DYNEX CAPITAL INC (DX) FY 2022 MD&A

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our financial statements and the related notes included in Item 8, "Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.

This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors including, but not limited to, those disclosed in Item 1A, “Risk Factors” elsewhere in this Annual Report on Form 10-K and in other documents filed with the SEC and otherwise publicly disclosed. Please refer to “Forward-Looking Statements” contained within this Item 7 for additional information. This discussion also contains non-GAAP financial measures, which are discussed in the section “Non-GAAP Financial Measures.”

For a complete description of our business including our operating policies, investment philosophy and strategy, financing and hedging strategies, and other important information, please refer to Item 1 of Part I of this Annual Report on Form 10-K.

EXECUTIVE OVERVIEW

Early in 2022, the markets continued to transition away from the COVID-19 pandemic, marked by broad shutdowns and supply chain issues, and began to focus on surging inflation, partially caused by unprecedented fiscal stimulus during the pandemic. The war in Ukraine brought new issues to consider, including major sanctions on Russia and the near-term impact on both food and energy exported by both countries as well as the longer-term impact on global trade. Primarily in response to rising global inflation, yields during the first quarter and into the second quarter experienced the fastest and the largest percentage change since 1980, and in an attempt to control inflation, the Federal Reserve clearly signaled that the quantitative easing cycle was over and tightening would begin.

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As the market started to adjust to the shift in monetary policy and sharply rising energy prices, market volatility also increased. Yields across the U.S. Treasury curve rose but were also volatile, marked by both dramatic increases and decreases in short periods of time, and the market demonstrated no signs of stability. Realized volatility, which is a measure of how much prices actually move in a given day, was the highest it has been since the early 1980s, and this level of volatility existed across many asset classes including MBS, Treasuries, equities, credit assets, currencies and cryptocurrencies. Agency RMBS lead the way on spread widening as they are directly linked to the reduction of the Federal Reserve’s asset purchase program and its balance sheet, but many other fixed income sectors also experienced significant spread widening in 2022.

Extreme interest rate volatility and spread widening continued, particularly in September and October, as rates rose rapidly and market direction was uncertain. Central banks across the globe struggled to fight inflation while attempting to balance growth and financial stability. As we closed out 2022, the Federal Reserve started to signal a slowing down or stopping of U.S. Federal Funds rate increases in 2023, which provided the market some stability. The market began projecting the end of rate increases and started projecting rate cuts in the near future, leading to an inversion of the yield curve. The perception of some certainty also spurred buying activity and as a result, spreads tightened from the widest levels experienced in the third and fourth quarter of 2022.

The charts below show the range of U.S. Treasury rates and information regarding market spreads as of and for the periods indicated:

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(1)Option adjusted spreads (“OAS”) are based on Company estimates using third-party models and market data. OAS shown for prior periods may differ from previous disclosures because.the Company regularly updates the third-party model used.

(2)Data represents the spread to swap rate on newly issued securities and is sourced from JP Morgan.

Summary of Our 2022 Performance

Regardless of the macroeconomic environment in which we operate, we seek to preserve book value for our shareholders. The degree of uncertainty and amount of volatility in the macroeconomic environment precluded us from accepting more risk, and so we remained focused on minimizing the impact of higher interest rates and spread widening by maintaining leverage within a lower range and increasing our available liquidity. To minimize the loss in fair value of our investments from higher interest rates, we continuously monitored and adjusted our hedge position throughout the year as macroeconomic views and market factors changed. We mitigated additional losses in book value from spread widening by strategically repositioning the coupon distribution in our investment portfolio throughout the year. Despite these measures, the loss of fair value from our investment portfolio exceeded the gains from our interest rate hedges (excluding TBA drop income) by $96.8 million, and as a result, we reported a comprehensive loss to common shareholders of $(52.6) million, or $(1.24) per common share for the year ended December 31, 2022 and a decline of $(3.26) in book value per common share to $14.73 as of December 31, 2022. Book value declined primarily from significant spread widening, particularly in September and October, and which ended the year much wider than at December 31, 2021. Total economic loss to our common shareholders, which consists of the decline in book value of $(3.26) offset by dividends declared of $1.56, was $(1.70) per common share, or (9.5)% of beginning book value.

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The following table provides details about the changes in our financial position during the year ended December 31, 2022:

(1)Common shareholders’ book value is equal to total shareholders' equity less the aggregate liquidation preference of the Company's preferred stock of $111,500.

(2)Net proceeds from stock issuance include $246.9 million from common stock ATM program and $3.0 million from share-based compensation grants, net of amortization. The amount shown for “per common share” includes the impact of the increase in the number of common shares outstanding.

During 2022, we raised equity of $246.9 million through our common stock ATM program at an average net issue price of $14.63 per common share compared to an average market price of approximately $15.01 per common share. These issuances contributed to the decline in book value per common share for 2022, but increased our capital base and liquidity. We expect to use this additional liquidity to add assets to our balance sheet with returns in the mid- teens, which exceeds our dividend yield to year end book value per common share of approximately 10.6%. We used a portion of these proceeds during 2022 to purchase $1.5 billion of primarily Agency RMBS at wider spreads and with lower premiums or, in some cases, below par. Our average portfolio including TBAs increased 20% during the year ended December 31, 2022 primarily as a result of these purchases, which led to an increase in our interest income and effective yield relative to the prior year. However, the rate hikes by the Federal Reserve during 2022 significantly increased our borrowing costs, and as a result, our net interest income for the year ended December 31, 2022 declined $(11.3) million compared to the year ended December 31, 2021.

Current Outlook

As the macroeconomic environment continues to evolve, we are approaching the markets with discipline and are preparing for many possible outcomes, given the degree of volatility and uncertainty that exists today. We remain in an unprecedented era of quantitative tightening which, if maintained, will continue to change the dynamics around the price of risk. Over time, we expect excess liquidity will continue to be drained from the system, which means less

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cash will remain to take on evolving risks as central banks continue to tighten monetary policy. In our opinion, this could create an environment of persistently higher returns as investors adjust expectations for an era of higher interest rates, scarcer capital, and less central bank involvement in the pricing of risk. This is a core tenet of our long-term view for portfolio construction and risk posture. Absent an abrupt turnaround in quantitative tightening by the Federal Reserve, there is a higher probability of more repricing of risk in 2023.

Unlike 2020, when the direction of interest rates and Federal Reserve policy was clearer, the current market is marked with uncertainty. The global economy is increasing in complexity given many factors including energy, human conflict, geopolitics, inflation, climate change, war, sanctions, and significant changes in global trading partners. Central banks are facing conflicting mandates between supporting employment and generating growth versus combating the worst global inflation since the 1970s. The markets continue to seek direction on the level of risk, rates, and curve. We believe the markets are pricing in a high degree of certainty that the Federal Reserve will cut rates in the medium-term in reaction to a slowdown in the economy. The markets also seem to have a high degree of confidence that inflation will approach the Federal Reserve’s target of 2% as soon as early 2024.

We also remain prepared for the possibility of continuing inflation pressures and coordinated hawkish behavior across global central banks. We expect that these factors will define the range in interest rates and keep market volatility elevated.

Given this backdrop, we believe there is potential for good investment opportunities ahead. For the first time since the 1970s, there will be no secondary market presence from the GSE’s or the Federal Reserve. The demand previously provided by the Federal Reserve must be replaced by private capital, particularly as current conditions do not favor banks absorbing the net supply. We believe we will be presented with additional opportunities to invest in assets with highly accretive returns. We have capacity to increase leverage and have liquidity to deploy into assets in the near and medium term that will benefit our earnings and book value well into the future. We continue to focus on minimizing large downside risk to book value while maintaining an opportunistic stance, highly liquid and flexible balance sheet position, and our eyes on the horizon for attractive investments across the mortgage-backed security landscape.

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FINANCIAL CONDITION

Investment Portfolio

Our investment portfolio as of December 31, 2022 increased approximately 33% (based on amortized cost) since December 31, 2021. Because we have been maintaining a highly liquid and lower leverage profile, we have deployed capital during intermittent periods of spread widening into assets with higher forward returns that are forecasted to meet or exceed our cost of capital raising during 2022. The following chart compares the composition of our MBS portfolio including TBA securities as of the dates indicated:

To minimize losses due to spread volatility, we frequently changed the coupon distribution in our Agency RMBS and TBA portfolios throughout 2022. During the first quarter, we shifted from lower coupon TBA securities into 3.0% and 3.5% while keeping our specified pools of Agency RMBS in predominantly 2.0% and 2.5% coupons. In the second quarter of 2022, we diversified our coupon exposure into 4.0% and 4.5% TBA securities and sold a portion of our lower coupon Agency RMBS, which initially bore the brunt of spread widening. Though we realized losses for some of the premium we paid on lower coupon securities sold during this shift, purchases of higher coupon Agency RMBS made when spreads widened during the third quarter were at a discount to par, which will be accreted into income over time as principal payments are received. As the year progressed, the coupon distribution of our Agency RMBS and TBA portfolios expanded into higher coupons to mitigate the impact of higher financing rates on our net interest income as well as to minimize book value loss due to higher interest rates.

Spreads tightened modestly toward the end of 2022 relative to their widest during September and October 2022 and have remained tighter in the early weeks of 2023; however, we expect spreads will remain volatile and range-bound in the intermediate term while the Federal Reserve continues reducing MBS from its balance sheet. Longer term, as investors return to the MBS market and demand improves, we expect the fair value of our investment portfolio to increase and our book value to recover.

The following tables compare our fixed-rate Agency RMBS investments, including TBA dollar roll positions, as of the dates indicated:

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(1)Implied cost basis of TBAs represents the forward price to be paid for the underlying Agency MBS.

(2)Fair value of TBAs is the implied market value of the underlying Agency security as of the end of the period.

(3)TBAs are included on the consolidated balance sheet within “derivative assets/liabilities” at their net carrying value which is the difference between their implied market value and implied cost basis. Please refer to Note 5 of the Notes to the Consolidated Financial Statements for additional information.

(4)TBAs are excluded from this calculation as they do not have a defined weighted-average loan balance or age until mortgages have been assigned to the pool.

(5)Constant prepayment rate (“CPR”) represents the 3-month CPR of Agency RMBS held as of date indicated.

(6)Duration measures the sensitivity of a security's price to the change in interest rates and represents the percent change in price of a security for a 100-basis point increase in interest rates. We calculate duration using third-party financial models and empirical data. Different models and methodologies can produce different estimates of duration for the same securities.

(7)Represents the weighted average market yield projected using cash flows generated off the forward curve based on market prices as of the date indicated and assuming zero volatility.

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The remainder of our MBS portfolio is mostly comprised of Agency CMBS, Agency CMBS IO, and non-Agency CMBS IO. Our Agency CMBS and Agency CMBS IO are backed by loans collateralized by multifamily properties and our non-Agency CMBS IO, which were all originated prior to 2018, are backed by loans collateralized by a number of different property types, including retail, office, multifamily, hotel, and other properties. In the current macroeconomic environment, we are not actively purchasing CMBS or CMBS IO as these securities are experiencing wider spreads and supply of new originations is significantly limited.

The following table provides certain information regarding our CMBS and CMBS IO as of the dates indicated:

Repurchase Agreements

We have not experienced any difficulty in securing financing with any of our counterparties, and our repurchase agreement counterparties have not indicated any concerns regarding leverage or credit. We expect our financing costs will continue to increase in 2023 as the Federal Reserve is expected to continue increasing the Federal Funds Rate. Please refer to Note 4 of the Notes to the Consolidated Financial Statements contained within this Annual Report on Form 10-K as well as “Results of Operations” and “Liquidity and Capital Resources” contained within this Item 7 for additional information relating to our repurchase agreement borrowings.

Derivative Assets and Liabilities

Our interest rate hedging portfolio increased since December 31, 2021 by a net notional of $1.0 billion in short positions of U.S. Treasury futures and $250.0 million in options on U.S. Treasury futures. As interest rate volatility increased and the direction of interest rates became less certain during the first half of 2022, we moved to a shorter duration position relative to the beginning of 2022. As rates sold off late in the third quarter of 2022, we removed a portion of our hedges in order to better protect book value in flattening or inverted yield curve environments. Please refer to Note 5 of the Notes to the Consolidated Financial Statements for details on our interest rate derivative instruments as well as “Quantitative and Qualitative Disclosures about Market Risk” in Item 7A of this Annual Report on Form 10-K.

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RESULTS OF OPERATIONS

The discussion below includes both GAAP and non-GAAP financial measures that management utilizes in its analysis of financial and operating performance. Please read the section “Non-GAAP Financial Measures” at the end of this section for additional important information about these financial measures.

Year Ended December 31, 2022 Compared to the Year Ended December 31, 2021

Net Interest Income

The following table presents information about our interest-earning assets and interest-bearing liabilities and their performance for the periods indicated:

(1)Average balance for assets is calculated as a simple average of the daily amortized cost and excludes securities pending settlement if applicable.

(2)Average balance for liabilities is calculated as a simple average of the daily borrowings outstanding during the period.

(3)Effective yield is calculated by dividing interest income by the average balance of asset type outstanding during the reporting period. Unscheduled adjustments to premium/discount amortization/accretion, such as for prepayment compensation, are not annualized in this calculation.

(4)Cost of funds is calculated by dividing annualized interest expense by the total average balance of borrowings outstanding during the period with an assumption of 360 days in a year.

(5)Includes Agency and non-Agency issued securities.

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Net interest income and net interest spread declined for the year ended December 31, 2022 compared to the year ended December 31, 2021 due to the higher Federal Funds Rate impacting the cost of repurchase agreement financing of our investment portfolio. The increase in interest expense/cost of funds was partially offset by higher interest income due to a larger average balance of higher yielding investments outstanding during the year ended December 31, 2022 compared to the year ended December 31, 2021. Our effective yield increased because the higher interest rate environment during the year ended December 31, 2022 resulted in slower prepayments speeds on our existing portfolio of mostly lower coupon Agency RMBS, thereby lowering our premium amortization expense. In addition, our purchases during the year ended December 31, 2022 have been higher coupon assets with lower premiums than what previously existed in our investment portfolio, and some purchases were at a discount to par.

Adjusted Net Interest Income. Please refer to the section “Non-GAAP Financial Measures” for additional information about non-GAAP financial measures used by management to evaluate results of operations.

(1) TBA drop income is calculated by multiplying the notional amount of the TBA dollar roll positions by the difference in price between two TBA securities with the same terms but different settlement dates.

(2) The impact of TBA drop income on adjusted net interest spread includes the implied average funding cost of TBA dollar roll transactions during the periods indicated.

We estimate the implied net interest spread on our TBA dollar roll transactions for the year ended December 31, 2022 to be 1.86% compared to 2.19% for the year ended December 31, 2021. The decline in implied net interest spread was due to significantly higher implied financing rates, which have increased more than our repurchase agreement financing costs on our Agency RMBS. We continue to invest in TBAs because they are more liquid relative to specified pools of Agency RMBS, which offers us greater flexibility in a volatile interest rate environment should we decide to change our exposure to leverage and duration.

Gains (Losses) on Investments and Derivative Instruments

The following tables provide details on realized and unrealized gains and losses within our investment and interest rate hedging portfolios for the periods indicated:

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(1)Realized and unrealized gains (losses) on TBA securities are recorded within “gain (loss) on derivative instruments, net” on the Company’s consolidated statements of comprehensive income.

(2)The Company did not hold any interest rate swaptions as of December 31, 2022. The unrealized loss of $(3.2) million shown for the year ended December 31, 2022 represents the reversal of the unrealized gain recorded prior to the maturity date of the contract.

Our interest rate hedges mitigated the impact of higher interest rates on the fair value of our investment portfolio during the year ended December 31, 2022; however, we experienced spread widening across all of our asset classes throughout 2022. As a result, the decline in the fair value of our investments including TBA securities exceeded the gains from our interest rate hedges by $54.2 million. For the year ended December 31, 2021, the benefit from our interest rate hedges was lower compared to the year ended December 31, 2022 because we hedged a lower percentage of our assets and the yield curve was steeper relative to the year ended December 31, 2022.

For the year ended December 31, 2022, we had capital losses of $(398.6) million, which may not be used to reduce taxable income in 2022. Likewise, the majority of realized gains on our interest rate hedges of $690.7 million during the year ended December 31, 2022 will not be recognized in taxable income for 2022. For additional information, please refer to “Liquidity and Capital Resources-Dividends” within this Item 7 as well as "Operating and Regulatory Structure" within Part I, Item 1, "Business" of this Annual Report on Form 10-K.

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General and Administrative Expenses

General and administrative expenses for the year ended December 31, 2022 increased $8.3 million compared to the year ended December 31, 2021 due to higher compensation expenses, the majority of which related to severance costs for the Company's CFO transition in August 2022, and to the ongoing implementation of a new investment accounting system.

Year Ended December 31, 2021 Compared to the Year Ended December 31, 2020

Please refer to “Results of Operations” within Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021 for a discussion of the results of operations for the year ended December 31, 2021 compared to the year ended December 31, 2020, which is incorporated herein by reference.

Non-GAAP Financial Measures

In evaluating the Company’s financial and operating performance, management considers book value per common share, total economic return (loss) to common shareholders, and other operating results presented in accordance with GAAP as well as certain non-GAAP financial measures, which include the following: earnings available for distribution (“EAD”) to common shareholders (including per common share), adjusted net interest income and the related metric adjusted net interest spread. Management believes these non-GAAP financial measures may be useful to investors because they are viewed by management as a measure of the investment portfolio’s return based on the effective yield of its investments, net of financing costs and, with respect to EAD, net of other normal recurring operating income/expenses. Drop income generated by TBA dollar roll positions, which is included in "gain (loss) on derivatives instruments, net" on the Company's consolidated statements of comprehensive income, is included in these non-GAAP financial measures because management views drop income as the economic equivalent of net interest income (interest income less implied financing cost) on the underlying Agency security from trade date to settlement date.

However, these non-GAAP financial measures are not a substitute for GAAP earnings and may not be comparable to similarly titled measures of other REITs because they may not be calculated in the same manner. Furthermore, though EAD is one of several factors our management considers in determining the appropriate level of distributions to common shareholders, it should not be utilized in isolation, and it is not an accurate indication of the Company’s REIT taxable income or its distribution requirements in accordance with the Tax Code.

Reconciliations of EAD to common shareholders and adjusted net interest income to the related GAAP financial measures are provided below.

(1)Amount includes realized and unrealized gains and losses recorded in net income and other comprehensive income due to changes in the fair value of the Company’s MBS and other investments.

(2)Amount includes unrealized gains and losses from changes in fair value of derivatives and realized gains and losses on terminated derivatives and excludes TBA drop income.

(3)TBA drop income is calculated by multiplying the notional amount of the TBA dollar roll positions by the difference in price between two TBA securities with the same terms but different settlement dates.

(4)The reconciliation for adjusted net interest spread to net interest spread is shown in “Results of Operations - Adjusted Net Interest Income”.

During the years ended December 31, 2022 and December 31, 2021, we primarily used U.S. Treasury futures to hedge the impact of increasing interest rates on our borrowing costs and the fair value of our investments. In the past, we used interest rate swaps to hedge interest rate risk and included the net periodic interest benefit/cost of those instruments in each of the non-GAAP measures mentioned above. Management is using U.S. Treasury futures instead of interest rate swaps because U.S. Treasury futures generally have lower margin requirements and offer more liquidity and flexibility in the current rapidly changing interest rate environment. During the year ended December 31, 2022, the Company realized substantial gains on its U.S. Treasury futures as well as other interest rate hedges which are included in GAAP earnings, but are not included in EAD or adjusted net interest income. Furthermore, because these U.S. Treasury futures and other derivative instruments were designated as hedges for tax purposes, the realized gains will be amortized into REIT taxable income over the next several years. For the year ended December 31, 2022, the tax benefit of our hedge gains is approximately $22.5 million, or $0.53 per common share, which is not included in the Company’s calculation of EAD, but is distributable to common shareholders as part of the Company’s ordinary income calculated for tax purposes. Our deferred tax hedge gains we expect to amortize into future taxable income is estimated to be $695.2 million as of December 31, 2022, which is a significant increase from $27.0 million as of December 31, 2021. Additional information regarding the expected impact of deferred tax hedge amortization on our estimated REIT taxable income is discussed in “Liquidity and Capital Resources.”

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LIQUIDITY AND CAPITAL RESOURCES

Our primary sources of liquidity include borrowings under repurchase arrangements and monthly principal and interest payments we receive on our investments. Additional sources may also include proceeds from the sale of investments, equity offerings, and net payments received from counterparties for derivative instruments. We use our liquidity to purchase investments, to pay amounts due on our repurchase agreement borrowings, and to pay our operating expenses and dividends on our common and preferred stock. We also use our liquidity to meet margin requirements for our repurchase agreements and derivative transactions, including TBA contracts, under the terms of the related agreements. We may also periodically use liquidity to repurchase shares of the Company’s stock.

Our liquidity fluctuates based on our investment activities, our leverage, capital raising activities, and changes in the fair value of our investments and derivative instruments. Our most liquid assets include unrestricted cash and cash equivalents and unencumbered Agency RMBS, CMBS, and CMBS IO. As of December 31, 2022, our most liquid assets were $632.3 million compared to $533.1 million as of December 31, 2021. We are continuing to maintain higher levels of available liquidity and lower absolute levels of leverage to protect our book value and to provide us greater financial flexibility against market volatility, which we believe is likely to continue for the near-term, especially given potential risk events on the horizon, such as the Federal Reserve’s quantitative tightening measures, the impact on global markets stemming from global central bank policies, and the war between Russia and Ukraine.

We continuously assess the adequacy of our liquidity under various scenarios based on changes in the fair value of our investments and derivative instruments due to market factors such as changes in the absolute level of interest rates and the shape of the yield curve, credit spreads, lender haircuts, and prepayment speeds. In performing these analyses, we will also consider the current state of the fixed income markets and the repurchase agreement markets in order to determine if market forces such as supply-demand imbalances or structural changes to these markets could change the liquidity of MBS or the availability of financing. We also communicate frequently with our counterparties. We have not experienced any material changes in the terms of our repurchase agreements with our counterparties, and they have not indicated to us any concerns regarding access to liquidity.

Our perception of the liquidity of our investments and market conditions significantly influences our targeted leverage. In general, our leverage will increase if we view the risk-reward opportunity of higher leverage on our capital outweighs the risk to our liquidity and book value. Our leverage, which we calculate using total liabilities plus the cost basis of TBA long positions, was 6.1 times shareholders’ equity as of December 31, 2022. We include the cost basis of our TBA securities in evaluating our leverage because it is possible under certain market conditions that it may be uneconomical for us to roll a TBA long position into future months, which may result in us having to take physical delivery of the underlying securities and use cash or other financing sources to fund our total purchase commitment.

Our repurchase agreement borrowings are principally uncommitted with terms renewable at the discretion of our lenders and generally have original terms to maturity of overnight to six months, though in some instances we may enter into longer-dated maturities depending on market conditions. We seek to maintain unused capacity under our existing repurchase agreement credit lines with multiple counterparties, which helps protect us in the event of a counterparty's failure to renew existing repurchase agreements. As part of our continuous evaluation of counterparty risk, we maintain our highest counterparty exposures with broker dealer subsidiaries of regulated financial institutions or primary dealers.

The amount outstanding for our repurchase agreement borrowings will typically fluctuate in any given period as it is dependent upon a number of factors, but particularly the extent to which we are active in buying and selling securities, including the volume of activity in dollar roll transactions versus buying specified pools. The following table presents information regarding the balances of our repurchase agreement borrowings as of and for the periods indicated:

For our repurchase agreement borrowings, we are required to post and maintain margin to the lender (i.e., collateral in excess of the repurchase agreement financing) in order to support the amount of the financing. This excess collateral is often referred to as a “haircut” and is intended to provide the lender protection against fluctuations in fair value of the collateral and/or the failure by us to repay the borrowing at maturity. Lenders have the right to change haircut requirements at maturity of the repurchase agreement and may change their haircuts based on market conditions and the perceived riskiness of the collateral pledged. If the fair value of the collateral falls below the amount required by the lender, the lender has the right to demand additional margin, or collateral, to increase the haircut back to the initial amount. These demands are referred to as “margin calls,” and if we fail to meet any margin call, our lenders have the right to terminate the repurchase agreement and sell any collateral pledged. The weighted average haircut for our borrowings as of December 31, 2022 was consistent with prior periods, which has typically averaged less than 5% for borrowings collateralized with Agency RMBS and CMBS and between 13-16% for borrowings collateralized with CMBS IO.

The collateral we post in excess of our repurchase agreement borrowing with any counterparty is also typically referred to by us as “equity at risk,” which represents the potential loss to the Company if the counterparty is unable or unwilling to return collateral securing the repurchase agreement borrowing at its maturity. The counterparties with whom we have the greatest amounts of equity at risk may vary significantly during any given period due to the short-term and generally uncommitted nature of the repurchase agreement borrowings. As of December 31, 2022, the Company had amounts outstanding under 24 different repurchase agreements and did not have more than 5% of equity at risk with any counterparty or group of related counterparties.

We have various financial and operating covenants in certain of our repurchase agreements, which we monitor and evaluate on an ongoing basis for compliance as well as for impacts these customary covenants may have on our operating and financing flexibility. Currently, we do not believe we are subject to any covenants that materially restrict our financing flexibility. We were in full compliance with our debt covenants as of December 31, 2022, and we are not aware of circumstances which could potentially result in our non-compliance in the foreseeable future.

Derivative Instruments

Derivative instruments we enter into may require us to post initial margin at inception and daily variation margin based on subsequent changes in their fair value. Daily variation margin requirements also entitle us to receive collateral from our counterparties if the value of amounts owed to us under the derivative agreement exceeds the

minimum margin requirement. The collateral posted as margin by us is typically in the form of cash. As of December 31, 2022, we had cash collateral posted to our counterparties of $117.8 million under these agreements.

Collateral requirements for interest rate derivative instruments are typically governed by the central clearing exchange and the associated futures commission merchant, which may establish margin requirements in excess of the clearing exchange. Collateral requirements for our TBA contracts are governed by the Mortgage-Backed Securities Division ("MBSD") of the Fixed Income Clearing Corporation and, if applicable, by our third-party brokerage agreements, which may establish margin levels in excess of the MBSD. Our TBA contracts, which are subject to master securities forward transaction agreements published by the Securities Industry and Financial Markets Association as well as supplemental terms and conditions with each counterparty, generally provide that valuations for our TBA contracts and any pledged collateral are to be obtained from a generally recognized source agreed to by both parties. However, in certain circumstances, our counterparties have the sole discretion to determine the value of the TBA contract and any pledged collateral. In such instances, our counterparties are required to act in good faith in making determinations of value. In the event of a margin call, we must generally provide additional collateral on the same business day.

Dividends

As a REIT, we are required to distribute to our shareholders amounts equal to at least 90% of our REIT taxable income for each taxable year after certain deductions. When declaring dividends, our Board of Directors considers the Company’s taxable income, the REIT distribution requirements of the Tax Code, financial performance measures, and maintaining compliance with dividend requirements of the Series C Preferred Stock, along with other factors that the Board of Directors may deem relevant from time to time.

Currently, we are primarily using U.S. Treasury futures to hedge the impact of increasing interest rates on our financing costs and fair value of our investments. Realized and unrealized gains (losses) on these derivative instruments are included in GAAP earnings, but are not included in EAD to common shareholders and are not factored into our repurchase agreement borrowing cost or net interest spread. Our net income for the year ended December 31, 2022 includes $690.7 million of realized gains from derivative instruments which were designated as interest rate hedges for tax purposes. Though these realized gains are included in our GAAP earnings, the majority will not be included in our REIT taxable income for 2022. As a result, our net deferred tax hedge gain has increased substantially to $695.2 million as of December 31, 2022 compared to $27.0 million as of December 31, 2021. The amortization of our net deferred tax hedge gain will be amortized into REIT taxable income over several years, which we expect to mitigate the impact of higher financing costs. We currently estimate our taxable income for 2023 will include approximately $71.3 million from amortization of deferred tax hedge gains. As of December 31, 2022, we also had $408.6 million in capital loss carryforwards, the majority of which expire in 2027, and NOL carryforwards of $9.3 million, which will expire over the next 3 years. Due to these amounts and other temporary and permanent differences between GAAP net income and REIT taxable income coupled with the degree of uncertainty about the trajectory of interest rates, we cannot reasonably estimate how much the deferred tax hedge gains to be recognized will impact our dividend declarations for next year, or in any year.

We generally fund our dividend distributions through our cash flows from operations. If we make dividend distributions in excess of our operating cash flows during the period, whether for purposes of meeting our REIT distribution requirements or other reasons, those distributions are generally funded either through our existing cash balances or through the return of principal from our investments (either through repayment or sale). Please refer to "Operating and Regulatory Structure" within Part I, Item 1, "Business" as well as Part I, Item 1A, “Risk Factors” of this Annual Report on Form 10-K for additional important information regarding dividends declared on our taxable income.

RECENT ACCOUNTING PRONOUNCEMENTS

There were no accounting pronouncements issued during the year ended December 31, 2022 that are expected to have a material impact on the Company’s financial condition or results of operations. Please refer to Note 1 of the Notes to the Consolidated Financial Statements contained within Part I, Item 1 of this Annual Report on Form 10-K for additional information.

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CRITICAL ACCOUNTING ESTIMATES

The discussion and analysis of our financial condition and results of operations are based in large part upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of our consolidated financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. We base these estimates and judgments on historical experience and assumptions believed to be reasonable under current facts and circumstances. Actual results, however, may differ from the estimated amounts we have recorded.

The following discussion provides information on our critical accounting policies that require management's most difficult, subjective or complex judgments, and which may result in materially different results under different assumptions and conditions. Please also refer to Note 1 of our Notes to the Consolidated Financial Statements included within Part II, Item 8 of this Annual Report on Form 10-K for additional information related to significant accounting policies.

Fair Value Measurements. Our Agency MBS, as well as a majority of our non-Agency MBS, are substantially similar to securities that either are actively traded or have been recently traded in their respective market. Pricing services and brokers have access to observable market information through trading desks and various information services. MBS prices are based on prices we receive from third-party pricing services and broker quotes. To determine each security's valuation, the pricing service uses either a market approach or income approach, both of which rely on observable market data. The market approach uses prices and other relevant information that is generated by market transactions of identical or similar securities, while the income approach uses valuation techniques to convert estimated future cash flows to a discounted present value. Management reviews the assumptions and inputs utilized in the valuation techniques. Examples of these observable inputs and assumptions include market interest rates, credit spreads, cash flows and projected prepayment speeds, among other things.

In addition, management reviews the prices received for each security by comparing those prices to actual purchase and sale transactions, our internally modeled prices that are calculated based on observable market rates and credit spreads, and the prices that our borrowing counterparties use in financing our securities. If the price of a security is obtained from quoted prices for similar instruments or model-derived valuations whose inputs are observable, the security is classified as a level 2 security. The security is classified as a level 3 security if the inputs are unobservable, resulting in an estimate of fair value based primarily on management's judgment. Please refer to Note 6 of the Notes to the Consolidated Financial Statements contained within Part II, Item 8 of this Annual Report on Form 10-K for additional information on fair value measurements.

FORWARD-LOOKING STATEMENTS

Certain written statements in this Annual Report on Form 10-K that are not historical facts constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act, as amended, and Section 21E of the Exchange Act. Statements in this report addressing expectations, assumptions, beliefs, projections, future plans and strategies, future events, developments that we expect or anticipate will occur in the future, and future operating results, capital management, and dividend policy are forward-looking statements. Forward-looking statements are based upon management’s beliefs, assumptions, and expectations as of the date of this report regarding future events and operating performance, taking into account all information currently available to us, and are applicable only as of the date of this report. Forward-looking statements generally can be identified by use of words such as “believe,” “expect,” “anticipate,” “estimate,” “plan,” “may,” “will,” “intend,” “should,” “could” or similar expressions. We caution readers not to place undue reliance on our forward-looking statements, which are not historical facts and may be based on projections, assumptions, expectations, and anticipated events that do not materialize. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statement whether as a result of new information, future events, or otherwise.

Forward-looking statements in this Annual Report on Form 10-K may include, but are not limited to statements about:

•Our business and investment strategy including our ability to generate acceptable risk-adjusted returns and our target investment allocations, and our views on the future performance of MBS and other investments;

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•Our views on the macroeconomic environment, monetary and fiscal policy, and conditions in the investment, credit, interest rate and derivatives markets;

•Our views on inflation, market interest rates and market spreads;

•Our views on the effect of actual or proposed actions of the Federal Reserve or other central banks with respect to monetary policy (including the targeted Federal Funds Rate), and the potential impact of these actions on interest rates, borrowing costs, inflation or unemployment;

•The effect of regulatory initiatives of the Federal Reserve, the Federal Housing Finance Agency, other financial regulators, and other central banks;

•Our financing strategy including our target leverage ratios, our use of TBA dollar roll transactions, and anticipated trends in financing costs including TBA dollar roll transaction costs, and our hedging strategy including changes to the derivative instruments to which we are a party, and changes to government regulation of hedging instruments and our use of these instruments;

•Our investment portfolio composition and target investments;

•Our investment portfolio performance, including the fair value, yields, and forecasted prepayment speeds of our investments;

•Our liquidity and ability to access financing, and the anticipated availability and cost of financing;

•Our capital stock activity including the impact of stock issuances and repurchases;

•The amount, timing, and funding of future dividends;

•Our use of our tax NOL carryforward and other tax loss carryforwards;

•Future competition for, and availability of, investments, financing and capital;

•Estimates of future interest expenses, including related to the Company’s repurchase agreements and derivative instruments;

•The status and effect of legislative reforms and regulatory rule-making or review processes, and the status of reform efforts and other business developments in the repurchase agreement financing market;

•Market, industry and economic trends, and how these trends and related economic data may impact the behavior of market participants and financial regulators;

•Uncertainties regarding the war between Russia and the Ukraine and the related impacts on macroeconomic conditions, including, among other things, interest rates;

•The financial position and credit worthiness of the depository institutions in which the Company’s MBS and cash deposits are held;

•The impact of applicable tax and accounting requirements on us including our tax treatment of derivative instruments such as TBAs, interest rate swaps, options and futures;

•Our future compliance with covenants in our master repurchase agreements, ISDA agreements, and debt covenants in our other contractual agreements;

•Our reliance on a single service provider of our trading, portfolio management, risk reporting and accounting services systems;

•The implementation in a timely and cost-effective manner of our operating platform, which includes trading, portfolio management, risk reporting, and accounting services systems, and the anticipated benefits thereof; and

•Possible future effects of the COVID-19 pandemic.

Forward-looking statements are inherently subject to risks, uncertainties and other factors that could cause our actual results to differ materially from historical results or from any results expressed or implied by such forward-looking statements. Not all of these risks and other factors are known to us. New risks and uncertainties arise over time, and it is not possible to predict those events or how they may affect us. The projections, assumptions, expectations or beliefs upon which the forward-looking statements are based can also change as a result of these risks or other factors. If such a risk or other factor materializes in future periods, our business, financial condition, liquidity and results of operations may vary materially from those expressed or implied in our forward-looking statements.

While it is not possible to identify all factors that may cause actual results to differ from historical results or from any results expressed or implied by forward-looking statements, or that may cause our projections, assumptions, expectations or beliefs to change, some of those factors include the following:

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•the risks and uncertainties referenced in this Annual Report on Form 10-K, especially those incorporated by reference into Part II, Item 1A, “Risk Factors,” and in particular, adverse effects of the ongoing COVID-19 pandemic and any governmental or societal responses thereto;

•our ability to find suitable reinvestment opportunities;

•changes in domestic economic conditions;

•geopolitical events, such as terrorism, war or other military conflict, including increased uncertainty regarding the war between Russia and the Ukraine and the related impact on macroeconomic conditions as a result of such conflict;

•changes in interest rates and credit spreads, including the repricing of interest-earning assets and interest-bearing liabilities;

•our investment portfolio performance particularly as it relates to cash flow, prepayment rates and credit performance;

•the impact on markets and asset prices from changes in the Federal Reserve’s policies regarding the purchases of Agency RMBS, Agency CMBS, and U.S. Treasuries;

•actual or anticipated changes in Federal Reserve monetary policy or the monetary policy of other central banks;

•adverse reactions in U.S. financial markets related to actions of foreign central banks or the economic performance of foreign economies including in particular China, Japan, the European Union, and the United Kingdom;

•uncertainty concerning the long-term fiscal health and stability of the United States;

•the cost and availability of financing, including the future availability of financing due to changes to regulation of, and capital requirements imposed upon, financial institutions;

•the cost and availability of new equity capital;

•changes in our leverage and use of leverage;

•changes to our investment strategy, operating policies, dividend policy or asset allocations;

•the quality of performance of third-party service providers, including our sole third-party service provider for our critical operations and trade functions;

•the loss or unavailability of our third-party service provider’s service and technology that supports critical functions of our business related to our trading and borrowing activities due to outages, interruptions, or other failures;

•the level of defaults by borrowers on loans underlying MBS;

•changes in our industry;

•increased competition;

•changes in government regulations affecting our business;

•changes or volatility in the repurchase agreement financing markets and other credit markets;

•changes to the market for interest rate swaps and other derivative instruments, including changes to margin requirements on derivative instruments;

•uncertainty regarding continued government support of the U.S. financial system and U.S. housing and real estate markets, or to reform the U.S. housing finance system including the resolution of the conservatorship of Fannie Mae and Freddie Mac;

•the composition of the Board of Governors of the Federal Reserve;

•the political environment in the U.S.;

•systems failures or cybersecurity incidents; and

•exposure to current and future claims and litigation.