the Series A Preferred Stock will not have the Change of Control Conversion Right described below under “-Conversion Rights” with respect to the shares of the Series A Preferred Stock called for redemption. If we elect to redeem any shares of the Series A Preferred Stock as described in this paragraph, we may use any available cash to pay the redemption price, and we will not be required to pay the redemption price only out of the proceeds from the issuance of other stock or any other specific source.

6


A “Change of Control” is deemed to occur when, after the original issuance of the Series A Preferred Stock, the following have occurred and are continuing:
the acquisition by any person, including any syndicate or group deemed to be a “person” under Section 13(d)(3) of the Exchange Act, of beneficial ownership, directly or indirectly, through a purchase, merger or other acquisition transaction or series of purchases, mergers or other acquisition transactions of our capital stock entitling that person to exercise more than 50% of the total voting power of all our capital stock entitled to vote generally in the election of our directors (except that such person will be deemed to have beneficial ownership of all securities that such person has the right to acquire, whether such right is currently exercisable or is exercisable only upon the occurrence of a subsequent condition); and
following the closing of any transaction referred to in the bullet point above, neither we nor the acquiring or surviving entity has a class of common securities (or American Depositary Receipts representing such securities) listed on the NYSE, the NYSE American or the Nasdaq Stock Market, or listed or quoted on an exchange or quotation system that is a successor to the NYSE, the NYSE American or the Nasdaq Stock Market.
Redemption Procedures. In the event we elect to redeem any shares of the Series A Preferred Stock, the notice of redemption will be mailed to each holder of record of the Series A Preferred Stock called for redemption at such holder’s address as it appears on our stock transfer records and will state the following:
the redemption date;
the number of shares of the Series A Preferred Stock to be redeemed;
the redemption price;
the place or places where certificates (if any) for the Series A Preferred Stock are to be surrendered for payment of the redemption price;
that dividends on the shares to be redeemed will cease to accumulate on the redemption date;
whether such redemption is being made pursuant to the provisions described above under “-Optional Redemption” or “-Special Optional Redemption”;
if applicable, that such redemption is being made in connection with a Change of Control and, in that case, a brief description of the transaction or transactions constituting such Change of Control; and
if such redemption is being made in connection with a Change of Control, that the holders of the shares of the Series A Preferred Stock being so called for redemption will not be able to tender such shares of the Series A Preferred Stock for conversion in connection with the Change of Control and that each share of the Series A Preferred Stock tendered for conversion that is called, prior to the Change of Control Conversion Date (as defined herein), for redemption will be redeemed on the related date of redemption instead of converted on the Change of Control Conversion Date
If less than all of the shares of the Series A Preferred Stock held by any holder are to be redeemed, the notice mailed to such holder shall also specify the number of shares of the Series A Preferred Stock held by such holder to be redeemed. No failure to give such notice or any defect thereto or in the mailing thereof shall affect the validity of the proceedings for the redemption of any shares of the Series A Preferred Stock except as to the holder to whom notice was defective or not given.
Holders of the Series A Preferred Stock to be redeemed shall surrender the Series A Preferred Stock at the place designated in the notice of redemption and shall be entitled to the redemption price and any accumulated and unpaid dividends payable upon the redemption following the surrender. If notice of redemption of any shares of the Series A Preferred Stock has been given and if we have irrevocably set aside the funds necessary for redemption for the benefit of the holders of the shares of the Series A Preferred Stock so called for redemption, then from and after the redemption date (unless default shall be made by us in providing for the payment of the redemption price plus accumulated and unpaid dividends, if any), dividends will cease to accumulate on those shares of the Series A Preferred Stock, those shares of the Series A Preferred Stock shall no longer be deemed outstanding and all rights of the holders of those shares will terminate, except the right to receive the redemption price plus accumulated and unpaid dividends, if any, payable upon redemption. If any redemption date is not a business day, then the redemption price and accumulated and unpaid dividends, if any, payable upon redemption may be paid on the next business day and no interest, additional dividends or other sums will accrue on the amount payable for the period from and after that redemption date to that next business day. If less than all of the outstanding Series A Preferred Stock is to be redeemed, the Series A Preferred Stock to be redeemed shall be selected pro rata or by lot (as nearly as may be practicable without creating fractional shares) that will not result in the automatic transfer of any shares of the Series A Preferred Stock to a trust as described below under “-Restrictions on Ownership and Transfer.”

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As part of any redemption of the Series A Preferred Stock, we shall pay, in cash, any accumulated and unpaid dividends to, but excluding, the redemption date, unless a redemption date falls after a dividend record date and prior to the corresponding dividend payment date, in which case each holder of the Series A Preferred Stock at the close of business on such dividend record date shall be entitled to the dividend payable on such shares on the corresponding dividend payment date notwithstanding the redemption of such shares before such dividend payment date. Except as provided above, we will make no payment or allowance for unpaid dividends, whether or not in arrears, on shares of the Series A Preferred Stock to be redeemed.
Unless full cumulative dividends on all shares of the Series A Preferred Stock have been or contemporaneously are declared and paid or declared and a sum sufficient for the payment thereof has been or contemporaneously is set apart for payment for all past Dividend Periods, no shares of the Series A Preferred Stock shall be redeemed unless all outstanding shares of the Series A Preferred Stock are simultaneously redeemed, and we may not purchase or otherwise acquire directly or indirectly any shares of the Series A Preferred Stock (except by conversion into or exchange for shares of, or options, warrants or rights to purchase or subscribe for, our common stock or other Junior Stock that we may issue); provided, however, that the foregoing shall not prevent the purchase or acquisition by us of shares of the Series A Preferred Stock where it is necessary to allow us to qualify and maintain our qualification as a REIT for U.S. federal income tax purposes or pursuant to a purchase or exchange offer made on the same terms to holders of all outstanding shares of the Series A Preferred Stock.
Subject to applicable law, we may purchase shares of the Series A Preferred Stock in the open market, by tender or by private agreement. Any shares of the Series A Preferred Stock that we acquire may be retired and re-classified as authorized but unissued shares of preferred stock, without designation as to class or series, and may thereafter be reissued as any class or series of preferred stock.
Conversion Rights
Upon the occurrence of a Change of Control, each holder of the Series A Preferred Stock will have the right (unless, prior to the Change of Control Conversion Date, we have provided notice of our election to redeem some or all of the shares of the Series A Preferred Stock held by such holder as described above under “-Redemption-Optional Redemption” or “-Redemption-Special Optional Redemption,” in which case such holder will have the right only with respect to shares of the Series A Preferred Stock that are not called for redemption) to convert some or all of the shares of the Series A Preferred Stock held by such holder (the “Change of Control Conversion Right”) on the Change of Control Conversion Date into a number of shares of our common stock per share of the Series A Preferred Stock (the “Common Stock Conversion Consideration”) equal to the lesser of:
the quotient obtained by dividing (i) the sum of the $25.00 per share liquidation preference of the Series A Preferred Stock plus any accumulated and unpaid dividends thereon (whether or not authorized or declared) to, but excluding, the Change of Control Conversion Date (unless the Change of Control Conversion Date is after a dividend record date and prior to the corresponding dividend payment date for the Series A Preferred Stock, in which case no additional amount for such accumulated and unpaid dividends to be paid on such dividend payment date will be included in this sum) by (ii) the Common Stock Price, as defined herein (such quotient, the “Conversion Rate”); and
2.75028 (the “Share Cap”), subject to certain adjustments as described below
Notwithstanding anything to the contrary in the certificate of designations and except as otherwise required by law, the persons who are the holders of record of shares of the Series A Preferred Stock at the close of business on a dividend record date will be entitled to receive the dividend payable on the corresponding dividend payment date notwithstanding the conversion of those shares after such dividend record date and on or prior to such dividend payment date and, in such case, the full amount of such dividend shall be paid on such dividend payment date to the persons who were the holders of record at the close of business on such dividend record date. Except as provided above, we will make no allowance for unpaid dividends that are in arrears on the shares of the Series A Preferred Stock to be converted.
The Share Cap is subject to pro rata adjustments for any share splits (including those effected pursuant to a distribution of our common stock to existing holders of our common stock), subdivisions or combinations (in each case, a “Share Split”) with respect to our common stock as follows: the adjusted Share Cap as the result of a Share Split will be the number of shares of our common stock that is equivalent to the product obtained by multiplying (i) the Share Cap in effect immediately prior to such Share Split by (ii) a fraction, the numerator of which is the number of shares of our common stock outstanding immediately after giving effect to such Share Split and the denominator of which is the number of shares of our common stock outstanding immediately prior to such Share Split.
For the avoidance of doubt, subject to the immediately succeeding sentence, the aggregate number of shares of our common stock (or equivalent Alternative Conversion Consideration, as applicable) issuable or deliverable, as applicable, in

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connection with the exercise of the Change of Control Conversion Right will not exceed 12,651,288 shares of our common stock in total (or equivalent Alternative Conversion Consideration, as applicable) (the “Exchange Cap”). The Exchange Cap is subject to pro rata adjustments for any Share Splits on the same basis as the corresponding adjustment to the Share Cap.
In the case of a Change of Control pursuant to which our common stock is or will be converted into cash, securities or other property or assets (including any combination thereof) (the “Alternative Form Consideration”), a holder of the Series A Preferred Stock will receive upon conversion of such shares of the Series A Preferred Stock the kind and amount of Alternative Form Consideration which such holder would have owned or been entitled to receive upon the Change of Control had such holder held a number of shares of our common stock equal to the Common Stock Conversion Consideration immediately prior to the effective time of the Change of Control (the “Alternative Conversion Consideration”; the Common Stock Conversion Consideration or the Alternative Conversion Consideration, whichever shall be applicable to a Change of Control, is referred to as the “Conversion Consideration”).
If the holders of our common stock have the opportunity to elect the form of consideration to be received in the Change of Control, the Conversion Consideration in respect of such Change of Control will be deemed to be the kind and amount of consideration actually received by holders of a majority of the outstanding shares of our common stock that made or voted for such an election (if electing between two types of consideration) or holders of a plurality of the outstanding shares of our common stock that made or voted for such an election (if electing between more than two types of consideration), as the case may be, and will be subject to any limitations to which all holders of our common stock are subject, including, without limitation, pro rata reductions applicable to any portion of the consideration payable in such Change of Control.
We will not issue fractional shares of our common stock upon the conversion of the Series A Preferred Stock in connection with a Change of Control. Instead, we will make a cash payment equal to the value of such fractional shares based upon the Common Stock Price used in determining the Common Stock Conversion Consideration for such Change of Control.
Within 15 days following the occurrence of a Change of Control, provided that we have not then exercised our right to redeem all shares of the Series A Preferred Stock pursuant to the redemption provisions described above, we will provide to holders of the Series A Preferred Stock a notice of occurrence of the Change of Control that describes the resulting Change of Control Conversion Right. This notice will be delivered to the holders of record of the shares of the Series A Preferred Stock at their addresses as they appear on our stock transfer records. No failure to give such notice or any defect thereto or in the giving thereof will affect the validity of the proceedings for the conversion of any shares of the Series A Preferred Stock except as to the holder to whom notice was defective or not given. This notice will state the following:
the events constituting the Change of Control;
the date of the Change of Control;
the last date on which the holders of the Series A Preferred Stock may exercise their Change of Control Conversion Right;
the method and period for calculating the Common Stock Price;
the Change of Control Conversion Date;
that if, prior to the Change of Control Conversion Date, we have provided notice of our election to redeem all or any shares of the Series A Preferred Stock, holders will not be able to convert the shares of the Series A Preferred Stock called for redemption and such shares will be redeemed on the related redemption date, even if such shares have already been tendered for conversion pursuant to the Change of Control Conversion Right;
if applicable, the type and amount of Alternative Conversion Consideration entitled to be received per share of the Series A Preferred Stock;
the name and address of the paying agent and transfer agent for the Series A Preferred Stock;
the procedures that the holders of the Series A Preferred Stock must follow to exercise the Change of Control Conversion Right (including procedures for surrendering shares for conversion through the facilities of a Share Depositary (as defined herein)), including the form of conversion notice to be delivered by such holders as described below; and
the last date on which holders of the Series A Preferred Stock may withdraw shares surrendered for conversion and the procedures that such holders must follow to effect such a withdrawal.
Under such circumstances, we will also issue a press release containing such notice for publication on Dow Jones & Company, Inc., the Wall Street Journal, Business Wire, PR Newswire or Bloomberg Business News (or, if these organizations are not in existence at the time of issuance of the press release, such other news or press organization as is reasonably

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calculated to broadly disseminate the relevant information to the public), and post a notice on our website, in any event prior to the opening of business on the first business day following any date on which we provide the notice described above to the holders of the Series A Preferred Stock.
To exercise the Change of Control Conversion Right, the holders of the Series A Preferred Stock will be required to deliver, on or before the close of business on the Change of Control Conversion Date, the certificates (if any) representing the shares of the Series A Preferred Stock to be converted, duly endorsed for transfer (or, in the case of any shares of the Series A Preferred Stock held in book-entry form through a Share Depositary, to deliver, on or before the close of business on the Change of Control Conversion Date, the shares of the Series A Preferred Stock to be converted through the facilities of such Share Depositary), together with a written conversion notice in the form provided by us, duly completed, to our transfer agent. The conversion notice must state:
the relevant Change of Control Conversion Date;
the number of shares of the Series A Preferred Stock to be converted; and
that the Series A Preferred Stock is to be converted pursuant to the applicable provisions of the Series A Preferred Stock.
The “Change of Control Conversion Date” is the date the Series A Preferred Stock is to be converted, which will be a business day selected by us that is no fewer than 20 days nor more than 35 days after the date on which we provide the notice described above to the holders of the Series A Preferred Stock.
The “Common Stock Price” is (i) if the consideration to be received in the Change of Control by the holders of our common stock is solely cash, the amount of cash consideration per share of our common stock or (ii) if the consideration to be received in the Change of Control by holders of our common stock is other than solely cash (x) the average of the closing sale prices per share of our common stock (or, if no closing sale price is reported, the average of the closing bid and ask prices per share or, if more than one in either case, the average of the average closing bid and the average closing ask prices per share) for the ten consecutive trading days immediately preceding, but not including, the date on which such Change of Control occurred as reported on the principal U.S. securities exchange on which our common stock is then traded, or (y) the average of the last quoted bid prices for our common stock in the over-the-counter market as reported by OTC Markets Group Inc. or similar organization for the ten consecutive trading days immediately preceding, but not including, the date on which such Change of Control occurred, if our common stock is not then listed for trading on a U.S. securities exchange.
Holders of the Series A Preferred Stock may withdraw any notice of exercise of a Change of Control Conversion Right (in whole or in part) by a written notice of withdrawal delivered to our transfer agent prior to the close of business on the business day prior to the Change of Control Conversion Date. The notice of withdrawal delivered by any holder must state:
the number of withdrawn shares of the Series A Preferred Stock
if certificated Series A Preferred Stock has been surrendered for conversion, the certificate numbers of the withdrawn shares of the Series A Preferred Stock; and
the number of shares of the Series A Preferred Stock, if any, which remain subject to the holder’s conversion notice.
Notwithstanding the foregoing, if any shares of the Series A Preferred Stock are held in book-entry form through The Depository Trust Company (“DTC”) or a similar depositary (each, a “Share Depositary”), the conversion notice and/or the notice of withdrawal, as applicable, must comply with applicable procedures, if any, of the applicable Share Depositary.
Series A Preferred Stock as to which the Change of Control Conversion Right has been properly exercised and for which the conversion notice has not been properly withdrawn will be converted into the applicable Conversion Consideration in accordance with the Change of Control Conversion Right on the Change of Control Conversion Date, unless prior to the Change of Control Conversion Date we have provided notice of our election to redeem some or all of the shares of the Series A Preferred Stock, as described above under “-Redemption-Optional Redemption” or “-Redemption-Special Optional Redemption,” in which case only the shares of the Series A Preferred Stock properly surrendered for conversion and not properly withdrawn that are not called for redemption will be converted as aforesaid. If we elect to redeem shares of the Series A Preferred Stock that would otherwise be converted into the applicable Conversion Consideration on a Change of Control Conversion Date, such shares of the Series A Preferred Stock will not be so converted and the holders of such shares will be entitled to receive on the applicable redemption date the redemption price described above under “-Redemption-Optional Redemption” or “-Redemption-Special Optional Redemption,” as applicable.
We will deliver all securities, cash and any other property owing upon conversion no later than the third business day following the Change of Control Conversion Date. Notwithstanding the foregoing, the persons entitled to receive any shares of

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our common stock or other securities delivered on conversion will be deemed to have become the holders of record thereof as of the Change of Control Conversion Date.
In connection with the exercise of any Change of Control Conversion Right, we will comply with all applicable federal and state securities laws and stock exchange rules in connection with any conversion of the Series A Preferred Stock into shares of our common stock or other property. Notwithstanding any other provision of the Series A Preferred Stock, no holder of the Series A Preferred Stock will be entitled to convert such Series A Preferred Stock into shares of our common stock to the extent that receipt of such common stock would cause such holder (or any other person) to exceed the applicable share ownership limitations contained in our certificate of incorporation and the certificate of designations, unless we provide an exemption from this limitation to such holder. Please see the section entitled “-Restrictions on Ownership and Transfer” below and “Certain Provisions of Delaware Law and Our Certificate of Incorporation and Bylaws-Restrictions on Ownership and Transfer”.
The Change of Control conversion feature may make it more difficult for a third party to acquire us or discourage a party from acquiring us. If exercisable, the Change of Control Conversion Rights (as defined herein) may not adequately compensate a holder of the Series A Preferred Stock. These Change of Control Conversion Rights may also make it more difficult for a party to acquire us or discourage a party from acquiring us.
Except as provided above in connection with a Change of Control, the Series A Preferred Stock is not convertible into or exchangeable for any other securities or property.
Voting Rights
Holders of the Series A Preferred Stock do not have any voting rights, except as set forth below or as otherwise required by law or any applicable stock exchange rules.
Whenever dividends on any shares of the Series A Preferred Stock are in arrears for six or more quarterly Dividend Periods, whether or not consecutive, the number of directors constituting our board of directors will be automatically increased by two (if not already increased by two by reason of the election of directors by the holders of any other class or series of our preferred stock that we may issue and upon which like voting rights have been conferred and are exercisable and which are entitled to vote with the Series A Preferred Stock as a class with respect to the election of those two directors) and the holders of the Series A Preferred Stock (voting together as a class with all other classes or series of preferred stock that we may issue and upon which like voting rights have been conferred and are exercisable and which are entitled to vote as a class with the Series A Preferred Stock in the election of those two directors) will be entitled to vote for the election of those two additional directors at a special meeting called by us at the request of the holders of record of at least 25% of the outstanding shares of the Series A Preferred Stock or by the holders of any other class or series of preferred stock upon which like voting rights have been conferred and are exercisable and which are entitled to vote as a class with the Series A Preferred Stock in the election of those two directors (unless the request is received less than 90 days before the date fixed for the next annual or special meeting of stockholders, in which case such vote will be held at the earlier of the next annual or special meeting of stockholders), and at each subsequent annual meeting until all dividends accumulated on the Series A Preferred Stock for all past Dividend Periods and the then current Dividend Period shall have been fully paid. In that case, the right of holders of the Series A Preferred Stock to elect any directors will cease and, unless there are other classes or series of our preferred stock upon which like voting rights have been conferred and are exercisable, any directors elected by holders of the Series A Preferred Stock shall immediately resign and the number of directors constituting the board of directors shall be reduced accordingly. In no event shall the holders of the Series A Preferred Stock be entitled pursuant to these voting rights to elect a director that would cause us to fail to satisfy a requirement relating to director independence of any national securities exchange or quotation system on which any class or series of our capital stock is listed or quoted. For the avoidance of doubt, in no event shall the total number of directors elected by holders of the Series A Preferred Stock (voting together as a class with all other classes or series of preferred stock that we may issue and upon which like voting rights have been conferred and are exercisable and which are entitled to vote as a class with the Series A Preferred Stock in the election of such directors) pursuant to these voting rights exceed two.
If at any time when the voting rights conferred upon the Series A Preferred Stock (as described above) are exercisable any vacancy in the office of a director elected pursuant to the procedures described above shall occur, then such vacancy may be filled only by the remaining director or by the vote of the holders of record of the outstanding Series A Preferred Stock and any other classes or series of preferred stock upon which like voting rights have been conferred and are exercisable and which are entitled to vote as a class with the Series A Preferred Stock in the election of directors (as described above). Any director elected or appointed pursuant to the procedures described above may be removed at any time, with or without cause, only by the affirmative vote of holders of the outstanding Series A Preferred Stock and any other classes or series of preferred stock upon which like voting rights have been conferred and are exercisable and which classes or series of preferred stock are entitled to vote as a class with the Series A Preferred Stock in the election of directors pursuant to the procedures described above, such

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removal to be effected by the affirmative vote of a majority of the votes entitled to be cast by the holders of the outstanding Series A Preferred Stock and any such other classes or series of preferred stock, and may not be removed by the holders of our common stock.
If a special meeting is not called by us within 30 days after request from the holders of the Series A Preferred Stock as described above, then the holders of record of at least 25% of the outstanding Series A Preferred Stock may designate a holder to call the meeting at our expense.
On each matter on which holders of the Series A Preferred Stock are entitled to vote, each share of the Series A Preferred Stock will be entitled to one vote, except that when shares of any other class or series of our preferred stock have the right to vote with the Series A Preferred Stock as a single class on any matter, the Series A Preferred Stock and the shares of each such other class or series will have one vote for each $25.00 of liquidation preference (excluding accumulated dividends).
So long as any shares of the Series A Preferred Stock remain outstanding, we will not, without the affirmative vote or consent of the holders of at least two-thirds of the shares of the outstanding Series A Preferred Stock and all Parity Stock having like voting rights that are exercisable at the time, voting as a single class, outstanding at the time, given in person or by proxy, either in writing or at a meeting (voting together as a class with all classes or series of Parity Stock that we may issue upon which like voting rights have been conferred and are exercisable), (a) authorize or create, or increase the authorized or issued amount of, any class or series of Senior Stock or reclassify any of our authorized capital stock into such shares, or create, authorize or issue any obligation or security convertible into or evidencing the right to purchase any such shares; or (b) amend, alter or repeal the provisions of our certificate of incorporation, whether by merger, consolidation or otherwise, so as to materially and adversely affect any right, preference, privilege or voting power of holders of the Series A Preferred Stock (each, an “Event”); provided, however, with respect to the occurrence of any Event set forth in (b) above, so long as the Series A Preferred Stock remains outstanding with the terms thereof materially unchanged, taking into account that, upon an occurrence of an Event, we may not be the surviving entity, the occurrence of any such Event shall not be deemed to materially and adversely affect such rights, preferences, privileges or voting powers of holders of the Series A Preferred Stock and, provided further, that any increase in the amount of the authorized preferred stock, including the Series A Preferred Stock, or the creation or issuance of any additional shares of the Series A Preferred Stock or other class or series of preferred stock that we may issue, or any increase in the amounts authorized of any Parity Stock or Junior Stock, shall not be deemed to materially and adversely affect such rights, preferences, privileges or voting powers.
Notwithstanding the foregoing, if any amendment, alteration or repeal of any provision of our certificate of incorporation would materially and adversely affect any right, preference, privilege or voting power of the Series A Preferred Stock disproportionately relative to any Parity Stock having like voting rights that are exercisable at the time, then the affirmative vote or consent of the holders of at least two-thirds of the outstanding shares of the Series A Preferred Stock (voting as a separate class) shall also be required.
The foregoing voting provisions will not apply if, at or prior to the time when the act with respect to which such vote would otherwise be required shall be effected, all outstanding shares of the Series A Preferred Stock shall have been redeemed or called for redemption upon proper notice and sufficient funds shall have been deposited in trust to effect such redemption.
Except as expressly stated in the certificate of designations or as may be required by applicable law, the Series A Preferred Stock do not have any relative, participating, optional and other special voting rights or powers and the consent of the holders thereof shall not be required for the taking of any corporate action.
Information Rights
During any period in which we are not subject to Section 13 or 15(d) of the Exchange Act and any shares of the Series A Preferred Stock are outstanding, we will use our best efforts to (i) transmit through our website at www.ellingtonfinancial.com (or other permissible means under the Exchange Act) to all holders of the Series A Preferred Stock, as their names and addresses appear on our record books and without cost to such holders, copies of the annual reports on Form 10-K and quarterly reports on Form 10-Q that we would have been required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act if we were subject thereto (other than any exhibits that would have been required) and (ii) promptly, upon request, supply copies of such reports to any holders or prospective holder of the Series A Preferred Stock. We will use our best effort to mail (or otherwise provide) the information to the holders of the Series A Preferred Stock within 15 days after the respective dates by which a periodic report on Form 10-K or Form 10-Q, as the case may be, in respect of such information would have been required to be filed with the SEC, if we were subject to Section 13 or 15(d) of the Exchange Act, in each case, based on the dates on which we would be required to file such periodic reports if we were a “non-accelerated filer” within the meaning of the Exchange Act.

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Restrictions on Ownership and Transfer
In order to qualify as a REIT under the Code, our shares of capital stock must be beneficially owned by 100 or more persons during at least 335 days of a taxable year of 12 months or during a proportionate part of a shorter taxable year (beginning with our taxable year ending December 31, 2020). Also, no more than 50% of the value of our outstanding shares of capital stock may be owned, directly or constructively, by five or fewer individuals (as defined in the Code to include certain entities) during the second half of any calendar year (beginning with our taxable year ending December 31, 2020).
Our certificate of incorporation and the certificate of designations establishing the terms of the Series A Preferred Stock contain restrictions on the ownership and transfer of the Series A Preferred Stock which are intended to assist us in complying with these requirements and continuing to qualify as a REIT. The certificate of designations provides that all holders of the Series A Preferred Stock will be subject to our certificate of incorporation, which provides that no person may beneficially or constructively own more than 9.8% in value or in number of shares, whichever is more restrictive, of the outstanding shares of any class or series of our stock, subject to certain exceptions.
Moreover, the constructive ownership rules are complex, and may cause shares of the Series A Preferred Stock owned actually or constructively by a group of related individuals and/or entities to be constructively owned by one individual or entity. As a result, the acquisition of less than 9.8% of the shares of the Series A Preferred Stock (or the acquisition of an interest in an entity that owns, actually or constructively, Series A Preferred Stock) by an individual or entity could nevertheless cause that individual or entity, or another individual or entity, to own constructively in excess of 9.8% of the outstanding Series A Preferred Stock and thus violate the ownership limitations, or any other limitations in our certificate of incorporation.
Under our certificate of incorporation, and the certificate of designations for the Series A Preferred Stock, any attempted transfer of our stock, which, if effective, would result in a violation of the foregoing restrictions will cause the number of shares of stock causing the violation (rounded up to the nearest whole share) to be automatically transferred to a trust for the exclusive benefit of one or more charitable beneficiaries, and the proposed transferee will not acquire any rights in such shares. Our board of directors, in its sole discretion, may exempt a person from the foregoing restrictions; however, it is not obligated to do so.
Furthermore, under our certificate of incorporation and, consequently, if the board of directors or any duly authorized committee thereof (or other designees if permitted by Delaware law) shall at any time determine in good faith that a transfer or other event has taken place that results in a violation of the foregoing restrictions, or that a person intends to acquire or has attempted to acquire beneficial or constructive ownership of any shares of our stock in violation of the foregoing restrictions, we may take actions to refuse to give effect to or prevent such transfer or other event, including, without limitation, redeeming shares of stock, refusing to give effect to such transfer on our books or instituting proceedings to enjoin such transfer or other event.
Any person who acquires or attempts or intends to acquire beneficial or constructive ownership of shares of our stock that will or may violate the foregoing restrictions or any person who would have owned shares of stock that resulted in a transfer to the trust for the exclusive benefit of one or more charitable beneficiaries as described above shall immediately give written notice to us of such event, or in the case of such a proposed or attempted transaction, give at least 15 days prior written notice, and shall provide to us such other information as we may request in order to determine the effect, if any, of such transfer on our status as a REIT.
For further information regarding restrictions on ownership and transfer of the Series A Preferred Stock, please see the section entitled “Certain Provisions of Delaware Law and Our Certificate of Incorporation and Bylaws-Restrictions on Ownership and Transfer”.
Preemptive Rights
No holders of the Series A Preferred Stock have any preemptive rights to purchase or subscribe for our common stock or any other security.
Book-Entry Procedures
All interests in the global securities certificates representing the shares of the Series A Preferred Stock are subject to the operations and procedures of DTC and, therefore, you must allow for sufficient time in order to comply with these procedures if you wish to exercise any of your rights with respect to the Series A Preferred Stock. We provide the following summary of those operations and procedures solely for the convenience of investors. The operations and procedures of DTC are controlled

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by that settlement system and may be changed at any time. Neither we nor the underwriters are responsible for those operations or procedures or for the accuracy or completeness of the following disclosure.
DTC acts as securities depositary for the Series A Preferred Stock. We issued one or more fully registered global securities certificates in the name of DTC’s nominee, Cede & Co. These certificates represent the total aggregate number of shares of the Series A Preferred Stock. We deposited these certificates with DTC or a custodian appointed by DTC. We will not issue certificates to you for the shares of the Series A Preferred Stock that you purchase, unless DTC’s services are discontinued as described below.
Title to book-entry interests in the Series A Preferred Stock will pass by book-entry registration of the transfer within the records of DTC in accordance with its procedures. Book-entry interests in the securities may be transferred within DTC in accordance with procedures established for these purposes by DTC. So long as DTC’s nominee is the registered owner of the global securities certificates, that nominee will be considered the sole owner and holder of the shares of the Series A Preferred Stock represented by those certificates for all purposes. Except as provided below, owners of beneficial interests in the certificates will not be entitled to have shares of the Series A Preferred Stock registered in their names; will not receive or be entitled to receive physical, certificated shares of the Series A Preferred Stock; and will not be considered the owners or holders of the shares of the Series A Preferred Stock for any purpose. As a result, each person owning a beneficial interest in shares of the Series A Preferred Stock must rely on the procedures of DTC and the participant through which such person owns its interest to exercise its rights as a holder of the Series A Preferred Stock.
DTC has advised us that it is a limited-purpose trust company organized under the New York Banking Law, a “banking organization” within the meaning of the New York State banking law, a member of the Federal Reserve System, a “clearing corporation” within the meaning of the New York Uniform Commercial Code and a “clearing agency” registered under the provisions of Section 17A of the Exchange Act. DTC holds securities that its participants (“Direct Participants”) deposit with DTC. DTC also facilitates the settlement among Direct Participants of securities transactions, such as transfers and pledges, in deposited securities through electronic computerized book-entry changes in Direct Participants’ accounts, thereby eliminating the need for physical movement of securities certificates. Direct Participants include securities brokers and dealers, including the underwriters, banks, trust companies, clearing corporations, and certain other organizations. Access to the DTC system is also available to others such as securities brokers and dealers, including the underwriters, banks and trust companies that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirectly (“Indirect Participants”). The rules applicable to DTC and its Direct and Indirect Participants are on file with the SEC.
When you purchase shares of the Series A Preferred Stock within the DTC system, the purchase must be by or through a Direct Participant. The Direct Participant will receive a credit for the Series A Preferred Stock on DTC’s records. You will be considered to be the “beneficial owner” of the Series A Preferred Stock. Your beneficial ownership interest will be recorded on the Direct and Indirect Participants’ records, but DTC will have no knowledge of your individual ownership. DTC’s records reflect only the identity of the Direct Participants to whose accounts shares of the Series A Preferred Stock are credited.
You will not receive written confirmation from DTC of your purchase. The Direct or Indirect Participants through whom you purchased the Series A Preferred Stock should send you written confirmations providing details of your transactions, as well as periodic statements of your holdings. The Direct and Indirect Participants are responsible for keeping an accurate account of the holdings of their customers like you.
Transfers of ownership interests held through Direct and Indirect Participants will be accomplished by entries on the books of Direct and Indirect Participants acting on behalf of the beneficial owners.
Conveyance of notices and other communications by DTC to Direct Participants, by Direct Participants to Indirect Participants, and by Direct Participants and Indirect Participants to beneficial owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time.
We understand that, under DTC’s existing practices, in the event that we request any action of the holders, or an owner of a beneficial interest in a global security, such as you, desires to take any action which a holder is entitled to take under our certificate of incorporation (including the certificate of designations designating the Series A Preferred Stock), DTC would authorize the Direct Participants holding the relevant shares to take such action, and those Direct Participants and any Indirect Participants would authorize beneficial owners owning through those Direct and Indirect Participants to take such action or would otherwise act upon the instructions of beneficial owners owning through them.
Any redemption notices with respect to the Series A Preferred Stock will be sent to Cede & Co. If less than all of the outstanding shares of the Series A Preferred Stock are being redeemed, DTC will reduce each Direct Participant’s holdings of shares of the Series A Preferred Stock in accordance with its procedures.

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In those instances where a vote is required, neither DTC nor Cede & Co. itself will consent or vote with respect to the shares of the Series A Preferred Stock. Under its usual procedures, DTC would mail an omnibus proxy to us as soon as possible after the dividend record date. The omnibus proxy assigns Cede & Co.’s consenting or voting rights to those Direct Participants whose accounts the shares of the Series A Preferred Stock are credited to on the dividend record date, which are identified in a listing attached to the omnibus proxy.
Dividends on the Series A Preferred Stock will be made directly to DTC’s nominee (or its successor, if applicable). DTC’s practice is to credit participants’ accounts on the relevant dividend payment date in accordance with their respective holdings shown on DTC’s records unless DTC has reason to believe that it will not receive payment on that dividend payment date.
Payments by Direct and Indirect Participants to beneficial owners will be governed by standing instructions and customary practices, as is the case with securities held for the accounts of customers in bearer form or registered in “street name.” These payments will be the responsibility of the Direct and Indirect Participants and not of DTC, us or any agent of ours.
DTC may discontinue providing its services as securities depositary with respect to the Series A Preferred Stock at any time by giving reasonable notice to us. Additionally, we may decide to discontinue the book-entry only system of transfers with respect to the Series A Preferred Stock. In that event, we will print and deliver certificates in fully registered form for the Series A Preferred Stock. If DTC notifies us that it is unwilling to continue as securities depositary, or it is unable to continue or ceases to be a clearing agency registered under the Exchange Act and a successor depositary is not appointed by us within 90 days after receiving such notice or becoming aware that DTC is no longer so registered, we will issue the Series A Preferred Stock in definitive form, at our expense, upon registration of transfer of, or in exchange for, such global security.
According to DTC, the foregoing information with respect to DTC has been provided to the financial community for informational purposes only and is not intended to serve as a representation, warranty or contract modification of any kind.
Global Clearance and Settlement Procedures
Initial settlement for the Series A Preferred Stock will be made in immediately available funds. Secondary market trading among DTC’s Participants will occur in the ordinary way in accordance with DTC’s rules and will be settled in immediately available funds using DTC’s Same-Day Funds Settlement System.
Transfer Agent and Registrar
The transfer agent and registrar for our Series A Preferred Stock is American Stock Transfer & Trust Company, LLC. The transfer agent and registrar’s address is 6201 15th Avenue, Brooklyn, New York 11219, and its telephone number is (718) 921-8300.
Listing
Our Series A Preferred Stock is listed on the NYSE under the ticker symbol “EFC PR A.”

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CERTAIN PROVISIONS OF DELAWARE LAW AND OUR CERTIFICATE OF INCORPORATION AND BYLAWS
Conversion and Incorporation
Our predecessor, Ellington Financial LLC, was formed as a limited liability company in Delaware in 2007, and was converted to a corporation as a result of the Conversion effective as of 11:59 P.M. Eastern Time on March 1, 2019.
Purpose
Under our certificate of incorporation, we are permitted to engage in any lawful act or activity (including, without limitation or obligation, engaging in business as a REIT under the Code) for which corporations may be organized under the DGCL as now or hereafter in force.
Election of Members of Our Board of Directors
Members of our Board of Directors are elected by stockholders based on a plurality of the votes cast.
Removal of Members of Our Board of Directors
Any director or the entire Board of Directors may be removed with or without cause by a vote of at least 66 2/3% of the votes entitled to be cast in the election of directors. The vacancy in the Board of Directors caused by any such removal will be filled by a vote of the majority of directors then in office even if the remaining directors do not constitute a quorum.
Stockholder Meetings
Under our bylaws, we are required to hold an annual meeting of stockholders for the election of directors and other business on a date and time to be set by the Board of Directors. In addition, our bylaws provide that a special meeting of stockholders may be called by our Board of Directors and certain of our officers. Our bylaws further provide that, subject to the satisfaction of certain procedural and information requirements, a special meeting of stockholders shall be called by the Secretary of the company upon written request of stockholders entitled to cast not less than a majority of all of the votes entitled to be cast at such meeting.
Advance Notice of Nominations and Stockholder Business
Our bylaws establish advance notice procedures with respect to stockholder proposals and the nomination of persons for election as directors at the annual meeting of our stockholders.
Stockholder Action by Written Consent
Unless our certificate of incorporation provides otherwise or it conflicts with the rules of the NYSE, pursuant to Section 228 of the DGCL, any action required to be taken at any annual or special meeting of the stockholders may be taken without a meeting, without prior notice and without a vote if a consent or consents in writing, setting forth the action so taken, is signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares of our stock entitled to vote thereon were present and voted, unless the certificate of incorporation provides otherwise or it conflicts with the rules of the NYSE. Our certificate of incorporation permits stockholder action by unanimous written consent by stockholders.
Limitations on Liability and Indemnification of Our Directors and Officers
Pursuant to our certificate of incorporation and the DGCL, our directors and officers will not be liable to us, or any subsidiary of ours, or any holder of shares, for monetary damages for any acts or omissions arising from the performance of any of such person’s obligations or duties in connection with us, including breach of fiduciary duty, except as follows: (1) for any breach of the director’s duty of loyalty to us or the holders of the shares; (2) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; or (3) for any transaction from which the director derived an improper personal benefit. The certificate of incorporation provides that, to the fullest extent permitted by law, we will indemnify our directors and officers or any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative, or investigative (other than an action by or in the right of us) by reason of the fact that the person is or was our director, officer, employee, tax matters member or agent, or is or was serving at our request as a director, officer, employee or agent of another company, to the fullest extent permitted by law against expenses (including attorneys’ fees), judgments, fines, and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding if the person acted in good faith and in a

16


manner the person reasonably believed to be in or not opposed to our best interests, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful.
Each of the persons entitled to be indemnified for expenses and liabilities as contemplated above may, in the performance of his, her or its duties, consult with legal counsel and accountants, and any act or omission by such person on our behalf in furtherance of our interests in good faith in reliance upon, and in accordance with, the advice of such legal counsel or accountants will be full justification for any such act or omission, and such person will be fully protected for such acts and omissions; provided that such legal counsel or accountants were selected with reasonable care by or on our behalf.
Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or persons controlling us pursuant to the foregoing provisions, we have been informed that, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.
Amendment of Our Certificate of Incorporation and Bylaws
Under the DGCL, amendments to our certificate of incorporation, with limited exceptions, must be approved by holders of a majority of the total voting power of our outstanding common stock and, to the extent that such amendment would have a material adverse effect on the holders of any class or series of shares, by the holders of a majority of the holders of such class or series. Our Board of Directors may amend, modify or repeal our bylaws without stockholder approval.
Business Combinations
Section 203 of the DGCL, provides that an “interested stockholder” (a person other than the corporation or any direct or indirect majority-owned subsidiary who, together with affiliates and associates, owns, or, if such person is an affiliate or associate of the corporation, within three years did own, 15% or more of the outstanding voting stock of a corporation) may not engage in “business combinations” (which is broadly defined to include a number of transactions, such as mergers, consolidations, asset sales and other transactions in which an interested stockholder receives or could receive a financial benefit on other than a pro rata basis with other stockholders) with the corporation for a period of three years after the date on which the person became an interested stockholder without certain statutorily mandated approvals.
Provisions in our Certificate of Incorporation and Bylaws that may have an Anti-Takeover Effect
Some of the provisions in our certificate of incorporation and bylaws described above could make it more difficult for a third party to acquire, or may discourage a third party from acquiring, control of us. These provisions include, among others:
allowing only our Board of Directors to fill newly created directorships,
requiring advance notice for our stockholders to nominate candidates for election to our Board of Directors or to propose business to be considered by our stockholders at a meeting of our stockholders;
requiring that (subject to certain exceptions) no person may own, or be deemed to own by virtue of the attribution provisions of the Code, more than 9.8% of the aggregate value or number (whichever is more restrictive) of our outstanding shares (See “-Restrictions on Ownership and Transfer”); and
limitations on the ability of our stockholders to call special meetings of our stockholders
Certain provisions of the management agreement between us and our Manager also could make it more difficult for third parties to acquire control of us by various means, including limitations on our right to terminate the management agreement and a requirement that, under certain circumstances, we make a substantial payment to our Manager in the event of a termination.
Restrictions on Ownership and Transfer
Our certificate of incorporation, subject to certain exceptions, contains restrictions on the amount of our shares that a person may own and may prohibit certain entities from owning our shares. Our certificate of incorporation provides that (subject to certain exceptions described below) no person may own, or be deemed to own by virtue of the attribution provisions of the Code, more than 9.8% of the aggregate value or number (whichever is more restrictive) of any class or series of our outstanding shares.
Any person who acquires or attempts or intends to acquire beneficial or constructive ownership of our shares that will or may violate any of the foregoing restrictions on transferability and ownership, or who is the intended transferee of our common stock which are transferred to the trust (as described below), will be required to give notice immediately to us, or in the case of

17


proposed or attempted transactions will be required to give at least 15 days written notice to us, and provide us with such other information as we may request in order to determine the effect of such transfer, including, without limitation, the effect on our status as a REIT.
Our Board of Directors, in its sole discretion, may exempt a person from the foregoing restrictions. The person seeking an exemption must provide to our Board of Directors such representations, covenants and undertakings as our Board of Directors may deem appropriate. Our Board of Directors may also condition any such exemption on the receipt of a ruling from the IRS or an opinion of counsel as it deems appropriate.
Any attempted transfer of our securities which, if effective, would result in a violation of the foregoing restrictions (other than those described in the preceding paragraph) will cause the number of securities causing the violation (rounded to the nearest whole share) to be automatically transferred to a trust for the exclusive benefit of one or more charitable beneficiaries, and the proposed transferee will not acquire any rights in such securities. The automatic transfer will be deemed to be effective as of the close of business on the business day (as defined in our certificate of incorporation) prior to the date of the transfer. If, for any reason, the transfer to the trust does not occur, our certificate of incorporation provides that the purported transfer in violation of the restrictions will be void ab initio. Shares held in the trust will be issued and outstanding shares. The proposed transferee will not benefit economically from ownership of any securities held in the trust, will have no rights to dividends or other distributions and no rights to vote or other rights attributable to the shares held in the trust. The trustee of the trust will have all voting rights and rights to distributions with respect to common stock held in the trust. These rights will be exercised for the exclusive benefit of the charitable beneficiary. Any distribution paid prior to our discovery that shares of stock have been transferred to the trust will be paid by the recipient to the trustee upon demand. Any distribution authorized but unpaid will be paid when due to the trustee. Any distribution paid to the trustee will be held in trust for the charitable beneficiary. Subject to Delaware law and pursuant to our certificate of incorporation, the trustee will have the authority (1) to rescind as void any vote cast by the proposed transferee prior to our discovery that the shares have been transferred to the trust and (2) to recast the vote in accordance with the desires of the trustee acting for the benefit of the charitable beneficiary. However, if we have already taken irreversible corporate action, then the trustee will not have the authority to rescind and recast the vote.
Within 20 days of receiving notice from us that the shares have been transferred to the trust, the trustee will sell the shares to a person designated by the trustee, whose ownership of the shares will not violate the above ownership limitations. Upon such sale, the interest of the charitable beneficiary in the shares sold will terminate and the trustee will distribute the net proceeds of the sale to the proposed transferee and to the charitable beneficiary as follows. The proposed transferee will receive the lesser of (1) the price paid by the proposed transferee for the shares or, if the proposed transferee did not give value for the shares in connection with the event causing the shares to be held in the trust (e.g., a gift, devise or other similar transaction), the market price (as defined in our certificate of incorporation) of the shares on the day of the event causing the shares to be held in the trust and (2) the price received by the trustee from the sale or other disposition of the shares. Any net sale proceeds in excess of the amount payable to the proposed transferee will be paid immediately to the charitable beneficiary. If, prior to our discovery that the shares have been transferred to the trust, the shares are sold by the proposed transferee, then (1) the securities shall be deemed to have been sold on behalf of the trust and (2) to the extent that the proposed transferee received an amount for the shares that exceeds the amount the proposed transferee was entitled to receive, the excess shall be paid to the trustee upon demand.
In addition, the securities held in the trust will be deemed to have been offered for sale to us, or our designee, at a price per share equal to the lesser of (1) the price per share in the transaction that resulted in the transfer to the trust (or, in the case of a devise or gift, the market price at the time of the devise or gift) and (2) the market price on the date we, or our designee, accept the offer. We will have the right to accept the offer until the trustee has sold the shares. Upon a sale to us, the interest of the charitable beneficiary in the shares sold will terminate and the trustee will distribute the net proceeds of the sale to the proposed transferee.
All certificates representing the shares bear a legend referring to the restrictions described above.
These ownership limitations could delay, defer or prevent a transaction or a change in control that might involve a premium price for the shares or might otherwise be in the best interests of our stockholders.

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Exhibit 21.1

List of Subsidiaries of Ellington Financial LLC
Name
 
State of Incorporation or Organization
EF Mortgage LLC
 
Delaware
EF Securities LLC
 
Delaware
EF CMO LLC
 
Delaware
Ellington Financial Operating Partnership LLC
 
Delaware
EF Corporate Holdings LLC
 
Delaware
EF MBS/ABS Holdings LLC
 
Delaware
EFQ LLC
 
Delaware
EF SBC 2013-1 LLC
 
Delaware
EF Holdco Inc.
 
Delaware
EF Cayman Holdings Ltd.
 
Cayman Islands
EF SBC 2013-1 REO Holdings LLC
 
Delaware
EF CH LLC
 
Delaware
Ellington Financial REIT
 
Maryland
EF Residential Loans LLC
 
Delaware
EF SBC 2015-2 LLC
 
Delaware
Ellington Financial REIT TRS LLC
 
Delaware
EF SBC 2015-1 LLC
 
Delaware
EF CH2 LLC
 
Delaware
EF CH3 LLC
 
Delaware
EF CH4 LLC
 
Delaware
EF NM 2015-1 LLC
 
Delaware
EF SBC 2016-1 LLC
 
Delaware
EF Holdco WRE Assets LLC
 
Delaware
EF Holdco RER Assets LLC
 
Delaware
EF Holdco AL Assets LLC
 
Delaware
EF Titan SBC 2016-1 LLC
 
Delaware
EF SBC FM Holdings LLC
 
Delaware
EF Edgewood SBC 2016-1 LLC
 
Delaware
EF Edgewood SBC 2018-1 LLC
 
Delaware
EF Mortgage Depositor LLC
 
Delaware
EF Mortgage Depositor II LLC
 
Delaware
EF Holdco WRE Assets REO LLC
 
Delaware
Ellington Financial REIT Cayman Ltd.
 
Cayman Islands
Armstrong Securities Holdings LLC
 
Delaware
Armstrong Securities LLC
 
Connecticut


Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration Statement on Form S-3 (No. 333-230416) of Ellington Financial Inc. of our report dated March 13, 2020 relating to the financial statements and the effectiveness of internal control over financial reporting, which appears in this Form 10-K.
/s/ PricewaterhouseCoopers LLP
New York, New York
March 13, 2020





Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Laurence Penn, certify that:
1. I have reviewed this Annual Report on Form 10-K of Ellington Financial Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date:
March 13, 2020
 
 
 
 
 
 
 
 
 
 
 
 
/s/ Laurence Penn
 
 
 
 
Laurence Penn
 
 
 
 
Chief Executive Officer
(Principal Executive Officer)




Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, JR Herlihy, certify that:
1. I have reviewed this Annual Report on Form 10-K of Ellington Financial Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date:
March 13, 2020
 
 
 
 
 
 
 
 
 
 
 
 
/s/ JR Herlihy
 
 
 
 
JR Herlihy
 
 
 
 
Chief Financial Officer
 
 
 
 
(Principal Financial and Accounting Officer)




Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Ellington Financial Inc. (the “Company”) on Form 10-K for the year ended December 31, 2019, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Laurence Penn, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
 
Date:
March 13, 2020
 
 
/s/ Laurence Penn
 
 
 
 
Laurence Penn
Chief Executive Officer
(Principal Executive Officer)




Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Ellington Financial Inc. (the “Company”) on Form 10-K for the year ended December 31, 2019, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, JR Herlihy, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
 
Date:
March 13, 2020
  
 
/s/ JR Herlihy
 
 
  
 
JR Herlihy
Chief Financial Officer
(Principal Financial and Accounting Officer)