Arlington Asset Investment (AAIC) Risk Analysis

We purchase and sell agency MBS 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 our TBAs under which we contract to purchase a TBA agency MBS ( "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 counsel 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.

The declaration, amount and payment of any future dividends on shares of common stock will be at the sole discretion of our Board of Directors. As a REIT, we are required to distribute annually 90% of our REIT taxable income (subject to certain adjustments). So long as we continue to qualify as a REIT, we will generally not be subject to U.S. federal or state corporate income taxes on our REIT taxable income that we distribute to our shareholders on a timely basis. At present, it is our intention to distribute 100% of our REIT taxable income, although we will not be required to do so. We intend to make distributions of our REIT taxable income within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year. As of December 31, 2022, we had estimated NOL carryforwards of $162.5 million that can be used to offset future REIT taxable income and reduce our future distribution requirements. As of December 31, 2022, we also had estimated NCL carryforwards of $155.7 million that can be used to offset future net capital gains. We have not established a minimum dividend payment level and the amount of future dividends, if any, may fluctuate. Our ability to pay dividends may be adversely affected by the risk factors described herein. All distributions will be made at the discretion of our Board of Directors. Our Board of Directors' determination to declare a dividend is based upon multiple factors, including REIT distribution requirements, current financial results, overall economic and market conditions, ongoing liquidity needs, opportunities to return capital to shareholders through accretive stock repurchases, available returns on new investments, and such other factors as our Board of Directors deems relevant from time to time. Our Board of Directors did not declare a dividend on our common stock for any quarter during 2022, and it is uncertain when our Board of Directors will determine to declare future dividends, if any, on our common stock. Accordingly, the timing and amount, if any, of future cash distributions to common stock shareholders is uncertain which may also negatively impact the market price of our common stock.

We measure the fair value of certain of our investments quarterly, in accordance with guidance set forth in FASB Accounting Standards Codification ("ASC") Topic 820, Fair Value Measurements and Disclosures. Ultimate realization of the value of an asset depends to a great extent on economic and other conditions that are beyond our control. Further, fair value is only an estimate based on good faith judgment of the price at which an investment can be sold because market prices of investments can only be determined by negotiation between a willing buyer and seller. If we were to liquidate a particular asset, the realized value may be more than or less than the amount at which such asset is valued. Accordingly, the value of our securities could be adversely affected by our determinations regarding the fair value of our investments, whether in the applicable period or in the future. Additionally, such valuations may fluctuate over short periods of time. Our determination of the fair value of our investments includes prices based on estimates provided by third-party pricing sources including pricing services and dealers. In general, these pricing sources heavily disclaim their valuations. Our credit and MSR related investments trade infrequently and may be considered illiquid. Our determination of the fair value of certain of our credit and MSR related investments are based on significant unobservable inputs based on various assumptions made by our management or third-party pricing services. These significant unobservable inputs may include assumptions regarding future interest rates, prepayment rates, discount rates, costs of servicing, default rates, loss-given-default rates and the timing of credit losses. These assumptions are inherently subjective and involve a high degree of management judgment, and our determinations of fair value may differ materially from the values that would have been used if a public market for these investments existed. Depending on the complexity and liquidity of an investment, valuations of the same investment can vary substantially from one pricing service to another. Our results of operations for a given period could be adversely affected if our determinations regarding the fair market value of these investments are materially different than the values that we ultimately realize upon their disposal.

Most securitizations of mortgage loans require a servicer to manage collections on each of the underlying loans. Both default frequency and default severity of loans may depend upon the quality of the servicer. If servicers are not vigilant in encouraging borrowers to make their monthly payments, the borrowers may be far less likely to make these payments, which could result in a higher frequency of default. If servicers take longer to liquidate non-performing assets, loss severities may tend to be higher than originally anticipated. Additionally, servicers can perform loan modifications, which could potentially impact the value of our securities. The failure of servicers to effectively service the mortgage loans underlying the non-agency MBS in our investment portfolio could negatively impact the value of our investments and our performance. Servicer quality is of prime importance in the default performance of non-agency MBS. If a servicer goes out of business, the transfer of servicing takes time and loans may become delinquent because of confusion or lack of attention. When servicing is transferred, previously advanced principal and interest is often recaptured rapidly by the new servicer, which may have an adverse effect on non-agency MBS credit support. In the case of pools of securitized loans, servicers may be required to advance interest on delinquent loans to the extent the servicer deems those advances recoverable. In the event the servicer does not advance funds, interest may be interrupted, even on more senior securities. Servicers may also advance more than is in fact recoverable once a defaulted loan is disposed, and the loss to the trust may be greater than the outstanding principal balance of that loan (greater than 100% loss severity).

Our investment portfolio 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 asset, downturns relating generally to such region or type of asset may result in defaults on a number of our assets within a short time period, which may reduce our net income and the value of our shares and accordingly reduce our ability to pay dividends to our stockholders. Our portfolio may contain other concentrations of risk, and we may fail to identify, detect or hedge against those risks, resulting in large or unexpected losses. This risk may be more pronounced during times of market volatility and negative economic conditions.

Our investments may include subordinated tranches of non-agency MBS, which are subordinated classes of securities in a structure collateralized by a pool of mortgage loans and, accordingly, are among the first to bear the loss upon a restructuring or liquidation of the underlying collateral and the last to receive payment of interest and principal. Additionally, estimated fair values of these subordinated interests tend to be more sensitive to changes in economic conditions than more senior securities. As a result, such subordinated interests generally are less actively traded and may not provide holders thereof with liquid investments. When we invest in securities that are illiquid, are unrated, have a higher risk of default or are difficult to value, such securities may be considered speculative, and their capacity to pay principal and interest in accordance with the terms of their issue is not certain.

The values of our MSR related assets are highly sensitive to changes in interest rates. The value of MSRs typically increases when interest rates rise and decreases when interest rates decline due to the effect those changes in interest rates have on prepayment estimates. Subject to qualifying and maintaining our qualification as a REIT, we may pursue various hedging strategies to seek to reduce our exposure to adverse changes in interest rates. Our hedging activity will vary in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions. Interest rate hedging may fail to protect or could adversely affect us. To the extent we do not utilize hedging instruments to hedge against changes in the fair value of our MSR related assets, our balance sheet, results of operations and cash flows would be susceptible to significant volatility due to changes in the fair value of, or cash flows from, those assets as interest rates change.

Our investment portfolio includes fixed-rate agency MBS with long-term maturities. The majority of our funding is in the form of repurchase agreements with short-term maturities with an interest rate that resets upon maturity and rolling the repurchase agreement financing to a new maturity date. We are exposed to interest rate risk that fluctuates based on changes in the level or volatility of interest rates and in the shape and slope of the yield curve. Under a normal yield curve, long-term interest rates are higher relative to short-term interest rates. In certain instances, the yield curve can become inverted when the short-term interest rates are higher than the long-term interest rates. A significant risk associated with our portfolio of mortgage-related assets is the risk that both long-term and short-term interest rates will increase significantly. If long-term rates were to increase significantly, the market value of fixed-rate agency MBS would decline and the duration and weighted average life of these MBS would increase. We could realize a loss in the future if the agency MBS in our portfolio are sold. If short-term interest rates were to increase, the financing costs on the repurchase agreements we enter into in order to finance the purchase of MBS would increase, thereby decreasing net interest margin if all other factors remain constant.

We engage in certain hedging transactions to limit our exposure from the adverse effects of changes in interest rates on the borrowing costs of our short-term financing agreements and the value of our fixed-rate agency MBS investment portfolio, and therefore may expose our company to the risks associated with such transactions. We have historically entered into and may enter into interest rate swap agreements, U.S. Treasury note futures, Eurodollar futures, interest rate swap futures, options on U.S. Treasury note futures, options on agency MBS, TBAs or may pursue other hedging strategies. Our hedging activities are generally designed to limit certain exposures and not to eliminate them. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. Such hedging transactions may also limit the opportunity for gain if the values of the portfolio positions should increase. Moreover, it may not be possible to hedge against an interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price. There are no perfect hedging strategies, and interest rate hedging may fail to protect us from loss. The success of our hedging transactions depends on our ability to accurately predict movements of interest rates and credit spreads. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss. Furthermore, our hedging strategies may adversely affect us because hedging activities involve costs that we incur regardless of the effectiveness of the hedging activity, which may decrease our net interest margin. Our hedging activity will vary in scope based on the level and volatility of interest rates and principal prepayments, the amount of leverage, the type of MBS held, the form and tenor of financing arrangements, and other changing market conditions. Interest rate hedging may fail to protect or could adversely affect us because, among other things: - interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;- available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;- the duration of the hedge may not match the duration of the related asset or liability;- the amount of income that a REIT may earn from hedging transactions other than hedging transactions that satisfy certain requirements of the Internal Revenue Code or that are done through a TRS is limited by federal tax provisions governing REITs;- the value of our interest rate hedges declines due to interest rate fluctuations, lapse of time or other factors; and - the party owing money in the hedging transaction may default on its obligation to pay. Our hedging activity may adversely affect our earnings and result in volatile fluctuations in the fair value of our hedges, net income and book value per share.

When the market spread widens between the yield on our mortgage assets and benchmark interest rates, our net book value could decline if the fair value of our mortgage assets falls by more than the offsetting fair value increases on our hedging instruments tied to the underlying benchmark interest rates or if the fair value of our mortgage assets do not increase as much as the fair value decreases on our hedging instruments. We refer to this scenario as an example of "spread risk" or "basis risk." The spread risk associated with our mortgage assets and the resulting fluctuations in fair value of these securities can occur independently of changes in benchmark interest rates and may relate to other factors impacting the mortgage and fixed income markets, such as actual or anticipated monetary policy actions by the Federal Reserve, market liquidity, changes in expected prepayments, or changes in required rates of return on different assets. Consequently, while we use various interest rate hedging instruments to attempt to protect against moves in interest rates, such instruments typically will not protect our net book value against spread risk, which could adversely affect our financial condition and results of operations.

As our repurchase agreements and other short-term borrowings mature, we must either enter into new borrowings or liquidate certain of our investments at times when we might not otherwise choose to do so. Lenders may also seek to use a maturity date as an opportune time to demand additional terms or increased collateral requirements that could be adverse to us and harm our operations. Due to the short-term nature of our repurchase agreements used to finance our investments, our borrowing costs are particularly sensitive to changes in short-term interest rates. An increase in short-term interest rates when we seek new borrowings would reduce the spread between our returns on our assets and the cost of our borrowings and may adversely affect our liquidity position, business, financial condition and results of operations.

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

We currently use repurchase agreements to finance our investments in agency MBS and other mortgage assets. Our repurchase agreements allow the lenders, to varying degrees, to determine a new market value of the collateral to reflect current market conditions. If the market value of the securities pledged or sold by us to a funding source declines in value, as occurred with great regularity during the onset of the COVID-19 pandemic, we may be required by the lender to provide additional collateral or pay down 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, which could adversely affect our business. 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. In the event we do not have sufficient liquidity to satisfy these margin calls, lending institutions can accelerate our indebtedness, increase our borrowing rates, liquidate our collateral and terminate our ability to borrow. Such a situation would likely result in a rapid deterioration of our financial condition and possibly necessitate a filing for protection under the bankruptcy code.

Our interest rate hedging agreements typically require that we pledge collateral on such agreements. We exchange collateral with the counterparties to our interest rate hedging instruments at least on a daily basis based upon daily changes in fair value (also known as "variation margin") as measured by the central clearinghouse through which those instruments are cleared. In addition, the central clearinghouse requires market participants to deposit and maintain an "initial margin" amount which is determined by the clearinghouse and is generally intended to be set at a level sufficient to protect the clearinghouse from the maximum estimated single-day price movement in that market participant's contracts. The clearing exchanges have the sole discretion to determine the value of the instruments. In the event of a margin call, we must generally provide additional collateral on the same business day. In response to events having or expected to have adverse economic consequences or which create market uncertainty, clearing facilities or exchanges upon which our hedging instruments are traded may require us to pledge additional collateral against our hedging instruments. In the event that future adverse economic developments or market uncertainty result in increased margin requirements for our hedging instruments, it could materially adversely affect our liquidity position, business, financial condition and results of operations.

We depend upon repurchase agreement financing to purchase agency MBS and other mortgage assets and reach our target leverage ratio. We cannot assure you that sufficient repurchase agreement financing will be available to us in the future on terms that are acceptable to us. Our lenders also may revise their eligibility requirements for the types of assets they are willing to finance or the terms of such financings based on, among other factors, the regulatory environment and their perceived risk. If we fail to obtain adequate funding or to renew or replace existing funding upon maturity, we will be limited in our ability to implement our business strategy, which will adversely affect our results of operations and may, in turn, negatively affect the market value of your investments in our securities.

We may utilize TBA dollar roll transactions as a means of investing in and financing agency MBS. TBA contracts enable us to purchase or sell, for future delivery, agency MBS with certain principal and interest terms and certain types of collateral, but the particular agency MBS to be delivered are not identified until shortly before the TBA settlement date. Prior to settlement of the TBA commitment, we may choose to move the settlement of the securities out to a later date by entering into an offsetting position (referred to as a "pair off"), net settling the paired off positions for cash, and simultaneously purchasing a similar TBA for a later settlement date, collectively referred to as a "dollar roll." The agency MBS purchased for a forward settlement date under the TBA commitment are typically priced at a discount to agency MBS for settlement in the current month. This difference (or discount) is referred to as the "price drop." As discussed under Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations- "Non-GAAP Core Operating Income," we believe this price drop is the economic equivalent of net interest carry income on the underlying agency MBS over the roll period (interest income less implied financing cost), which is commonly referred to as "dollar roll income." Consequently, dollar roll transactions and such forward purchases of agency MBS represent a form of off-balance sheet financing. Under certain market conditions, TBA dollar roll transactions may result in negative carry income whereby the agency MBS purchased for a forward settlement date under the TBA commitment are priced at a premium to agency MBS for settlement in the current month. Under such conditions, it may be uneconomical to roll our TBA positions prior to the settlement date and we could have to take physical delivery of the underlying securities and settle our obligations for cash. We may not have sufficient funds or alternative financing sources available to settle such obligations. In addition, our TBA commitments are subject to master securities forward transaction agreements published by SIFMA as well as supplemental terms and conditions with each counterparty. Under the terms of these agreements, we may be required to pledge collateral to our counterparty in the event the fair value of our agency MBS commitments decline and such counterparty demands collateral through a margin call. Negative carry income on TBA dollar roll transactions or failure to procure adequate financing to settle our obligations or meet margin calls under our TBA commitments could result in defaults or force us to sell assets under adverse market conditions or through foreclosure and adversely affect our financial condition and results of operations.

Our borrowings under repurchase agreements may qualify for special treatment under the bankruptcy code, giving our lenders the ability to avoid the automatic stay provisions of the bankruptcy code and take possession of and liquidate our collateral under the repurchase agreements without delay if we file for bankruptcy. Furthermore, the special treatment of repurchase agreements under the bankruptcy code may make it difficult for us to recover our pledged assets in the event that any of our lenders file for bankruptcy. Thus, the use of repurchase agreements exposes our pledged assets to risk in the event of a bankruptcy filing by either our lenders or us. In addition, if the lender is a broker or dealer subject to the Securities Investor Protection Act of 1970 or an insured depository institution subject to the Federal Deposit Insurance Act, our ability to exercise our rights to recover our investment under a repurchase agreement or to be compensated for any damages resulting from the lender's insolvency may be further limited by those statutes.

When we engage in a repurchase transaction, we initially sell securities to a counterparty under a master repurchase agreement in exchange for cash from the counterparty. The counterparty is obligated to resell the same securities back to us at the end of the term of the repurchase agreement, which typically is 30 to 60 days, but may have terms from one day to up to one year or more. The cash we receive when we initially sell the collateral is less than the value of the collateral, which is referred to as the "haircut." If the counterparty in a repurchase transaction defaults on its obligation to resell the securities back to us, we will incur a loss on the transaction equal to the amount of the haircut (assuming no change in the value of the securities). Losses incurred on our repurchase transactions would adversely affect our operating results and the market price of our securities.

If we default on one of our obligations under a repurchase agreement, the counterparty may terminate the agreement and cease entering into any other repurchase agreements with us. In that case, we would likely need to establish a replacement repurchase facility with another financial institution in order to continue to leverage the assets in our investment portfolio and to carry out our investment strategy. We may be unable to establish a suitable replacement repurchase facility on acceptable terms or at all.

As of December 31, 2022, we had total unsecured indebtedness (excluding payables, derivative liabilities and repurchase agreement financing) of $87.7 million, which includes $34.9 million in principal amount of our 6.75% Senior Notes due 2025 (the "Senior Notes due 2025"), $37.8 million in principal amount of our 6.00% Senior Notes due 2026 (the "Senior Notes due 2026" and, collectively with the Senior Notes due 2025, the "Senior Notes") and $15.0 million in principal amount of subordinated unsecured long-term debentures due between 2033 and 2035. Our level of indebtedness could have important consequences to you, because: - it could affect our ability to satisfy our financial obligations;- a substantial portion of our cash flows from operations will have to be dedicated to interest and principal payments and may not be available for operations, expansion, acquisitions or general corporate or other purposes;- it may impair our ability to obtain additional debt or equity financing in the future;- it may limit our ability to refinance all or a portion of our indebtedness on or before maturity;- it may limit our flexibility in planning for, or reacting to, changes in our business and industry;- it may make it more difficult to meet REIT distribution requirements; and - it may make us more vulnerable to downturns in our business, our industry or the economy in general. Our operations may not generate sufficient cash to enable us to service our debt. If we fail to make payment on the Senior Notes, we could default on the Senior Notes.

On March 5, 2021, the FCA, which regulates LIBOR, announced that all LIBOR tenors relevant to us will cease to be published or will no longer be representative after June 30, 2023. The FCA's announcement coincides with the March 5, 2021 announcement of LIBOR's administrator, the IBA, indicating that, as a result of not having access to input data necessary to calculate LIBOR tenors relevant to us on a representative basis after June 30, 2023, IBA would have to cease publication of such LIBOR tenors immediately after the last publication on June 30, 2023. These announcements mean that any of our LIBOR-based financial instruments that extend beyond June 30, 2023 will need to be converted to a replacement rate. The U.S. Federal Reserve and the Federal Reserve Bank of New York jointly convened the ARRC, a steering committee comprised of private sector entities, each with an important presence in markets effected by LIBOR, and official-sector entities,including banking and financial sector regulators. The ARCC's initial objectives were to identify risk-free alternative reference rates for USD LIBOR, identify best practices for contract robustness and create an implementation plan. The ARRC has recommended SOFR and, in some cases, the forward-looking term rate based on SOFR published by CME Group Benchmark Administration Limited ("CME Term SOFR") plus, in each case, a recommended spread adjustment, as LIBOR's replacement. The U.S. federal government enacted the Adjustable Interest Rate (LIBOR) Act ("LIBOR Act") to provide for uniform nationwide solution for certain contracts that do not have clear and practical provisions for replacing LIBOR after June 30, 2023. On December 16, 2022, the Federal Reserve Board implemented a final rule that implements the LIBOR Act and identifies replacement benchmark rates based on SOFR to replace overnight, one-month, three-month, six-month and 12-month LIBOR in U.S. contracts that do not mature before LIBOR ends and that lack adequate fallback provisions that would replace LIBOR with a practicable replacement benchmark rate. The final rule also restates the safe harbor protections contained in the LIBOR Act for selection or use of the replacement benchmark rate selected by the Federal Reserve Board and clarifies who would be considered a determining person able to choose to use the replacement benchmark rate selected by the Federal Reserve Board for certain LIBOR contracts. Any of our LIBOR-based borrowings that extend beyond June 30, 2023 will need to be converted to a replacement rate. There are significant differences between LIBOR and SOFR, such as LIBOR being an unsecured lending rate while SOFR is a secured lending rate, and SOFR is an overnight rate while LIBOR reflects term rates at different maturities. If our LIBOR-based borrowings are converted to SOFR, the differences between LIBOR and SOFR, plus the recommended spread adjustment, could result in interest costs that are higher than if LIBOR remained available, which could have a material adverse effect on our operating results. Although SOFR is the ARRC's recommended replacement rate, it is also possible that lenders may instead choose alternative replacement rates that may differ from LIBOR in ways similar to SOFR or in other ways that would result in higher interest costs for us. Furthermore, lenders may select alternative rates sooner than June 30, 2023, either in amendments to existing facilities or as we decide to enter into new facilities. It is possible that not all of our assets and liabilities will transition away from LIBOR at the same time, and it is possible that not all of our assets and liabilities will transition to the same alternative reference rate, in each case increasing the difficulty of hedging. We and other market participants have less experience understanding and modeling SOFR-based assets and liabilities than LIBOR-based assets and liabilities, increasing the difficulty of investing, hedging, and risk management. The process of transition involves operational risks. We are still evaluating the potential effect of LIBOR's end on our borrowing costs and other operations, which remains uncertain given the varying replacement rates and timing. We are party to various financial instruments which include LIBOR as a reference rate that mature or expire after June 30, 2023. As of December 31, 2022, these financial instruments include preferred stock and unsecured notes issued by us. At this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates or any other reforms to LIBOR that may be implemented in the U.K. or elsewhere. While we expect one- and three-month LIBOR to be available in substantially their current form through June 2023, if sufficient banks decline to make submissions to IBA, it is possible that these LIBOR tenors will become unavailable prior to that point. Uncertainty as to the nature of such potential changes, alternative reference rates or other reforms may adversely affect the market for, or value of, any securities, loans, derivatives and other financial obligations on which the interest or dividend is determined by reference to LIBOR, which could negatively impact our overall financial condition or results of operations. More generally, any of the above changes or any other consequential changes to LIBOR or any other "benchmark" as a result of international, national or other proposals for reform or other initiatives or investigations, or any further uncertainty in relation to the timing and manner of implementation of such changes, could have a material adverse effect on the value of and return on any securities based on or linked to a "benchmark."

Liquidity, or ready access to funds, is essential to our business. Failures of similar businesses have often been attributable in large part to insufficient liquidity. Liquidity is of particular importance to our business and perceived liquidity issues may affect our counterparties' willingness to engage in transactions with us. Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption, the payment of significant legal defense and indemnification costs, expenses, damages or settlement amounts, or an operational problem that affects us or third parties. Further, our ability to sell assets may be impaired if other market participants are seeking to sell similar assets at the same time or the market is experiencing significant volatility. Our inability to maintain adequate liquidity would materially harm our business and operations.

Before making certain investments, we may undertake due diligence efforts with respect to various aspects of the acquisition, including investigating the strengths and weaknesses of the originator or issuer of the asset and verifying certain aspects of the underlying securities, loans or properties themselves as well as other factors and characteristics that may be material to the performance of the investment. In making the assessment and otherwise conducting due diligence, we rely on resources available to us and, in some cases, third party information. There can be no assurance that any due diligence process that we conduct will uncover relevant facts that could be determinative of whether or not an investment will be successful.

Investments in mortgage-related assets where repayment of principal and interest is not guaranteed by a U.S. government agency or GSE subject us to the potential risk of loss of principal and/or interest due to delinquency, foreclosure and related losses on the underlying mortgage loans. Residential mortgage loans underlying non-agency residential MBS are secured by residential property and are subject to risks of delinquency, foreclosure and loss. The ability of a borrower to repay a loan secured by residential property is dependent upon the income or assets of the borrower. A number of factors may impair a borrower's ability to repay the loan, including: loss of employment; divorce; illness; acts of God; acts of war or terrorism; adverse changes in national and local economic and market conditions; changes in laws and regulations, fiscal policies and zoning ordinances and the related costs of complying with such laws and regulations, fiscal policies and ordinances; costs of remediation and liabilities associated with environmental conditions such as mold; and the potential for uninsured or under-insured property losses. Business purpose residential mortgage loans are loans to professional real estate investors secured by non-owner occupied residential property that are also subject to risks of delinquency, foreclosure and loss. The properties that secure these mortgage loans often require construction, repair, or rehabilitation and are not income producing. The repayment of the mortgage loans is often largely based on the ability of the borrower to sell the mortgaged property or to convert the property for rental purposes and obtain refinancing in the form of a longer-term loan. The risks of delinquency and foreclosure on these residential properties may be greater than similar risks associated with loans made on the security of single-family, owner-occupied, residential property. The borrower's ability to repay our mortgage loans will depend, to a great extent, on the borrower's ability to complete the construction, repair or rehabilitation of the property in a timely and cost efficient manner as well as the value of the property at the maturity date of the loan. In the event of any default under a mortgage loan held by us, we will bear a risk of loss to the extent of any deficiency between the value of the collateral and 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 make distributions to our shareholders. Commercial mortgage loans are secured by commercial property and are subject to risks of delinquency and foreclosure, and risks of loss that are greater than similar risks associated with loans made on the security of 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 affected by, among other things: tenant mix; success of tenant businesses; property management decisions; property location and condition; competition from comparable types of properties; changes in laws that increase operating expense or limit rents that may be charged; any need to address environmental contamination at the property; the occurrence of any uninsured casualty at the property; changes in national, regional or local economic conditions or specific industry segments; 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; changes in governmental rules, regulations and fiscal policies, including environmental legislation; acts of God, acts of war or terrorism, a pandemic, social unrest and civil disturbances. These risks may be more pronounced during times of market volatility and negative economic conditions.

We have a mortgage loan investment that is secured by the real property of healthcare facilities and guaranteed by the operator of the facilities. The revenues of the operators are primarily driven by occupancy, private pay rates and Medicare and Medicaid reimbursements. Expenses of these facilities are primarily driven by the costs of labor, food, utilities, taxes, insurance and rent. To the extent that any decrease in revenue or increase in operating expenses result in the facilities not generating enough cash to make payments to us, we would have to rely on the creditworthiness of the guarantor and the value of the collateral. To the extent the value of the property is reduced, we may need to reduce the fair value of our mortgage loan investment and we could incur a realized loss upon the disposition of the investment. The healthcare industry is highly competitive. The operators of the facilities securing our mortgage loan investments compete on a local and regional basis with other properties and healthcare providers that provide comparable services. We cannot be certain that the operators of the facilities securing our investments will be able to achieve and maintain occupancy levels and rates that will enable them to meet our borrower's obligations to us. The operators and healthcare facilities securing our investments may also face litigation and may experience rising liability and insurance costs. Litigation brought by individual patients and advocacy groups against operators of facilities can result in large damage awards of alleged abuses and may result in material increases in the costs incurred by operators, including increases to their costs of liability and medical malpractice insurance. The operators and healthcare facilities are also subject to varying levels of federal, state, local and industry-regulated licensures, certification and inspection laws, regulations and standards. The failure to comply with any of these laws, regulations, or standards could result in loss of accreditation, denial of reimbursements, imposition of fines, suspension, decertification or exclusion from federal and state healthcare programs, loss of licensure or closure of the facility. The operators and healthcare facilities rely on reimbursement from third-party payors, including Medicare and Medicaid programs, for their revenues. Changes in the reimbursement rates or methods of payment of insurance companies and Medicare and Medicaid programs could have a material adverse effect on the operators and healthcare facilities securing our mortgage loan investment.

We have investments in MSR related assets that expose us to additional risk of loss. We do not hold the requisite licenses to purchase or hold MSRs directly. However, we have entered into agreements with a licensed, GSE approved residential mortgage loan servicer that enable us to garner the economic return of an investment in an MSR purchased by the mortgage servicing counterparty through an MSR financing transaction. Under the terms of the arrangement, for an MSR acquired by the mortgage servicing counterparty (i) we purchase the "excess servicing spread" from the mortgage servicer counterparty, entitling us to monthly distributions of the servicing fees collected by the mortgage servicing counterparty in excess of 12.5 basis points per annum (and to distributions of corresponding proceeds of sale of the MSRs), and (ii) we fund the balance of the MSR purchase price to the parent company of the mortgage servicing counterparty (the "basic fee") and, in exchange, have an unsecured right to payment of certain amounts determined by reference to the MSR, generally equal to the servicing fee revenue less the excess servicing spread and the costs of servicing (and to distributions of corresponding proceeds of sale of the MSRs), net of fees earned by the mortgage servicing counterparty and its affiliates including an incentive fee. Under GAAP, we account for transactions executed under this arrangement as financing transactions and reflect the associated financing receivables in the line item "MSR financing receivables" on our consolidated balance sheets. The counterparty to our agreements has the approvals from Fannie Mae and Freddie Mac and the requisite state licenses to hold and manage MSRs. While we are the owner of the "excess servicing spread" of the MSR, the mortgage servicing counterparty is the legal owner of the MSR and our right to receive proceeds on our MSR financing receivable from the basic fee component part of the transaction is an unsecured obligation of the mortgage servicing counterparty. If the counterparty were to default under its obligation to return any of the proceeds from the MSR financing receivable to us, we could realize a loss on our mortgage servicing related asset that could adversely affect our financial condition and results of operations. The underlying mortgage loans related to the MSRs the counterparty purchases are subject and subordinate in all respects to the interests of Fannie Mae and Freddie Mac, which includes the right of the applicable agency to terminate the mortgage servicing counterparty with or without cause, the right to sell, retain or have transferred the related MSRs, and the right to direct the sale or transfer process of the related MSRs. A default by the mortgage servicing counterparty in its capacity as servicer relating to its obligations under any acknowledge agreement with an agency, pooling and servicing agreement, agency requirements and/or failure of the servicer to perform its obligations related to any MSR could result in a loss of value of our excess servicing spread of the MSR and a loss in value of our MSR financing receivable that references the MSR. In addition to being subject to regulations by the related agency, mortgage servicers are also subject to extensive federal, state and local laws, regulations and administrative decisions that failure to comply with expose the servicer to fines, damages and losses. In its capacity as servicer, the mortgage servicing counterparty also operates in a highly litigious industry that subject it to potential lawsuits related to billing and collections practices, modification protocols or foreclosure practices. If the MSRs that are referenced to our contractual arrangements are terminated or transferred or if our counterparty incurred significant losses, such mortgage servicing counterparty to our MSR financing receivables may not be able to satisfy its obligation to us which could adversely affect our financial condition and results of operations.

Pursuant to our MSR financing receivables, we are entitled to an unsecured right of payment determined by reference to a pool of specific MSRs owned by the mortgage servicing counterparty. At our election and direction, the mortgage servicing counterparty could utilize leverage on the MSRs that are subject to our MSR financing receivables to finance the purchase of additional MSRs to increase potential returns to us. The lender providing the leverage to our mortgage servicing counterparty would have a secured interest in the MSRs pledged under a credit facility between the lender and our mortgage servicing counterparty. Under the credit facility, if the fair value of the pledged MSR collateral declines and the lender demands additional collateral from our mortgage servicing counterparty through a margin call, we would be required to provide the mortgage servicing counterparty with additional funds to meet such margin call. If we were unable to satisfy such margin call, the lender could liquidate the MSR collateral position that are referenced to our MSR financing receivable to satisfy the loan obligation which would adversely affect our financial condition, liquidity and results of operations.

An owner of an MSR is obligated to fund servicing advances for the payment of principal and interest due to the third-party owners of the loans, property taxes and insurance premiums, legal expenses and other protective advances that have not yet been received from the individual borrowers. Under the arrangements of our MSR financing receivables, we are required to fund to the mortgage servicing counterparty any servicing advances that it is required to fund as the owner of the referenced MSR. These advances may be subject to delays in recovery and may not be recoverable under certain circumstances. During periods of economic disruption, there is a greater possibility that mortgage loan borrowers could request forbearance of their monthly mortgage payments. In addition, agencies and other federal and state regulators may require servicers to grant forbearance under these circumstances. If a borrower is granted forbearance, the owner of the MSR would be required to fund the servicing advances. If we had to fund servicing advances under our mortgage servicing related assets, our liquidity and financial condition could be adversely affected.

We have entered and may in the future enter into repurchase agreements that are structured as sale and repurchase agreements pursuant to which we nominally sell certain of our assets to a counterparty and simultaneously enter into an agreement to repurchase these assets at a later date in exchange for a purchase price. Economically, these agreements are financings that are secured by the assets sold pursuant thereto. We believe that we are treated for REIT asset and income test purposes as the owner of the assets that are the subject of any such sale and repurchase agreement notwithstanding that such agreements may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could assert that we did not own the assets during the term of the sale and repurchase agreement, in which case we could fail to qualify as a REIT.

As a REIT, we generally must distribute annually at least 90% of our REIT taxable income, excluding any net capital gain. If we incur capital losses in excess of capital gains, such net capital losses are not allowed to reduce our taxable income for purposes of determining our distribution requirement. They may be carried forward for a period of up to five years and applied against future capital gains subject to the limitation of our ability to generate sufficient capital gains, which cannot be assured. Accordingly, if we generate a net capital loss during the year, the minimum amount of our REIT taxable income that we are required to distribute could exceed our net earnings for the year resulting in a reduction of our shareholders' equity capital. The difference in character between our gains and losses on our agency MBS and our interest rate hedging transactions could make this situation more likely to occur. The gains and losses on the sale of our agency MBS generally are characterized as capital for U.S. federal income tax purposes. However, our income and losses from interest rate hedging transactions that are designated as hedges generally are characterized as ordinary for U.S. federal income tax purposes. In general, to the extent that interest rates rise, the value of our interest rate hedging instruments increase in value while the value of our fixed-rate agency MBS decrease in value. As a result, we could realize annual ordinary income from our interest rate hedges that would not be offset, for purposes of the REIT distribution requirements, by annual net capital losses on our fixed-rate agency MBS. This could lead to a required distribution to our shareholders in excess of our net earnings, which could result in a reduction in our shareholders' equity.

Prior to the effective time of the Merger, some of our customers, prospective customers or vendors may delay or defer decisions, which could negatively affect our revenues, earnings, cash flows and expenses, regardless of whether the Merger are completed. Similarly, our current and prospective employees may experience uncertainty about their future roles with the combined company following the Merger, which may materially adversely affect our ability to attract and retain key personnel during the pendency of the Merger. In addition, due to operating restrictions in the Merger Agreement, we may be unable, during the pendency of the Merger, to pursue strategic transactions, undertake significant capital projects, undertake certain significant financing transactions and otherwise pursue other actions, even if such actions would prove beneficial.

Either EFC or the Company may terminate the Merger Agreement if the Merger has not been consummated by December 29, 2023. However, this termination right will not be available to a party if that party failed to comply with the Merger Agreement and that failure was the primary cause of, or resulted in, the failure to consummate the Merger on or before December 29, 2023.

Pursuant to the Merger Agreement, we have agreed not to (a) initiate, solicit or knowingly encourage or facilitate any inquiries, proposals or offers for, or that could reasonably be expected to lead to an alternative transaction, (b) enter into or engage in, continue or otherwise participate in any discussions or negotiations in connection with any proposal for an alternative transaction from a third party, (c) furnish non-public information to a third party in connection with or in response to alternative transactions, (d) enter into any binding or nonbinding letter of intent or agreement providing for any such alternative transaction, or (e) withhold, withdraw, modify, qualify or propose publicly to withhold, withdraw, modify or qualify, in any manner adverse to the Company, approval the board recommendation that the shareholders approve the Merger or publicly recommend the approval or adoption of, or publicly approve or adopt any alternative transactions, subject to certain exceptions set forth in the Merger Agreement. These provisions could discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of us from considering or proposing such an acquisition, even if the potential competing acquirer was prepared to pay consideration with a higher per share value than the value proposed to be received or realized in the Merger, or might result in a potential competing acquirer proposing to pay a lower per share value than it might otherwise have proposed to pay because of the added expense of the termination fee that may become payable in certain circumstances under the Merger Agreement.

If the Merger is not completed, our ongoing business could be adversely affected and we will be subject to a variety of risks associated with the failure to complete the Merger, including the following: - the market price of our common stock could decline;- being required, under certain circumstances, to pay to EFC a termination fee of $5 million;- if the Merger Agreement is terminated and our board of directors seeks another business combination, we may not be able to find a party willing to enter into a transaction on terms equivalent to or more attractive than the terms EFC has agreed to in the Merger Agreement;- we may experience negative reactions from the financial markets or our customers, vendors or employees;- having to pay certain costs relating to the proposed Merger, such as legal, accounting, financial advisor, filing, printing and mailing fees; and - diversion of management focus and resources from operational matters and other strategic opportunities while working to implement the Merger. If the Merger is not completed, these risks could materially affect our business, financial results and stock price.

The completion of the Merger may trigger change in control or other provisions in certain agreements to which the Company is a party. If EFC and the Company are unable to negotiate waivers of those provisions, the counterparties may exercise their rights and remedies under the agreements, potentially terminating the agreements or seeking monetary damages. Even if EFC and the Company are able to negotiate waivers, the counterparties may require a fee for such waivers or seek to renegotiate the agreements on terms less favorable to the Company once the Merger is consummated.

The consummation of the Merger is subject to certain conditions, including the receipt of the approval by our shareholders of the Merger and other customary conditions specified in the Merger Agreement. There can be no assurance that the conditions to closing of the Merger will be satisfied or waived or that the Merger will be completed. Failure to consummate the Merger may adversely affect our results of operations and business prospects for the following reasons, among others: (i) we have incurred and will incur certain transaction costs, regardless of whether the proposed Merger close, which could adversely affect our financial condition, results of operations and ability to make distributions to our shareholders; and (ii) the proposed Merger, whether or not they close, will divert the attention of certain of our management and other key employees from ongoing business activities, including the pursuit of other opportunities that could be beneficial to us. In addition, we or EFC may terminate the Merger Agreement under certain circumstances, including, among other reasons, if the Merger is not completed by December 29, 2023, and if the Merger Agreement is terminated under certain circumstances specified in the Merger Agreement, we may be required to pay EFC a termination fee of $5 million. If the Merger is not consummated, the price of our common stock might decline.

We may change our investment strategy, hedging strategy, asset allocation and operational policies at any time without the consent of our shareholders, which could result in our making investment or hedge decisions that are different from, and possibly riskier than, the investments and hedges described in this Annual Report on Form 10-K. A change in our investment or hedging strategy may increase our exposure to interest rate and real estate market fluctuations. A change in our asset allocation could result in us making investments in securities, assets or business different from those described in this Annual Report on Form 10-K. Our Board of Directors oversees our operational policies, including those with respect to our acquisitions, growth, operations, indebtedness, capitalization and distributions and approves transactions that deviate from these policies without a vote of, or notice to, our shareholders. Operational policy changes could adversely affect the market value of our securities and our ability to make distributions to our shareholders. Investing in assets or businesses other than our historical investment strategies may not be successful and could adversely affect our results of operations and the market value of our securities.