# Our financing and hedging strategy

We generate income principally from the yields earned on our investment portfolio and, to the extent that leverage is deployed, on the difference between (i) the yields earned on our investments and (ii) the sum of our borrowing costs and hedging costs. We use leverage to increase potential returns to our stockholders and to fund the acquisition of our assets.

As of December 31, 2016 our non-GAAP “at-risk” and GAAP debt-to-equity leverage ratios were 2.9 to 1 and 2.9 to 1, respectively. As of December 31, 2015 our non-GAAP “at-risk” and GAAP debt-to-equity leverage ratios were 3.5 to 1 and 3.4 to 1, respectively. To calculate our leverage ratios, we divide our non-GAAP “at-risk” leverage and our GAAP leverage by our GAAP stockholders equity. We define non-GAAP “at-risk” leverage as the sum of: (i) our GAAP repurchase agreements, (ii) advances from the Federal Home Loan Bank of Cincinnati (“FHLBC Advances”), if any, (iii) repurchase agreements held through affiliated entities but exclusive of any financing utilized through AG Arc (iv) the amount payable on purchases that have not yet settled less the financing remaining on sales that have not yet settled, (v) the consolidated tranche issued by the Consolidated VIE, (vi) the Participation Interest and (vii) our net TBA position (at cost). Our calculations of each type of leverage exclude repurchase agreements and net receivables/payables on unsettled trades pertaining to U.S. Treasury securities due to the highly liquid and temporary nature of these investments. For a tabular representation of our leverage, refer to the “Financing activities” section of Item 7.

Subject to maintaining our qualification as a REIT for U.S. federal income tax purposes and our Investment Company Act exemption, to the extent leverage is deployed, we may use a number of sources to finance our investments. We currently finance the acquisition of certain assets within our portfolio with repurchase agreements. Prior to March 31, 2016, we also financed our Agency RMBS portfolio with FHLBC Advances. As of December 31, 2016, we, either directly or through our equity method investments in affiliates, had master repurchase agreements, (“MRAs”) or loan agreements with 37 counterparties, under which we had borrowed an aggregate \$1.9 billion, on a non-GAAP basis from 23 counterparties. As of December 31, 2016, the borrowings under our repurchase agreements had maturities between January 3, 2017 and September 17, 2019.

In July 2015, our captive insurance subsidiary, MITT Insurance, was granted membership in the Federal Home Loan Bank of Cincinnati (the “FHLBC”) and commenced obtaining advances from the FHLBC. However, in January 2016, the Federal Housing Finance Agency, the FHFA, issued RIN 2590-AA39, Members of Federal Home Loan Banks (“the Final Rule”), which expressly excludes captive insurance companies, such as MITT Insurance (“Excluded Captives”), from being eligible for membership in the FHLBC. Refer to the “Recent government activity” section in Item 7 for more information. As of December 31, 2016, we had no outstanding advances with the FHLBC.

Subject to maintaining our qualification as a REIT and our Investment Company Act exemption, to the extent leverage is deployed, we utilize derivative financial instruments, including interest rate swap agreements, TBAs, interest rate swaptions, credit derivatives and other instruments including Eurodollar futures and U.S. Treasury futures (collectively, “Futures”) and long or short positions in U.S. Treasury securities in an effort to manage and mitigate the interest rate risk associated with the financing of our portfolio. Specifically, we may seek to hedge our exposure to potential interest rate mismatches between the interest we earn on our investments and our borrowing costs caused by fluctuations in short-term interest rates. In utilizing leverage and interest rate hedges, our objectives are to improve risk-adjusted returns and, where possible, to lock in, on a long-term basis, a spread between the yield on our assets and the cost of our financing. As of December 31, 2016, we had entered into \$644.0 million notional amount of interest rate swaps that have variable maturities between October 30, 2017 and December 7, 2026, \$24.0 million notional amount of short positions in U.S. Treasury securities that mature on May 15, 2026 and \$141.5 million notional amount of short positions in U.S. Treasury Futures that have variable maturities between January 27, 2022 and January 27, 2027.

# Risk management strategy

Our overall portfolio strategy is designed to generate attractive returns through various phases of the economic cycle. We believe that our broad approach within the real estate market, which considers all major categories of real estate assets, allows us to invest in a variety of attractive investment opportunities and helps insulate our portfolio from some of the risks that arise from investing in a single collateral type.

The components of our risk management strategy are:

• Disciplined adherence to risk-adjusted return. Our Manager deploys capital only when it believes that risk-adjusted returns are attractive. In this analysis, our Manager considers the initial net interest spread of the investment, the cost of hedging and our ability to optimize returns over time through rebalancing activities. Our Manager’s management team has extensive experience implementing this approach.

• Focus on multiple sectors. Our Manager looks for attractive investment opportunities in all major sectors of the U.S. mortgage market. Our management team evaluates investment opportunities in residential mortgage loans and securities and across a wide spectrum of commercial property types. We believe this approach enables our Manager to identify attractive investments when it believes certain portions of the market are attractively priced or when investment opportunities in one or more sectors are scarce. By pursuing a broad investment strategy within the mortgage market, we believe our investment mortgage portfolio is less exposed to dislocations in specific sectors of the market. We believe a diversified investment portfolio outperforms the traditional single strategy portfolios in the REIT market, with returns that are more resistant to changes in the interest rate and consumer credit environment.

• Concurrent evaluation of interest rate and credit risk. Our Manager seeks to balance our portfolio with both credit risk-intensive assets and interest rate risk-intensive assets. Both of these primary risk types are evaluated against a common risk-adjusted return framework.

• Active hedging and rebalancing of portfolio. Our Manager periodically evaluates our portfolio against pre-established risk tolerances and will take corrective action through asset sales, asset acquisitions, and dynamic hedging activities to bring the portfolio back within these risk tolerances. We believe this approach generates more attractive long-term returns than an approach that either attempts to hedge away a majority of the interest rate or credit risk in the portfolio at the time of acquisition, on the one end of the risk spectrum, or a highly speculative approach that does not attempt to hedge any of the interest rate or credit risk in the portfolio, on the other end of the risk spectrum.

• Opportunistic approach to increased risk. Our Manager’s investment strategy is to preserve our ability to extend our risk taking capacity during periods of changing market fundamentals.

# Investment policies

We comply with investment policies and procedures and investment guidelines (our “Investment Policies”) that are approved by our board of directors and implemented by our Manager. Our Manager reports on our investment portfolio at each regularly scheduled meeting of our board of directors. Our independent directors do not review or approve individual investment, leverage or hedging decisions made by our Manager made in accordance with our Investment Policies.

Our Investment Policies include the following guidelines, among others:

• no investment shall be made that would cause us to fail to qualify as a REIT for federal income tax purposes;

• no investment shall be made that would cause us to be regulated as an investment company under the Investment Company Act;and

• our investments will be in our target assets.

Our Investment Policies may be changed by our board of directors without the approval of our stockholders.

# Our target assets

Our target asset classes and the principal investments in which we invest are as follows:

<table><tr><td>Asset Class</td><td>Principal Investments</td></tr><tr><td>Agency RMBS</td><td>•   RMBS for which Ginnie Mae, Fannie Mae or Freddie Mac
guarantees payments of principal and interest on the securities
they issue.</td></tr><tr><td>Non-Agency RMBS</td><td>•   Fixed and floating-rate residential Non-Agency RMBS, including
investment grade and non-investment grade classes. The
mortgage loan collateral for residential Non-Agency RMBS
consists of residential mortgage loans that do not generally
conform to underwriting guidelines issued by U.S. government
agencies or U.S. government-sponsored entities.</td></tr><tr><td>Other real estate-related assets and financial assets</td><td> •   Fixed and floating-rate CMBS, including investment grade and
non-investment grade classes. CMBS are secured by, or evidence
ownership interest in, a sinlge commercial mortgage loan or a
pool of commercial mortgage loans.</td></tr></table>