UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549









FORM
10-K











(Mark
      One)




x
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For
the fiscal year ended December 31, 2009




or




 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For
the Transition Period from
             to




Commission
file number 001-34385





INVESCO
MORTGAGE CAPITAL INC.


(Exact
name of registrant as specified in its charter)











Maryland
            26-2749336(State
      or other jurisdiction of
              incorporation
      or organization)
            (I.R.S.
      Employer
              Identification
      No.)





1555
      Peachtree Street, N.E., Suite 1800
              Atlanta,
      Georgia
            30309(Address
      of principal executive offices)
            (Zip
      Code)




(404)
892-0896


(Registrant’s
telephone number, including area code)





Securities
registered pursuant to Section 12(b) of the Securities Exchange Act of
1934:





Title
      of Each Class
            Name
      of Each Exchange on Which Registered




Common
Stock, par value $0.01 per
share                                                                                                           New
York Stock Exchange


Securities registered pursuant to
Section 12(g) of the Securities Exchange Act of
1934:None





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.   Yes   ̈    No  x




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act.   Yes   ̈    No  x




Indicate
by check mark whether the registrant: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
  Yes  x    No   ̈




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).   Yes   ̈    No   ̈




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or
any amendment to this Form 10-K. x




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act (check one):





Large accelerated filer   ̈                                              Accelerated
filer   ̈




Non-accelerated
filer  x                                               Smaller
reporting company   ̈




(Do not
check if a smaller reporting company)




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).   Yes   ̈    No  x




The
aggregate market value of the registrant’s common stock held by non-affiliates
was $164,119,000 based on the closing sales price on the New York Stock Exchange
on June 30, 2009.




As of
March 16, 2010, there were 16,938,046 outstanding shares of common stock of
Invesco Mortgage Capital Inc.




Documents
Incorporated by Reference




Part III
of this Form 10-K incorporates by reference certain information (solely to the
extent explicitly indicated) from the registrant’s proxy statement for the 2010
Annual Meeting of Stockholders to be filed pursuant to Regulation
14A.





Invesco
Mortgage Capital Inc.




TABLE
OF CONTENTS





Item
      1.
              Business
              5Item
      1A.
              Risk
      Factors
              14Item
      1B.
              Unresolved
      Staff Comments
              47Item
      2.
              Properties
              48Item
      3.
              Legal
      Proceedings
              48Item
      4.
              Omitted
      and Reserved
              48Part
      IIItem
      5.
              Market
      for Registrants Common Equity, Related Stockholder Matters and IssuerPurchases
      of Equity Securities
              49Item
      6.
              Selected
      Financial Data
              51Item
      7.
              Management’s
      Discussion and Analysis of Financial Conditional and Results of
      Operations
              52Item
      7A.
              Quantitative
      and Qualitative Disclosures About Market Risk
              63Item
      8.
              Financial
      Statements and Supplementary Data
              66Item
      9.
              Changes
      in and Disagreements with Accounts on Accounting and Financial
      Disclosure
              66Item
      9A(T).
              Controls
      and Procedures
              66Item
      9B.
              Other
      Information
              66Part
      IIIItem
      10.
              Directors,
      Executive Officers and Corporate Governance
              67Item
      11.
              Executive
      Compensation
              67Item
      12.
              Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
              67Item
      13.
              Certain
      Relationships and Related Transactions and Director
      Independence
              67Item
      14.
              Principal
      Accountant Fees and Services
              67Part
      IVItem
      15.
              Exhibits,
      Financial Statement Schedules
              68SIGNATURES
              
              93
 
  
  Forward-Looking
Statements


We make
forward-looking statements in this Annual Report on Form 10-K (this “Report”)
and other filings we make with the Securities and Exchange Commission (“SEC”)
within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as
amended, and such statements are intended to be covered by the safe harbor
provided by the same. Forward-looking statements are subject to substantial
risks and uncertainties, many of which are difficult to predict and are
generally beyond our control. These forward-looking statements include
information about possible or assumed future results of our business, financial
condition, liquidity, results of operations, plans and objectives. When we use
the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,”
“intend,” “should,” “may” or similar expressions, we intend to identify
forward-looking statements. Statements regarding the following subjects, among
others, may be forward-looking:


·
            use
      of proceeds of our equity
offerings;





·
            our
      business and investment strategy;





·
            our
      investment portfolio;





·
            our
      projected operating results;





·
            actions
      and initiatives of the U.S. government and changes to
      U.S. government policies;





·
            our
      ability to obtain additional financing
  arrangements;





·
            financing
      and advance rates for our target
assets;





·
            our
      expected leverage;





·
            general
      volatility of the securities markets in which we
  invest;





·
            our
      expected investments;





·
            interest
      rate mismatches between our target assets and our borrowings used to fund
      such investments;





·
            changes
      in interest rates and the market value of our target
    assets;





·
            changes
      in prepayment rates on our target
assets;





·
            effects
      of hedging instruments on our target
assets;





·
            rates
      of default or decreased recovery rates on our target
    assets;





·
            modifications
      to whole loans or loans underlying
securities;





·
            the
      degree to which our hedging strategies may or may not protect us from
      interest rate volatility;





·
            changes
      in governmental regulations, tax law and rates, and similar
      matters;





·
            our
      ability to qualify as a REIT for U.S. federal income tax
      purposes;




·
            our
      ability to maintain our exemption from registration under the 1940
      Act;







3





·
            availability
      of investment opportunities in mortgage-related, real estate-related and
      other securities;





·
            availability
      of qualified personnel;





·
            estimates
      relating to our ability to continue to make distributions to our
      shareholders in the future;





·
            our
      understanding of our
competition; and





·
            market
      trends in our industry, interest rates, real estate values, the debt
      securities markets or the general
economy.







The
forward-looking statements are based on our beliefs, assumptions and
expectations of our future performance, taking into account all information
currently available to us. You should not place undue reliance on these
forward-looking statements. These beliefs, assumptions and expectations can
change as a result of many possible events or factors, not all of which are
known to us. Some of these factors are described in this Report under the
headings “Risk Factors,” “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and “Business.” If a change occurs, our
business, financial condition, liquidity and results of operations may vary
materially from those expressed in our forward-looking statements. Any
forward-looking statement speaks only as of the date on which it is made. New
risks and uncertainties arise over time, and it is not possible for us to
predict those events or how they may affect us. Except as required by law, we
are not obligated to, and do not intend to, update or revise any forward-looking
statements, whether as a result of new information, future events or
otherwise.





4
  PART I








Item 1. Business.





Our
Company





We were
incorporated in Maryland in June 2008 and commenced operations in July
2009.  We are focused on investing in, financing and managing
residential and commercial mortgage-backed securities and mortgage loans, which
we collectively refer to as our target assets.  Our objective is to
provide attractive risk-adjusted returns to our investors, primarily through
dividends and secondarily through capital appreciation. To achieve this
objective, we selectively acquire assets to construct a diversified investment
portfolio designed to produce attractive returns across a variety of market
conditions and economic cycles.
 
 Our
target assets consist of residential mortgage-backed securities (“RMBS”) for
which a U.S. government agency such as the Government National Mortgage
Association (“Ginnie Mae”) or a federally chartered corporation such as the
Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan
Mortgage Corporation (“Freddie Mac”) guarantees payments of principal and
interest on the securities. We refer to these securities as Agency RMBS. Our
Agency RMBS investments include mortgage pass-through securities and may include
collateralized mortgage obligations (“CMOs”). We also invest in RMBS that are
not issued or guaranteed by a U.S. government agency (“non-Agency RMBS”),
commercial mortgage-backed securities (“CMBS”) and residential and commercial
mortgage loans.








We
generally finance our Agency RMBS investments, and may finance our non-Agency
RMBS investments, through traditional repurchase agreement financing or
committed borrowing facilities. In addition, we finance our investments in CMBS
with financings under the Term Asset-Backed Securities Loan Facility (“TALF”).
We have also financed, and may do so again in the future, our investments in
certain non-Agency RMBS, CMBS and residential and commercial mortgage loans by
contributing capital to one or more of the legacy securities public-private
investment funds (“PPIFs”), that receive financing under the
U.S. government’s Public-Private Investment Program (“PPIP”), established
and managed by our Manager (the “Invesco PPIP Fund”) or one of its
affiliates.








We have
invested the net proceeds from our initial public offering (“IPO”) and private
placement, as well as monies that we borrowed under repurchase agreements and
TALF, in accordance with our investment strategy. As of December 31, 2009, we
had an investment portfolio of $802.6 million consisting of $556.4 million in
Agency RMBS, $115.3 million in non-Agency RMBS, $101.2 million in CMBS
and  $29.7 million in CMOs.  In addition, we invested $4.1
million in the Invesco PPIP Fund.





As of
December 31, 2009, 19.1% of our equity (net of related debt) was invested in
Agency RMBS, 54.8% in non-Agency RMBS, 9.9% in CMBS, 2.0% in the Invesco PPIP
Fund and 14.2% in other assets (including cash and restricted
cash).


We intend
to qualify to be taxed as a real estate investment trust (“REIT”) for
U.S. federal income tax purposes, commencing with our taxable year ended
December 31, 2009. Accordingly, we generally will not be subject to
U.S. federal income taxes on our taxable income to the extent that we
annually distribute all of our net taxable income to our shareholders and
maintain our qualification as a REIT. We operate our business in a manner that
permits us to maintain our exemption from registration under the Investment
Company Act of 1940, as amended (the “1940 Act”).





Public Offerings and Private
Placement








On
July 1, 2009, we successfully completed our IPO pursuant to which we sold
8,500,000 shares of our common stock to the public at a price of $20.00 per
share for net proceeds of $164.8 million. Concurrent with our IPO, we
completed a private placement in which we sold 75,000 shares of our common
stock to our Manager at a price of $20.00 per share. In addition, IAS Operating
Partnership LP (our
“Operating Partnership”) sold 1,425,000 limited partnership units (“OP
Units”) to Invesco Investments (Bermuda) Ltd., a wholly-owned subsidiary of
Invesco, at a purchase price of $20.00 per unit. The net proceeds from the
private placement totaled $30.0 million.





5


On
July 27, 2009, the underwriters of our IPO exercised their over-allotment
option to purchase an additional 311,200 shares of our common stock at a
price of $20.00 per share for net proceeds of $6.1 million. Collectively,
we received net proceeds from our IPO and the related private placement of
approximately $200.9 million.
 
 On
January 15, 2010, we completed a follow-on public offering of 7,000,000 shares
of common stock, and an issuance of an additional 1,050,000 shares of common
stock pursuant to the underwriters’ full exercise of their over-allotment
option, at $21.25 per share. The net proceeds to us were $162.7
million.


Our
Manager





We are
externally managed and advised by Invesco Advisers, Inc. (formerly Invesco
Institutional (N.A.), Inc.) (our “Manager”), an SEC-registered investment
adviser and indirect, wholly-owned subsidiary of Invesco Ltd. (NYSE: IVZ)
(“Invesco”).





We are
externally managed and advised by our Manager. Pursuant to the terms of the
management agreement, our Manager provides us with our management team,
including our officers, along with appropriate support personnel. Each of our
officers is an employee of Invesco. We do not have any employees. With the
exception of our Chief Financial Officer, our Manager does not dedicate any of
its employees exclusively to us, nor is our Manager or its employees obligated
to dedicate any specific portion of its or their time to our business. Our
Manager is at all times subject to the supervision and oversight of our board of
directors and has only such functions and authority as our board of directors
delegates to it.





Our
Competitive Advantages


We
believe that our competitive advantages include the
following:





Significant
Experience of Our Manager


Our
Manager’s senior management team has a long track record and broad experience in
managing residential and commercial mortgage-related assets through a variety of
credit and interest rate environments and has demonstrated the ability to
generate attractive risk-adjusted returns under different market conditions and
cycles. In addition, our Manager benefits from the insight and capabilities of
WL Ross & Co. LLC (“WL Ross’) and Invesco’s real estate team. Through WL
Ross and Invesco’s real estate team, we have access to broad and deep teams of
experienced investment professionals in real estate and distressed investing.
Through these teams, we have real time access to research and data on the
mortgage and real estate industries. We believe having in-house access to these
resources and expertise provides us with a competitive advantage over other
companies investing in our target assets who have less internal resources and
expertise.





Extensive
Strategic Relationships and Experience of our Manager and its
Affiliates


Our
Manager maintains extensive long-term relationships with other financial
intermediaries, including primary dealers, leading investment banks, brokerage
firms, leading mortgage originators and commercial banks. We believe these
relationships enhance our ability to source, finance and hedge investment
opportunities and, thus, will enable us to grow in various credit and interest
rate environments.


Disciplined
Investment Approach








We seek
to maximize our risk-adjusted returns through our Manager’s disciplined
investment approach, which relies on rigorous quantitative and qualitative
analysis. Our Manager monitors our overall portfolio
risk and evaluates the characteristics of our investments in our target assets
including, but not limited to, loan balance distribution, geographic
concentration, property type, occupancy, periodic interest rate caps (which
limit the amount an interest rate can increase during any given period,)
lifetime interest rate caps, weighted-average loan-to-value and weighted-average
credit score. In addition, with respect to any particular target asset, our
Manager’s investment team evaluates, among other things, relative valuation,
supply and demand trends, shape of yield curves, prepayment rates, delinquency
and default rates recovery of various sectors and vintage of collateral. We
believe this strategy and our commitment to capital preservation provide us with
a competitive advantage when operating in a variety of market
conditions.


6
   Access to Our
Manager’s Sophisticated Analytical Tools, Infrastructure and
Expertise








We
utilize our Manager’s proprietary and third-party mortgage-related security and
portfolio management tools to generate an attractive net interest margin from
our portfolio. We focus on in-depth analysis of the numerous factors that
influence our target assets, including: (1) fundamental market and sector
review; (2) rigorous cash flow analysis; (3) disciplined security
selection; (4) controlled risk exposure; and (5) prudent balance sheet
management. We utilize these tools to guide the hedging strategies developed by
our Manager to the extent consistent with satisfying the requirements for
qualification as a REIT. In addition, we use our Manager’s proprietary
technology management platform called QTechsm
to monitor investment risk. QTechsm
collects and stores real-time market data and integrates markets performance
with portfolio holdings and proprietary risk models to measure portfolio risk
positions. This measurement system portrays overall portfolio risk and its
sources. Through the use of these tools, we analyze factors that affect the rate
at which mortgage prepayments occur, including changes in the level of interest
rates, directional trends in residential and commercial real estate prices,
general economic conditions, the locations of the properties securing the
mortgage loans and other social and demographic conditions in order to acquire
the target assets that we believe are undervalued. We believe that sophisticated
analysis of both macro and micro economic factors enable us to manage cash flow
and distributions while preserving capital.





Our
Manager has created and maintains analytical and portfolio management
capabilities to aid in security selection and risk management. We capitalize on
the market knowledge and ready access to data across our target markets that our
Manager and its affiliates obtain through their established platform. We also
benefit from our Manager’s comprehensive financial and administrative
infrastructure, including its risk management and financial reporting
operations, as well as its business development, legal and compliance
teams.


Investment
Strategy





We invest
in a diversified pool of mortgage assets that generate attractive risk adjusted
returns. Our target assets include Agency RMBS, non-Agency RMBS, CMBS and
residential and commercial mortgage loans. In addition to direct purchases of
our target assets, we also invest in the Invesco PPIP Fund, which, in turn,
invests in our target assets. Our Manager’s investment committee makes
investment decisions for the Invesco PPIP Fund.








Agency
RMBS





Agency
RMBS are residential mortgage-backed securities for which a U.S. government
agency such as Ginnie Mae, or a federally chartered corporation such as Fannie
Mae or Freddie Mac guarantees payments of principal and interest on the
securities. Payments of principal and interest on Agency RMBS, not the market
value of the securities themselves, are guaranteed. Agency RMBS differ from
other forms of traditional debt securities, which normally provide for periodic
payments of interest in fixed amounts with principal payments at maturity or on
specified call dates. Instead, Agency RMBS provide for monthly payments, which
consist of both principal and interest. In effect, these payments are a
“pass-through” of scheduled and prepaid principal payments and the monthly
interest payments made by the individual borrowers
on the mortgage loans, net of any fees paid to the issuers, servicers or
guarantors of the securities.
  7
  The principal may be prepaid at any time due to prepayments on the underlying
mortgage loans or other assets. These differences can result in significantly
greater price and yield volatility than is the case with traditional
fixed-income securities.


Various
factors affect the rate at which mortgage prepayments occur, including changes
in the level and directional trends in housing prices, interest rates, general
economic conditions, the age of the mortgage loan, the location of the property
and other social and demographic conditions. Generally, prepayments on Agency
RMBS increase during periods of falling mortgage interest rates and decrease
during periods of rising mortgage interest rates. However, this may not always
be the case. We may reinvest principal repayments at a yield that is higher or
lower than the yield on the repaid investment, thus affecting our net interest
income by altering the average yield on our assets.
 
 However,
when interest rates are declining, the value of Agency RMBS with prepayment
options may not increase as much as other fixed income securities. The rate of
prepayments on underlying mortgages will affect the price and volatility of
Agency RMBS and may have the effect of shortening or extending the duration of
the security beyond what was anticipated at the time of purchase. When interest
rates rise, our holdings of Agency RMBS may experience reduced returns if the
owners of the underlying mortgages pay off their mortgages slower than
anticipated. This is generally referred to as extension risk.
 
 Mortgage
pass-through certificates, CMOs, Freddie Mac Gold Certificates, Fannie Mae
Certificates and Ginnie Mae Certificates are types of Agency RMBS that are
collateralized by either fixed-rate mortgage loans (“FRMs”), adjustable-rate
mortgage loans (“ARMs”), or hybrid ARMs. FRMs have an interest rate that is
fixed for the term of the loan and do not adjust. The interest rates on ARMs
generally adjust annually (although some may adjust more frequently) to an
increment over a specified interest rate index. Hybrid ARMs have interest rates
that are fixed for a specified period of time (typically three, five, seven or
ten years) and, thereafter, adjust to an increment over a specified interest
rate index. ARMs and hybrid ARMs generally have periodic and lifetime
constraints on how much the loan interest rate can change on any predetermined
interest rate reset date. Our allocation of our Agency RMBS collateralized by
FRMs, ARMs or hybrid ARMs will depend on various factors including, but not
limited to, relative value, expected future prepayment trends, supply and
demand, costs of hedging, costs of financing, expected future interest rate
volatility and the overall shape of the U.S. Treasury and interest rate
swap yield curves. We intend to take these factors into account when we make
investments.


Non-Agency
RMBS





Non-Agency
RMBS are residential mortgage-backed securities that are not issued or
guaranteed by a U.S. government agency. Like Agency RMBS, non-Agency RMBS
represent interests in “pools” of mortgage loans secured by residential real
property. We finance our non-Agency RMBS portfolio with financings under the
TALF, committed borrowing facilities or with other private financing sources. We
have also financed and may continue to finance certain non-Agency RMBS by
investing in the Invesco PPIP Fund, which, in turns, invests in our target
assets. Non-Agency RMBS may be AAA rated through unrated. The rating, as
determined by one or more of the nationally recognized statistical rating
organizations, including Fitch, Inc. Moody’s Investors Service, Inc. and
Standard & Poor’s Corporation, indicates the organization’s view of the
creditworthiness of the investment. The mortgage loan collateral for non-Agency
RMBS generally consists of residential mortgage loans that do not generally
conform to the U.S. government agency underwriting guidelines due to
certain factors including mortgage balance in excess of such guidelines,
borrower characteristics, loan characteristics and level of
documentation.





CMBS


CMBS are
securities backed by obligations (including certificates of participation in
obligations) that are principally secured by commercial mortgages on real
property or interests therein having a multifamily or commercial use, such as
regional malls, other retail space, office buildings, industrial or warehouse
properties, hotels, apartments, nursing homes and senior living facilities. We
finance certain of our CMBS portfolio with financings under the TALF and by
investing in the Invesco PPIP Fund, which, in turns, invests in our target
assets. See ‘‘Our Investments— Financing Strategy” below.


8
  CMBS are
typically issued in multiple tranches whereby the more senior classes are
entitled to priority distributions to make specified interest and principal
payments on such tranches. Losses and other shortfalls from expected amounts to
be received on the mortgage pool are borne by the most subordinate classes,
which receive payments only after the more senior classes have received all
principal and/or interest to which they are entitled. The credit quality of CMBS
depends on the credit quality of the underlying mortgage loans, which is a
function of factors such as the following: the principal amount of loans
relative to the value of the related properties; the mortgage loan terms, such
as amortization; market assessment and geographic location; construction quality
of the property; and the creditworthiness of the borrowers.





Residential
Mortgage Loans


Residential
mortgage loans are loans secured by residential real properties. We generally
focus our residential mortgage loan acquisitions on the purchase of loan
portfolios made available to us under the legacy loan program. See ‘‘Our
Investments— Financing Strategy” below. We expect that the residential mortgage
loans we acquire will be first lien, single-family FRMs, ARMs and Hybrid ARMs
with original terms to maturity of not more than 40 years and that are
either fully amortizing or are interest-only for up to ten years, and fully
amortizing thereafter.


Prime and Jumbo Mortgage
Loans





Prime
mortgage loans are mortgage loans that generally conform to U.S. government
agency underwriting guidelines. Jumbo prime mortgage loans are mortgage loans
that generally conform to U.S. government agency underwriting guidelines
except that the mortgage balance exceeds the maximum amount permitted by
U.S. government agency underwriting guidelines.


Alt-A Mortgage
Loans





Alt-A
mortgage loans are mortgage loans made to borrowers whose qualifying mortgage
characteristics do not conform to U.S. government agency underwriting
guidelines, but whose borrower characteristics may. Generally, Alt-A mortgage
loans allow homeowners to qualify for a mortgage loan with reduced or
alternative forms of documentation. The credit quality of Alt-A borrowers
generally exceeds the credit quality of subprime borrowers.


Subprime
Mortgage Loans


Subprime
mortgage loans are loans that do not conform to U.S. government agency
underwriting guidelines.


Commercial
Mortgage Loans





Commercial
mortgage loans are mortgage loans secured by first or second liens on commercial
properties such as regional malls, other retail space, office buildings,
industrial or warehouse properties, hotels, apartments, nursing homes and senior
living facilities. These loans, which tend to range in term from five to
15 years, can carry either fixed or floating interest rates. They generally
permit pre-payments before final maturity but only with the payment to the
lender of yield maintenance pre-payment penalties. First lien loans represent
the senior lien on a property while second lien loans or second mortgages
represent a subordinate or second lien on a property.
 
 We have
generally focused our commercial mortgage loan acquisitions on the purchase of
loan portfolios made available to us through our investment in the Invesco PPIP
Fund. See ‘‘Our Investments— Financing Strategy” below.


B-Notes


A B-Note,
unlike a second mortgage loan, is part of a single larger commercial mortgage
loan, with the other part evidenced by an A-Note, which are evidenced by a
single commercial mortgage. The holder of the A-Note and B-Note enter into an
agreement which sets forth the respective rights and obligations of each of the
holders. 
  9
  The terms
of the agreement provide that the holder of the A-Note has a priority of payment
over the holder of the B-Note. A loan evidenced by a note which is secured by a
second mortgage is a separate loan and the holder has a direct relationship with
the borrower. In addition, unlike the holder of a B-Note, the holder of the loan
would also be the holder of the mortgage. The holder of the second mortgage loan
typically enters into an intercreditor agreement with the holder of the first
mortgage loan which sets forth the respective rights and obligations of each of
the holders, similar in substance to the agreement that is entered into between
the holder of the A-Note and the holder of the B-Note. B-Note lenders have the
same obligations, collateral and borrower as the A-Note lender, but typically
are subordinated in recovery upon a default.


Bridge Loans


Bridge
loans tend to be floating rate whole loans made to borrowers who are seeking
short-term capital (with terms of up to five years) to be used in the
acquisition, construction or redevelopment of a property. This type of bridge
financing enables the borrower to secure short-term financing while improving
the property and avoid burdening it with restrictive long-term
debt.


Mezzanine
Loans


Mezzanine
loans are generally structured to represent senior positions to the borrower’s
equity in, and subordinate to a first mortgage loan on a property. These loans
are generally secured by pledges of ownership interests, in whole or in part, in
entities that directly or indirectly own the real property. At times, mezzanine
loans may be secured by additional collateral, including letters of credit,
personal guarantees, or collateral unrelated to the property. Mezzanine loans
may be structured to carry either fixed or floating interest rates as well as
carry a right to participate in a percentage of gross revenues and a percentage
of the increase in the fair market value of the property securing the loan.
Mezzanine loans may also contain prepayment lockouts, penalties, minimum profit
hurdles and other mechanisms to protect and enhance returns to the lender.
Mezzanine loans usually have maturities that match the maturity of the related
mortgage loan but may have shorter or longer terms.


Financing
Strategy





We
finance our investments in Agency RMBS, and in the future finance our
investments in non-Agency RMBS, primarily through short-term borrowings
structured as repurchase agreements. In addition, we currently finance our
investments in CMBS with financing under the TALF and with private financing
sources. We also finance our investments in certain non-Agency RMBS, CMBS and
residential and commercial mortgage loans by investing in the Invesco PPIP Fund,
which receives financing from the U.S. Treasury and from the Federal
Deposit Insurance Corporation (the “FDIC”).


Repurchase Agreements





Repurchase
agreements are financings pursuant to which we sell our target assets to the
repurchase agreement counterparty, the buyer, for an agreed upon price with the
obligation to repurchase these assets from the buyer at a future date and at a
price higher than the original purchase price. The amount of financing we
receive under a repurchase agreement is limited to a specified percentage of the
estimated market value of the assets we sell to the buyer. The difference
between the sale price and repurchase price is the cost, or interest expense, of
financing under a repurchase agreement. Under repurchase agreement financing
arrangements, certain buyers, or lenders, require us to provide additional cash
collateral, or a margin call, to re-establish the ratio of value of the
collateral to the amount of borrowing. As of December 31, 2009, we had entered
into master repurchase agreements with eighteen counterparties and have borrowed
$546.0 million under five of those master repurchase agreements to finance our
purchases of Agency RMBS. In addition, as of December 31, 2009, we had entered
into three interest rate swap agreements, for a notional amount of $375.0
million, designed to mitigate the effects of increases in interest rates under a
portion of our repurchase agreements.


10


The Term Asset-Backed Securities
Loan Facility





On
November 25, 2008, the U.S. Treasury and the Federal Reserve announced
the creation of the TALF. The TALF is intended to make credit available to
consumers and businesses on more favorable terms by facilitating the issuance of
asset-backed securities and improving the market conditions for asset-backed
securities generally. The Federal Reserve Bank of New York (the “FRBNY”) will
make up to $200 billion of loans under the TALF. The TALF loans will have a
term of three years or, in certain cases, five years, will be non-recourse to
the borrower, and will be fully secured by eligible asset-backed securities. At
December 31, 2009, we have secured borrowings of $80.4 million under the
TALF.





The Public-Private Investment
Program





On
March 23, 2009, the U.S. Treasury, in conjunction with the FDIC and
the Federal Reserve, announced the creation of the PPIP. The PPIP is designed to
encourage the transfer of certain illiquid legacy real estate-related assets off
of the balance sheets of financial institutions, restarting the market for these
assets and supporting the flow of credit and other capital into the broader
economy. PPIP funds established under the legacy loan program will be
established to purchase troubled loans from insured depository institutions and
PPIP funds established under the legacy securities program to purchase from
financial institutions legacy non-Agency RMBS and newly issued and legacy CMBS
that were originally AAA rated. PPIFs will have access to equity capital from
the U.S. Treasury as well as debt financing provided or guaranteed by the
U.S. government. As of December 31, 2009, we have a commitment to invest up
to $25.0 million in the Invesco PPIP Fund of which $4.1 million has been
called.


Leverage





We use
leverage on our target assets to achieve our return objectives. For our
investments in Agency RMBS (including CMOs), we focus on securities we believe
provide attractive returns when levered approximately 6 to 8 times. For our
investments in non-Agency RMBS, we primarily focus on securities we believe
provide attractive unlevered returns, however, in the future we may employ
leverage of up to 1 time. We leverage our CMBS 3 to 5
times.


Risk
Management Strategy
 
 Interest Rate
Hedging





Subject
to maintaining our qualification as a REIT, we may engage in a variety of
interest rate management techniques that seek on one hand to mitigate the
influence of interest rate changes on the costs of liabilities and on the other
hand help us achieve our risk management objective. Specifically, we 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, we
seek to improve risk-adjusted returns and, where possible, to lock in, on a
long-term basis, a favorable spread between the yield on our assets and the cost
of our financing. We rely on our Manager’s expertise to manage these risks on
our behalf. We utilize derivative financial instruments, including, puts and
calls on securities or indices of securities, interest rate swaps, interest rate
caps, interest rate swaptions, exchange-traded derivatives, U.S. Treasury
securities and options on U.S. Treasury securities and interest rate floors
to hedge all or a portion of the interest rate risk associated with the
financing of our investment portfolio.


Market Risk
Management





Risk
management is an integral component of our strategy to deliver returns to our
shareholders. Because we invest in mortgage-backed securities (“MBS”),
investment losses from prepayment, interest rate volatility or other risks can
meaningfully reduce or eliminate our distributions to shareholders. In addition,
because we employ financial leverage in funding our investment portfolio,
mismatches in the maturities of our assets and liabilities can create the need
to continually renew or otherwise refinance our liabilities.
  11
  Our net
interest margins are dependent upon a positive spread between the returns on our
asset portfolio and our overall cost of funding. To minimize the risks to our
portfolio, we actively employ portfolio-wide and security-specific risk
measurement and management processes in our daily operations. Our Manager’s risk
management tools include software and services licensed or purchased from third
parties, in addition to proprietary software and analytical methods developed by
Invesco. There can be no guarantee that these tools will protect us from market
risks.


Credit Risk


We
believe our investment strategy generally keeps our credit losses and financing
costs low. However, we retain the risk of potential credit losses on all of the
residential and commercial mortgage loans, as well as the loans underlying the
non-Agency RMBS and CMBS we hold. We seek to manage this risk through our
pre-acquisition due diligence process and through use of non-recourse financing,
which limits our exposure to credit losses to the specific pool of mortgages
that are subject to the non-recourse financing. In addition, with respect to any
particular target asset, our Manager’s investment team evaluates, among other
things, relative valuation, supply and demand trends, shape of yield curves,
prepayment rates, delinquency and default rates, recovery of various sectors and
vintage of collateral.


Investment
Guidelines


Our board
of directors has adopted the following investment guidelines:





·
            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 1940
Act;





·
            our
      assets will be invested within our target
  assets; and





·
            until
      appropriate investments can be identified, our Manager may pay off
      short-term debt or invest the proceeds of this and any future offerings in
      interest-bearing, short-term investments, including funds that are
      consistent with our intention to qualify as a
  REIT.





These
investment guidelines may be changed from time to time by our board of directors
without the approval of our shareholders.


Investment
Committee





We have
an investment committee comprised certain of our officers and certain of our
Manager’s investment professionals. The investment committee periodically
reviews our investment portfolio and its compliance with our investment policies
and procedures, including our investment guidelines, and provides our board of
directors an investment report at the end of each quarter in conjunction with
its review of our quarterly results. In addition, our Manager has a separate
investment committee that makes investment decisions for the Invesco PPIP Fund.
From time to time, as it deems appropriate or necessary, our board of directors
also reviews our investment portfolio and its compliance with our investment
policies and procedures, including our investment guidelines.


Investment
Process


The
investment team has a strong focus on security selection and on the relative
value of various sectors within the mortgage market. Our Manager utilizes this
expertise to build a diversified portfolio of Agency RMBS, non-Agency RMBS, CMBS
and residential and commercial mortgage loans. Our Manager incorporates its
views on the economic environment and the outlook for the mortgage market,
including relative valuation, supply and demand trends, the level of interest
rates, the shape of the yield curve, prepayment rates, financing and liquidity,
housing prices, delinquencies, default rates, recovery of various sectors and
vintage of collateral.
   12
 Our
investment process includes sourcing and screening investment opportunities,
assessing investment suitability, conducting interest rate and prepayment
analysis, evaluating cash flow and collateral performance, reviewing legal
structure and servicer and originator information and investment structuring, as
appropriate, to ensure an attractive return commensurate with the risk we are
bearing. Upon identification of an investment opportunity, the investment will
be screened and monitored by our Manager to determine its impact on maintaining
our REIT qualification and our exemption from registration under the 1940 Act.
We make investments in sectors where our Manager has strong core competencies
and where we believe market risk and expected performance can be reasonably
quantified.
 
 Our
Manager evaluates each of our investment opportunities based on its expected
risk-adjusted return relative to the returns available from other, comparable
investments. In addition, we evaluate new opportunities based on their relative
expected returns compared to securities held in our portfolio. The terms of any
leverage available to us for use in funding an investment purchase are also
taken into consideration, as are any risks posed by illiquidity or correlations
with other securities in the portfolio. Our Manager also develops a macro
outlook with respect to each target asset class by examining factors in the
broader economy such as gross domestic product, interest rates, unemployment
rates and availability of credit, among other factors. Our Manager also analyzes
fundamental trends in the relevant target asset class sector to adjust/maintain
its outlook for that particular target asset class. Views on a particular target
asset class are recorded in our Manager’s QTechsm
system. These macro decisions guide our Manager’s assumptions regarding model
inputs and portfolio allocations among target assets. Additionally, our Manager
conducts extensive diligence with respect to each target asset class by, among
other things, examining and monitoring the capabilities and financial
wherewithal of the parties responsible for the origination, administration and
servicing of relevant target assets.


Competition


Our net
income depends, in large part, on our ability to acquire assets at favorable
spreads over our borrowing costs. In acquiring our investments, we compete with
other REITs, specialty finance companies, savings and loan associations,
mortgage bankers, insurance companies, mutual funds, institutional investors,
investment banking firms, financial institutions, governmental bodies and other
entities. See “Management’s Discussion and Analysis of Financial Condition and
Results of Operations — Market Conditions.” In addition, there are numerous
REITs with similar asset acquisition objectives, including a number that have
been recently formed, and others may be organized in the future. These other
REITs increase competition for the available supply of mortgage assets suitable
for purchase. Many of our competitors are significantly larger than we are, have
access to greater capital and other resources and may have other advantages over
us. In addition, some of our competitors may have higher risk tolerances or
different risk assessments, which could allow them to consider a wider variety
of investments and establish more relationships than we can. Current market
conditions may attract more competitors, which may increase the competition for
sources of financing. An increase in the competition for sources of financing
could adversely affect the availability and cost of financing, and thereby
adversely affect the market price of our common stock.
 
 In the
face of this competition, we have access to our Manager’s professionals and
their industry expertise, which provides us with a competitive advantage. These
professionals help us assess investment risks and determine appropriate pricing
for certain potential investments. These relationships enable us to compete more
effectively for attractive investment opportunities. Despite certain competitive
advantages, we may not be able to achieve our business goals or expectations due
to the competitive risks that we face. For additional information concerning
these competitive risks, see “Risk Factors — Risks Related to Our
Investments — We operate in a highly competitive market for investment
opportunities and competition may limit our ability to acquire desirable
investments in our target assets and could also affect the pricing of these
securities.”





13


Staffing





We are
managed by our Manager pursuant to the management agreement between our Manager
and us. See “Certain Relationships, Related Transactions, and Director
Independence” for a discussion of the management fee and our relationship with
our Manager. All of our officers are employees of Invesco. We do not have any
employees.


Our
Corporate Information


Our
principal executive offices are located at 1555 Peachtree Street, N.E., Atlanta,
Georgia 30309. Our telephone number is (404) 892-0896. Our website is
www.invescomortgagecapital.com. The contents of our website are not a part of
this Report. The information on our website is not intended to form a part of or
be incorporated by reference into this Report.





Compliance
with NYSE Corporate Governance Standards





Each
year, the chief executive officer of each company listed on the New York Stock
Exchange (“NYSE”) must certify to the NYSE that he or she is not aware of any
violation by the company of NYSE corporate governance listing standards as of
the date of certification, qualifying the certification to the extent necessary.
In July 2009, we listed our common stock on the NYSE and our chief executive
officer will submit our first required certification to the within 30 days of
our 2010 annual shareholders’ meeting.





Item 1A.  Risk
Factors.





Investing in our common stock
involves a high degree of risk. You should carefully consider the following risk
factors and all other information contained in this Report before purchasing our
common stock. If any of the following risks occur, our business, financial
condition or results of operations could be materially and adversely affected.
In that case, the trading price of our common stock could decline and you may
lose some or all of your investment.





Risks Related to Our Relationship
With Our Manager





We
are dependent on our Manager and its key personnel for our
success.





We have
no separate facilities and are completely reliant on our Manager. We do not have
any employees. Our executive officers are employees of Invesco. Our Manager has
significant discretion as to the implementation of our investment and operating
policies and strategies. Accordingly, we believe that our success depends to a
significant extent upon the efforts, experience, diligence, skill and network of
business contacts of the executive officers and key personnel of our Manager.
The executive officers and key personnel of our Manager evaluate, negotiate,
close and monitor our investments; therefore, our success depends on their
continued service. The departure of any of the executive officers or key
personnel of our Manager could have a material adverse effect on our
performance. In addition, we offer no assurance that our Manager will remain our
investment manager or that we will continue to have access to our Manager’s
principals and professionals. The initial term of our management agreement with
our Manager only extends until the second anniversary of the closing of our IPO,
or July 1, 2011, with automatic one-year renewals thereafter. If the
management agreement is terminated and no suitable replacement is found to
manage us, we may not be able to execute our business plan. Moreover, with the
exception of our Chief Financial Officer, our Manager is not obligated to
dedicate certain of its personnel exclusively to us nor is it obligated to
dedicate any specific portion of its time to our business, and none of our
Manager’s personnel are contractually dedicated to us under our management
agreement with our Manager.





As of
December 31, 2009, we had entered into master repurchase agreements with
eighteen counterparties in order to finance our acquisitions of Agency RMBS and
non-Agency RMBS. Our Manager has obtained commitments on our behalf from a
number of the counterparties. Therefore, if the management agreement is
terminated, we cannot assure you that we would continue to have access to these
sources of financing for our investments.
   14





Invesco and our
Manager have limited experience operating a REIT or managing a portfolio of our
target assets on a leveraged basis and we cannot assure you that our Manager’s
past experience will be sufficient to successfully manage our business as a REIT
with such a portfolio.





Prior to
our inception, our Manager had never operated a REIT. The REIT provisions of the
Internal Revenue Code are complex, and any failure to comply with those
provisions in a timely manner could prevent us from qualifying as a REIT or
force us to pay unexpected taxes and penalties. In such event, our net income
would be reduced and we could incur a loss. In addition, our Manager has limited
experience managing a portfolio of our target assets using
leverage.





There are
conflicts of interest in our relationship with our Manager and Invesco, which
could result in decisions that are not in the best interests of our
shareholders.





We are
subject to conflicts of interest arising out of our relationship with Invesco
and our Manager. Specifically, each of our officers and two of our directors,
Mr. Armour and Ms. Dunn Kelley, are employees of Invesco. Our Manager
and our executive officers may have conflicts between their duties to us and
their duties to, and interests in, Invesco. Our Manager is not required to
devote a specific amount of time to our operations. We compete for investment
opportunities directly with our Manager or other clients of our Manager or
Invesco and its subsidiaries. A substantial number of separate accounts managed
by our Manager have limited exposure to our target assets. In addition, in the
future our Manager may have additional clients that compete directly with us for
investment opportunities. Our Manager has an investment and financing allocation
policy in place intended to enable us to share equitably with the investment
companies and institutional and separately managed accounts that effect
securities transactions in fixed income securities for which our Manager is
responsible in the selection of brokers, dealers and other trading
counterparties. Therefore, we may compete with our Manager for investment or
financing opportunities sourced by our Manager and, as a result, we may either
not be presented with the opportunity or have to compete with our Manager to
acquire these investments or have access to these sources of financing. Our
Manager and our executive officers may choose to allocate favorable investments
to Invesco or other clients of Invesco instead of to us. Further, at times when
there are turbulent conditions in the mortgage markets or distress in the credit
markets or other times when we will need focused support and assistance from our
Manager, Invesco or entities for which our Manager also acts as an investment
manager will likewise require greater focus and attention, placing our Manager’s
resources in high demand. In such situations, we may not receive the level of
support and assistance that we may receive if we were internally managed or if
our Manager did not act as a manager for other entities. There is no assurance
that our Manager’s allocation policies that address some of the conflicts
relating to our access to investment and financing sources will be adequate to
address all of the conflicts that may arise.





We pay
our Manager substantial management fees regardless of the performance of our
portfolio. Our Manager’s entitlement to a management fee, which is not based
upon performance metrics or goals, might reduce its incentive to devote its time
and effort to seeking investments that provide attractive risk-adjusted returns
for our portfolio. This in turn could hurt both our ability to make
distributions to our shareholders and the market price of our common
stock.





Concurrently
with the completion of our IPO, we completed a private placement in which we
sold 75,000 shares of our common stock to Invesco, through our Manager, at
$20.00 per share and 1,425,000 OP units to Invesco, through Invesco Investments
(Bermuda) Ltd., a wholly owned subsidiary of Invesco, at $20.00 per unit. As of
December 31, 2009, Invesco, through our Manager, beneficially owned 0.73% of our
common stock As of December 31, 2009, assuming that all OP units are redeemed
for an equivalent number of shares of our common stock. Invesco would
beneficially own approximately 15% of our outstanding common stock. Each of
our Manager and Invesco Investments (Bermuda) Ltd. agreed that, for a period of
one year after June 25, 2009, neither will, without the prior written
consent of Credit Suisse Securities (USA) LLC and Morgan Stanley & Co.
Incorporated, dispose of or hedge any of the shares of our common stock or OP
units that it purchased in the private placement, subject to extension in
certain circumstances. Each of our Manager and Invesco Investments (Bermuda)
Ltd. may sell any of these securities at any time following the expiration of
this one-year lock-up period. To the extent our Manager or Invesco Investments
(Bermuda) Ltd. sell some of these securities, its interests may be less aligned
with our interests.
 
 15





Our Manager would
have a conflict in recommending our participation in any legacy security or
legacy loan PPIFs it manages.





To the
extent available to us, we seek to finance additional non-Agency RMBS and CMBS
by contributing capital to the Invesco PPIP Fund, which qualified to obtain
financing under the legacy securities program under the PPIP. We committed to
invest up to up to $25.0 million in the Invesco PPIP Fund, which, in turn,
invests in our target assets and may seek additional investments in this or a
similar PPIP fund managed by our Manager. Our Manager’s investment committee
makes investment decisions for the Invesco PPIP Fund. As of December 31,
2009, $4.1 million of the commitment has been called. Pursuant to the terms of
the management agreement, we pay our Manager a management fee. As a result, we
do not pay any management or investment fees with respect to our investment in
the Invesco PPIP Fund managed by our Manager. Our Manager waives all such fees.
Our Manager has a conflict of interest in recommending our participation in any
PPIF it manages because the fees payable to it by the PPIF may be greater than
the fees payable to it by us under the management agreement. We have addressed
this conflict by requiring that the terms of any equity investment we make in
any such PPIF be approved by our audit committee consisting of our independent
directors; however, there can be no assurance that our audit committee’s
approval of investments in any such PPIF will eliminate the conflict of
interest.





The management
agreement with our Manager was not negotiated on an arm’s-length basis and may
not be as favorable to us as if it had been negotiated with an unaffiliated
third party and may be costly and difficult to
terminate.





Our
executive officers and two of our five directors are employees of Invesco. Our
management agreement with our Manager was negotiated between related parties and
its terms, including fees payable, may not be as favorable to us as if it had
been negotiated with an unaffiliated third party.





Termination
of the management agreement with our Manager without cause is difficult and
costly. Our independent directors will review our Manager’s performance and the
management fees annually and, following the initial two-year term, the
management agreement may be terminated annually upon the affirmative vote of at
least two-thirds of our independent directors based upon: (1) our Manager’s
unsatisfactory performance that is materially detrimental to us, or (2) a
determination that the management fees payable to our Manager are not fair,
subject to our Manager’s right to prevent termination based on unfair fees by
accepting a reduction of management fees agreed to by at least two-thirds of our
independent directors. Our Manager will be provided 180 days prior notice
of any such termination. Additionally, upon such a termination, the management
agreement provides that we will pay our Manager a termination fee equal to three
times the sum of the average annual management fee received by our Manager
during the prior 24-month period before such termination, calculated as of the
end of the most recently completed fiscal quarter. These provisions may increase
the cost to us of terminating the management agreement and adversely affect our
ability to terminate our Manager without cause.





Our
Manager is only contractually committed to serve us until the second anniversary
of the closing of our IPO, or July 1, 2011. Thereafter, the management
agreement is renewable for one-year terms; provided, however, that our Manager
may terminate the management agreement annually upon 180 days prior notice.
If the management agreement is terminated and no suitable replacement is found
to manage us, we may not be able to execute our business
plan.





Pursuant
to the management agreement, our Manager does not assume any responsibility
other than to render the services called for thereunder and is not responsible
for any action of our board of directors in following or declining to follow its
advice or recommendations. Our Manager maintains a contractual as opposed to a
fiduciary relationship with us. Under the terms of the management agreement, our
Manager, its officers, shareholders, members, managers, partners, directors and
personnel, any person controlling or controlled by our Manager and any person
providing sub-advisory services to our Manager will not be liable to us, any
subsidiary of ours, our directors, our shareholders or any subsidiary’s
shareholders or partners for acts or omissions performed in accordance with and
pursuant to the management agreement, except because of acts constituting bad
faith, willful misconduct, gross negligence, or reckless disregard of their
duties under the management agreement, as determined by a final non-appealable
order of a court of competent jurisdiction. We have agreed to indemnify our
Manager, its officers, shareholders, members, managers, directors and personnel,
any person controlling or controlled by our Manager and any person providing
sub-advisory services to our Manager with respect to all expenses, losses,
damages, liabilities, demands, charges and claims arising from acts of our
Manager not constituting bad faith, willful misconduct, gross negligence, or
reckless disregard of duties, performed in good faith in accordance with and
pursuant to the management agreement.
  16


Our board of
directors approved very broad investment guidelines for our Manager and does not
approve each investment and financing decision made by our
Manager.





Our
Manager is authorized to follow very broad investment guidelines. Our board of
directors will periodically review our investment guidelines and our investment
portfolio but does not, and is not required to, review all of our proposed
investments, except that an investment in a security structured or issued by an
entity managed by Invesco must be approved by a majority of our independent
directors prior to such investment. In addition, in conducting periodic reviews,
our board of directors may rely primarily on information provided to them by our
Manager. Furthermore, our Manager may use complex strategies, and transactions
entered into by our Manager may be costly, difficult or impossible to unwind by
the time they are reviewed by our board of directors. Our Manager has great
latitude within the broad parameters of our investment guidelines in determining
the types and amounts of Agency RMBS, non-Agency RMBS, CMBS and mortgage loans
it may decide are attractive investments for us, which could result in
investment returns that are substantially below expectations or that result in
losses, which would materially and adversely affect our business operations and
results. Further, decisions made and investments and financing arrangements
entered into by our Manager may not fully reflect the best interests of our
shareholders.





Risks Related to Our
Company





There can be no
assurance that the actions of the U.S. government, Federal Reserve, U.S.
Treasury and other governmental and regulatory bodies for the purpose of
stabilizing the financial markets, including the establishment of the TALF and
the PPIP, or market response to those actions, will achieve the intended effect,
and our business may not benefit from these actions; further government actions
or the cessation or curtailment of current U.S. government programs and/or
participation in the mortgage and securities markets could adversely impact
us.





In
response to the financial issues affecting the banking system and the financial
markets and going concern threats to investment banks and other financial
institutions, the U.S. government, Federal Reserve and U.S. Treasury
and other governmental and regulatory bodies have taken action to stabilize the
financial markets. Significant measures include: the enactment of the Emergency
Economic Stabilization Act of 2008, or the EESA, to, among other things,
establish the Troubled Asset Relief Program, or TARP; the enactment of the
Housing and Economic Recovery Act of 2008, or the HERA, which established a new
regulator for Fannie Mae and Freddie Mac; and the establishment of the TALF and
the PPIP.





There can
be no assurance that the EESA, HERA, TALF, PPIP or other recent
U.S. government actions will have a beneficial impact on the financial
markets, including on current extreme levels of volatility. To the extent the
market does not respond favorably to these initiatives or these initiatives do
not function as intended, our business may not receive the anticipated positive
impact from the legislation. There can also be no assurance that we will
continue to be eligible to participate in programs established by the
U.S. government such as the TALF or the PPIP or, if we remain eligible,
that we will be able to utilize them successfully or at all. In addition,
because the programs are designed, in part, to restart the market for certain of
our target assets, the establishment of these programs may result in increased
competition for attractive opportunities in our target assets. It is also
possible that our competitors may utilize the programs which would provide them
with attractive debt and equity capital funding from the U.S. government.
In addition, the U.S. government, the Federal Reserve, the
U.S. Treasury and other governmental and regulatory bodies have taken or
are considering taking other actions to address the financial crisis. However,
there can be no assurance that the U.S. government, the Federal Reserve,
the U.S. Treasury and other governmental and regulatory bodies will not
eliminate or curtail current U.S. government programs and/or participation
in the mortgage and securities markets. We cannot predict whether or when such
actions may occur, and such actions could have a dramatic impact on our
business, results of operations and financial condition.
  17





We may change any
of our strategies, policies or procedures without shareholder
consent.





We may
change any of our strategies, policies or procedures with respect to
investments, acquisitions, growth, operations, indebtedness, capitalization and
distributions at any time without the consent of our shareholders, which could
result in an investment portfolio with a different risk profile. A change in our
investment strategy may increase our exposure to interest rate risk, default
risk and real estate market fluctuations. Furthermore, a change in our asset
allocation could result in our making investments in asset categories different
from those described in this Report. These changes could adversely affect our
financial condition, results of operations, the market price of our common stock
and our ability to make distributions to our shareholders.





We have a limited
operating history and may not be able to successfully operate our business or
generate sufficient revenue to make or sustain distributions to our
shareholders.





We were
organized in June 2008 and commenced operations upon completion of our IPO on
July 1, 2009. We cannot assure you that we will be able to operate our
business successfully or execute our operating policies and strategies as
described in this Report. The results of our operations depend on several
factors, including the availability of opportunities for the acquisition of
assets, the level and volatility of interest rates, the availability of adequate
short and long-term financing, conditions in the financial markets and economic
conditions.





We are highly
dependent on information systems and systems failures could significantly
disrupt our business, which may, in turn, negatively affect the market price of
our common stock and our ability to pay dividends.





Our
business is highly dependent on communications and information systems of
Invesco. Any failure or interruption of Invesco’s systems could cause delays or
other problems in our securities trading activities, which could have a material
adverse effect on our operating results and negatively affect the market price
of our common stock and our ability to pay dividends to our
shareholders.





Maintenance of
our 1940 Act exemption imposes limits on our
operations.





The
company conducts its operations so as not to become regulated as an investment
company under the 1940 Act. Because the company is a holding company that
conducts its businesses through the operating partnership and its wholly owned
or majority-owned subsidiaries, the securities issued by these subsidiaries that
are excepted from the definition of “investment company” under
Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any
other investment securities the operating partnership may own, may not have a
combined value in excess of 40% of the value of the operating partnership’s
total assets on an unconsolidated basis which we refer to as the 40% test. This
requirement limits the types of businesses in which we may engage through our
subsidiaries. IAS Asset I LLC and certain of the operating partnership’s other
subsidiaries that we may form in the future intend to rely upon the exemption
from registration as an investment company under the 1940 Act pursuant to
Section 3(c)(5)(C) of the 1940 Act, which is available for entities
“primarily engaged in the business of purchasing or otherwise acquiring
mortgages and other liens on and interests in real estate.” This exemption
generally requires that at least 55% of our subsidiaries’ portfolios must be
comprised of qualifying assets and at least another 25% of each of their
portfolios must be comprised of real estate-related assets under the 1940 Act
(and no more than 20% comprised of miscellaneous assets). Qualifying assets for
this purpose include mortgage loans and other assets, such as whole pool Agency
and non-Agency RMBS, that the SEC staff in various no-action letters has
determined are the functional equivalent of mortgage loans for the purposes of
the 1940 Act. We treat as real estate-related assets CMBS, debt and equity
securities of companies primarily engaged in real estate businesses, agency
partial pool certificates and securities issued by pass-through entities of
which substantially all of the assets consist of qualifying assets and/or real
estate-related assets. IAS Asset I LLC invests in the Invesco PPIP Fund.
 18
  We treat
IAS Asset I LLC’s investment in the Invesco PPIP Fund as a “real
estate-related asset” for purposes of the Section 3(c)(5)(C) analysis. As a
result, IAS Asset I LLC can invest no more than 25% of its assets in the Invesco
PPIP and other real estate-related assets. We note that the SEC has not provided
any guidance on the treatment of interests in PPIFs as real estate-related
assets and any such guidance may require us to change our strategy. We may need
to adjust IAS Asset I LLC’s assets and strategy in order for it to continue to
rely on Section 3(c)(5)(C) for its 1940 Act exemption. Any such adjustment
in IAS Asset I LLC’s assets or strategy is not expected to have a material
adverse effect on our business or strategy. Although we monitor our portfolio
periodically and prior to each investment acquisition, there can be no assurance
that we will be able to maintain this exemption from registration for each of
these subsidiaries. The legacy securities PPIF formed and managed by our Manager
or one of its affiliates relies on Section 3(c)(7) for its 1940 Act
exemption.





IMC
Investments I LLC was organized as a special purpose subsidiary of the operating
partnership that borrows under the TALF. This subsidiary relies on
Section 3(c)(7) for its 1940 Act exemption and, therefore, the operating
partnership’s interest in this TALF subsidiary would constitute an “investment
security” for purposes of determining whether the operating partnership passes
the 40% test. We may in the future organize one or more TALF subsidiaries that
seek to rely on the 1940 Act exemption provided to certain structured financing
vehicles by Rule 3a-7. Any such TALF subsidiary would need to be structured
to comply with any guidance that may be issued by the Division of Investment
Management of the SEC on the restrictions contained in Rule 3a-7. The
company expects that the aggregate value of the operating partnership’s
interests in TALF subsidiaries that seek to rely on Rule 3a-7 will comprise
less than 20% of the operating partnership’s (and, therefore, the company’s)
total assets on an unconsolidated basis.





To the
extent that we organize subsidiaries that rely on Rule 3a-7 for an
exemption from the 1940 Act, these subsidiaries will need to comply with the
restrictions contained in this Rule. In general, Rule 3a-7 exempts from the
1940 Act issuers that limit their activities as follows:


·
            the
      issuer issues securities the payment of which depends primarily on the
      cash flow from “eligible assets,” which include many of the types of
      assets that we acquire in our TALF fundings, that by their terms convert
      into cash within a finite time
period;





·
            the
      securities sold are fixed income securities rated investment grade by at
      least one rating agency (fixed income securities which are unrated or
      rated below investment grade may be sold to institutional accredited
      investors and any securities may be sold to “qualified institutional
      buyers” and to persons involved in the organization or operation of the
      issuer);





·
            the
      issuer acquires and disposes of eligible assets (1) only in
      accordance with the agreements pursuant to which the securities are
      issued, (2) so that the acquisition or disposition does not result in
      a downgrading of the issuer’s fixed income securities and (3) the
      eligible assets are not acquired or disposed of for the primary purpose of
      recognizing gains or decreasing losses resulting from market value
      changes; and





·
            unless
      the issuer is issuing only commercial paper, the issuer appoints an
      independent trustee, takes reasonable steps to transfer to the trustee an
      ownership or perfected security interest in the eligible assets, and meets
      rating agency requirements for commingling of cash
  flows.





In
addition, in certain circumstances, compliance with Rule 3a-7 may also
require, among other things that the indenture governing the subsidiary include
additional limitations on the types of assets the subsidiary may sell or acquire
out of the proceeds of assets that mature, are refinanced or otherwise sold, on
the period of time during which such transactions may occur, and on the level of
transactions that may occur. In light of the requirements of Rule 3a-7, our
ability to manage assets held in a special purpose subsidiary that complies with
Rule 3a-7 will be limited and we may not be able to purchase or sell assets
owned by that subsidiary when we would otherwise desire to do so, which could
lead to losses.





19


The
determination of whether an entity is a majority-owned subsidiary of our company
is made by us. The 1940 Act defines a majority-owned subsidiary of a person as a
company 50% or more of the outstanding voting securities of which are owned by
such person, or by another company which is a majority-owned subsidiary of such
person. The 1940 Act further defines voting securities as any security presently
entitling the owner or holder thereof to vote for the election of directors of a
company. We treat companies in which we own at least a majority of the
outstanding voting securities as majority-owned subsidiaries for purposes of the
40% test. We have not requested the SEC to approve our treatment of any company
as a majority-owned subsidiary and the SEC has not done so. If the SEC were to
disagree with our treatment of one or more companies as majority-owned
subsidiaries, we would need to adjust our strategy and our assets in order to
continue to pass the 40% test. Any such adjustment in our strategy could have a
material adverse effect on us.
 
 Qualification
for exemption from registration under the 1940 Act will limit our ability to
make certain investments. For example, these restrictions will limit the ability
of our subsidiaries to invest directly in mortgage-backed securities that
represent less than the entire ownership in a pool of mortgage loans, debt and
equity tranches of securitizations and certain asset-backed securities and real
estate companies or in assets not related to real estate.





There can
be no assurance that the laws and regulations governing the 1940 Act status of
REITs, including the Division of Investment Management of the SEC providing more
specific or different guidance regarding these exemptions, will not change in a
manner that adversely affects our operations. To the extent that the SEC staff
provides more specific guidance regarding any of the matters bearing upon such
exclusions, we may be required to adjust our strategy accordingly. Any
additional guidance from the SEC staff could provide additional flexibility to
us, or it could further inhibit our ability to pursue the strategies we have
chosen. If we, the operating partnership or its subsidiaries fail to maintain an
exception or exemption from the 1940 Act, we could, among other things, be
required either to (a) change the manner in which we conduct our operations
to avoid being required to register as an investment company, (b) effect
sales of our assets in a manner that, or at a time when, we would not otherwise
choose to do so, or (c) register as an investment company, any of which
could negatively affect the value of our common stock, the sustainability of our
business model, and our ability to make distributions which could have an
adverse effect on our business and the market price for our shares of common
stock.





Risks Related to Financing and
Hedging





We use leverage
in executing our business strategy, which may adversely affect the return on our
assets and may reduce cash available for distribution to our shareholders, as
well as increase losses when economic conditions are
unfavorable.





We use
leverage to finance our assets through borrowings from repurchase agreements,
borrowings under programs established by the U.S. government such as the
TALF, and other secured and unsecured forms of borrowing and we contribute
capital to funds that receive financing under the PPIP. Although we are not
required to maintain any particular debt-to-equity leverage ratio, the amount of
leverage we may deploy for particular assets will depend upon our Manager’s
assessment of the credit and other risks of those assets. As of
December 31, 2009, our total leverage, on a debt-to-equity basis, was 3.0
times, which consisted of 13.6 times on our Agency RMBS assets and 3.9 times on
our CMBS. As of December 31, 2009, our non-Agency RMBS had no leverage. We
consider these leverage ratios to be prudent for these asset
classes.





The
capital and credit markets have been experiencing extreme volatility and
disruption since July 2007. In the last year, the volatility and disruption have
reached unprecedented levels. In a large number of cases, the markets have
exerted downward pressure on stock prices and credit capacity for issuers. Our
access to capital depends upon a number of factors over which we have little or
no control, including:





·
            general
      market conditions;





·
            the
      market’s view of the quality of our
assets;






20


·
            the
      market’s perception of our growth
potential;





·
            our
      eligibility to participate in and access capital from programs established
      by the U.S. government;





·
            our
      current and potential future earnings and cash
      distributions; and





·
            the
      market price of the shares of our capital
stock.





The
current weakness in the financial markets, the residential and commercial
mortgage markets and the economy generally could adversely affect one or more of
our potential lenders and could cause one or more of our potential lenders to be
unwilling or unable to provide us with financing or to increase the costs of
that financing. Current market conditions have affected different types of
financing for mortgage-related assets to varying degrees, with some sources
generally being unavailable, others being available but at a higher cost, while
others being largely unaffected. For example, in the repurchase agreement
market, non-Agency RMBS have been more difficult to finance than Agency RMBS. In
connection with repurchase agreements, financing rates and advance rates, or
haircut levels, have also increased. Repurchase agreement counterparties have
taken these steps in order to compensate themselves for a perceived increased
risk due to the illiquidity of the underlying collateral. In some cases, margin
calls have forced borrowers to liquidate collateral in order to meet the capital
requirements of these margin calls, resulting in losses.





The
return on our assets and cash available for distribution to our shareholders may
be reduced to the extent that market conditions prevent us from leveraging our
assets or cause the cost of our financing to increase relative to the income
that can be derived from the assets acquired. Our financing costs will reduce
cash available for distributions to shareholders. We may not be able to meet our
financing obligations and, to the extent that we cannot, we risk the loss of
some or all of our assets to liquidation or sale to satisfy the obligations. We
leverage our Agency RMBS, and may leverage our non-Agency RMBS, through
repurchase agreements. A decrease in the value of these assets may lead to
margin calls which we will have to satisfy. We may not have the funds available
to satisfy any such margin calls and may be forced to sell assets at
significantly depressed prices due to market conditions or otherwise, which may
result in losses. The satisfaction of such margin calls may reduce cash flow
available for distribution to our shareholders. Any reduction in distributions
to our shareholders may cause the value of our common stock to
decline.





As a result of
recent market events, including the contraction among and failure of certain
lenders, it may be more difficult for us to secure non-governmental
financing.





Our
results of operations are materially affected by conditions in the financial
markets and the economy generally. Recently, concerns over inflation, energy
price volatility, geopolitical issues, unemployment, the availability and cost
of credit, the mortgage market and a declining real estate market have
contributed to increased volatility and diminished expectations for the economy
and markets.





Dramatic
declines in the residential and commercial real estate markets, with decreasing
home prices and increasing foreclosures and unemployment, have resulted in
significant asset write-downs by financial institutions, which have caused many
financial institutions to seek additional capital, to merge with other
institutions and, in some cases, to fail. We rely on the availability of
repurchase agreement financing to acquire Agency RMBS, and in some cases CMBS,
on a leveraged basis. Although we use U.S. government financing to acquire
certain target assets, we also seek private funding sources to acquire these
assets as well. Institutions from which we seek to obtain financing may have
owned or financed residential or commercial mortgage loans, real estate-related
securities and real estate loans which have declined in value and caused losses
as a result of the recent downturn in the markets. Many lenders and
institutional investors have reduced and, in some cases, ceased to provide
funding to borrowers, including other financial institutions. If these
conditions persist, these institutions may become insolvent. As a result of
recent market events, it may be more difficult for us to secure non-governmental
financing as there are fewer institutional lenders and those remaining lenders
have tightened their lending standards.





21


If a counterparty
to our repurchase transactions defaults on its obligation to resell the
underlying security back to us at the end of the transaction term, or if the
value of the underlying security has declined as of the end of that term, or if
we default on our obligations under the repurchase agreement, we will lose money
on our repurchase transactions.





When we
engage in repurchase transactions, we generally sell securities to lenders
(repurchase agreement counterparties) and receive cash from these lenders. The
lenders are obligated to resell the same securities back to us at the end of the
term of the transaction. Because the cash we receive from the lender when we
initially sell the securities to the lender is less than the value of those
securities (this difference is the haircut), if the lender defaults on its
obligation to resell the same securities back to us we may incur a loss on the
transaction equal to the amount of the haircut (assuming there was no change in
the value of the securities). We would also lose money on a repurchase
transaction if the value of the underlying securities has declined as of the end
of the transaction term, as we would have to repurchase the securities for their
initial value but would receive securities worth less than that amount. Further,
if we default on one of our obligations under a repurchase transaction, the
lender can terminate the transaction and cease entering into any other
repurchase transactions with us. Some of our repurchase agreements contain
cross-default provisions, so that if a default occurs under any one agreement,
the lenders under our other agreements could also declare a default. Any losses
we incur on our repurchase transactions could adversely affect our earnings and
thus our cash available for distribution to our shareholders.





Our use or future
use of repurchase agreements to finance our Agency RMBS and non-Agency RMBS may
give our lenders greater rights in the event that either we or a lender files
for bankruptcy.





Our
borrowings or future borrowings under repurchase agreements for our Agency RMBS
and non-Agency RMBS may qualify for special treatment under the
U.S. Bankruptcy Code, giving our lenders the ability to avoid the automatic
stay provisions of the U.S. Bankruptcy Code and to take possession of and
liquidate the assets that we have pledged under their repurchase agreements
without delay in the event that we file for bankruptcy. Furthermore, the special
treatment of repurchase agreements under the U.S. Bankruptcy Code may make
it difficult for us to recover our pledged assets in the event that a lender
party to such agreement files for bankruptcy. Therefore, our use of repurchase
agreements to finance our investments exposes our pledged assets to risk in the
event of a bankruptcy filing by either a lender or us.





We depend, and
may in the future depend, on repurchase agreement financing to acquire Agency
RMBS and non-Agency RMBS and our inability to access this funding for our Agency
RMBS and non-Agency RMBS could have a material adverse effect on our results of
operations, financial condition and business.





We use
repurchase agreement financing as a strategy to increase the return on our
assets. However, we may not be able to achieve our desired leverage ratio for a
number of reasons, including if the following events occur:


·
            our
      lenders do not make repurchase agreement financing available to us at
      acceptable rates;





·
            certain
      of our lenders exit the repurchase
market;





·
            our
      lenders require that we pledge additional collateral to cover our
      borrowings, which we may be unable to
  do; or





·
            we
      determine that the leverage would expose us to excessive
    risk.





Our ability to fund our Agency RMBS and non-Agency RMBS may be impacted by our
ability to secure repurchase agreement financing on acceptable terms. We can
provide no assurance that lenders will be willing or able to provide us with
sufficient financing. In addition, because repurchase agreements are short-term
commitments of capital, lenders may respond to market conditions making it more
difficult for us to secure continued financing. During certain periods of the
credit cycle, lenders may curtail their willingness to provide financing.





22


If major
market participants continue to exit the repurchase agreement financing
business, the value of our Agency RMBS and non-Agency RMBS could be negatively
impacted, thus reducing net shareholder equity, or book value. Furthermore, if
many of our potential lenders are unwilling or unable to provide us with
repurchase agreement financing, we could be forced to sell our Agency RMBS,
non-Agency RMBS and assets at an inopportune time when prices are depressed. In
addition, if the regulatory capital requirements imposed on our lenders change,
they may be required to significantly increase the cost of the financing that
they provide 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
management of perceived risk, particularly with respect to assignee liability.
Moreover, the amount of financing we receive, or may in the future receive,
under our repurchase agreements is directly related to the lenders’ valuation of
the Agency RMBS and non-Agency RMBS that secure the outstanding borrowings.
Typically repurchase agreements grant the respective lender the absolute right
to reevaluate the market value of the assets that secure outstanding borrowings
at any time. If a lender determines in its sole discretion that the value of the
assets has decreased, it has the right to initiate a margin call. A margin call
would require us to transfer additional assets to such lender without any
advance of funds from the lender for such transfer or to repay a portion of the
outstanding borrowings. Any such margin call could have a material adverse
effect on our results of operations, financial condition, business, liquidity
and ability to make distributions to our shareholders, and could cause the value
of our common stock to decline. We may be forced to sell assets at significantly
depressed prices to meet such margin calls and to maintain adequate liquidity,
which could cause us to incur losses. Moreover, to the extent we are forced to
sell assets at such time, given market conditions, we may be selling at the same
time as others facing similar pressures, which could exacerbate a difficult
market environment and which could result in our incurring significantly greater
losses on our sale of such assets. In an extreme case of market duress, a market
may not even be present for certain of our assets at any price.


The current
dislocations in the residential and commercial mortgage sector could cause one
or more of our potential lenders to be unwilling or unable to provide us with
financing for our target assets on attractive terms or at
all.





The
current dislocations in the residential mortgage sector have caused many lenders
to tighten their lending standards, reduce their lending capacity or exit the
market altogether. Further contraction among lenders, insolvency of lenders or
other general market disruptions could adversely affect one or more of our
potential lenders and could cause one or more of our potential lenders to be
unwilling or unable to provide us with financing on attractive terms or at all.
This could increase our financing costs and reduce our access to liquidity. If
one or more major market participants fails or otherwise experiences a major
liquidity crisis, it could negatively impact the marketability of all fixed
income securities, including our target assets, and this could negatively impact
the value of the assets we acquire, thus reducing our net book value.
Furthermore, if many of our potential lenders are unwilling or unable to provide
us with financing, we could be forced to sell our assets at an inopportune time
when prices are depressed.





The repurchase
agreements that we use to finance our investments may require us to provide
additional collateral and may restrict us from leveraging our assets as fully as
desired.





We use
repurchase agreements to finance our acquisition of Agency RMBS, and may use
repurchase agreements to finance our acquisition of non-Agency RMBS. If the
market value of the Agency RMBS pledged or sold by us to a financing institution
declines, we may be required by the financing institution to provide additional
collateral or pay down a portion of the funds advanced, but we may not have the
funds available to do so, which could result in defaults. Posting additional
collateral to support our credit will reduce our liquidity and limit our ability
to leverage our assets, which could adversely affect our business. In the event
we do not have sufficient liquidity to meet such requirements, financing
institutions can accelerate repayment of our indebtedness, increase interest
rates, liquidate our collateral or 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 bankruptcy
protection.





Further,
financial institutions providing the repurchase facilities may require us to
maintain a certain amount of cash uninvested or to set aside non-levered assets
sufficient to maintain a specified liquidity position which would allow us to
satisfy our collateral obligations. As a result, we may not be able to leverage
our assets as fully as we would choose, which could reduce our return on equity.
If we are unable to meet these collateral obligations, our financial condition
could deteriorate rapidly.
  23
  An increase in
our borrowing costs relative to the interest we receive on investments in our
target assets may adversely affect our profitability and our cash available for
distribution to our shareholders.





As our
financings mature, we will be required either to enter into new borrowings or to
sell certain of our investments. An increase in short-term interest rates at the
time that we seek to enter into new borrowings would reduce the spread between
our returns on our assets and the cost of our borrowings. This would adversely
affect our returns on our assets, which might reduce earnings and, in turn, cash
available for distribution to our shareholders.





We use U.S.
government equity and debt financing to acquire our CMBS and mortgage loan
portfolio.





We
acquire CMBS with financings under the TALF. On March 23, 2009, the
U.S. Treasury announced preliminary plans to expand the TALF to include
non-Agency RMBS and CMBS that were originally rated AAA. On May 1, 2009,
the Federal Reserve published the terms for the expansion of TALF to CMBS and
announced that, beginning on June 16, 2009, up to $100 billion of TALF
loans will be available to finance purchases of CMBS created on or after
January 1, 2009. Additionally, on May 19, 2009, the Federal Reserve
announced that certain high quality legacy CMBS, including CMBS issued before
January 1, 2009, would become eligible collateral under the TALF starting
in July 2009. On August 17, 2009, the TALF, which was originally scheduled
to terminate December 31, 2009, was extended through March 31, 2010
for TALF loans against newly issued asset-backed securities backed by consumer
and business loans and legacy CMBS, and through June 30, 2010 for TALF
loans against newly issued CMBS. The Federal Reserve noted in its
August 17th release that the TALF will most likely not be extended to
include any new classes of eligible collateral. On October 5, 2009, the
Federal Reserve announced that, beginning with November subscriptions, the FRBNY
will conduct a formal risk assessment of all pledged asset-backed securities
collateral, not just newly issued and legacy CMBS. On December 4, 2009, the
Federal Reserve announced a final rule establishing criteria for the FRBNY to
choose additional rating organizations for newly issued asset-backed securities
not backed by commercial real estate.





We also
finance our investments in non-Agency RMBS and CMBS by contributing capital to
funds that receive financing under the legacy securities PPIP. We may also
finance our investments in residential and commercial mortgage loans by
contributing capital to funds that receive financing under the legacy loan PPIP.
There can be no assurance that U.S. government equity and/or debit
financing will be available to finance our investments. See “Risk Factors —
Risks Relating to the PPIP and TALF” below.





We enter into
hedging transactions that could expose us to contingent liabilities in the
future.





Subject
to maintaining our qualification as a REIT, part of our investment strategy
involves entering into hedging transactions that could require us to fund cash
payments in certain circumstances (such as the early termination of the hedging
instrument caused by an event of default or other early termination event, or
the decision by a counterparty to request margin securities it is contractually
owed under the terms of the hedging instrument). The amount due would be equal
to the unrealized loss of the open swap positions with the respective
counterparty and could also include other fees and charges. These economic
losses will be reflected in our results of operations, and our ability to fund
these obligations will depend on the liquidity of our assets and access to
capital at the time, and the need to fund these obligations could adversely
impact our financial condition.





Hedging against
interest rate exposure may adversely affect our earnings, which could reduce our
cash available for distribution to our shareholders.





Subject
to maintaining our qualification as a REIT, we pursue various hedging strategies
to seek to reduce our exposure to adverse changes in interest rates. Our hedging
activity varies 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 because, among other
things:
   24


·
            interest
      rate hedging can be expensive, particularly during periods of rising and
      volatile interest rates;





·
            available
      interest rate hedges may not correspond directly with the interest rate
      risk for which protection is
sought;





·
            due
      to a credit loss, the duration of the hedge may not match the duration of
      the related 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 taxable REIT subsidiary
      (“TRS”)) to offset interest rate losses is limited by U.S. federal
      tax provisions governing REITs;





·
            the
      credit quality of the hedging counterparty owing money on the hedge may be
      downgraded to such an extent that it impairs our ability to sell or assign
      our side of the hedging
transaction; and





·
            the
      hedging counterparty owing money in the hedging transaction may default on
      its obligation to pay.





Our
hedging transactions, which are intended to limit losses, may actually adversely
affect our earnings, which could reduce our cash available for distribution to
our shareholders.





In
addition, hedging instruments involve risk since they often are not traded on
regulated exchanges, guaranteed by an exchange or its clearing house, or
regulated by any U.S. or foreign governmental authorities. Consequently,
there are no requirements with respect to record keeping, financial
responsibility or segregation of customer funds and positions. Furthermore, the
enforceability of agreements underlying hedging transactions may depend on
compliance with applicable statutory and commodity and other regulatory
requirements and, depending on the identity of the counterparty, applicable
international requirements. The business failure of a hedging counterparty with
whom we enter into a hedging transaction will most likely result in its default.
Default by a party with whom we enter into a hedging transaction may result in
the loss of unrealized profits and force us to cover our commitments, if any, at
the then current market price. Although generally we seek to reserve the right
to terminate our hedging positions, it may not always be possible to dispose of
or close out a hedging position without the consent of the hedging counterparty
and we may not be able to enter into an offsetting contract in order to cover
our risk. We cannot assure you that a liquid secondary market will exist for
hedging instruments purchased or sold, and we may be required to maintain a
position until exercise or expiration, which could result in
losses.





Risks Relating to the PPIP and
TALF





The terms and
conditions of the TALF may change, which could adversely affect our
investments.





The terms
and conditions of the TALF, including asset and borrower eligibility, could be
changed at any time. Any such modifications may adversely affect the market
value of any of our assets financed through the TALF or our ability to obtain
additional TALF financing. If the TALF is prematurely discontinued or reduced
while our assets financed through the TALF are still outstanding, there may be
no market for these assets and the market value of these assets would be
adversely affected.





There is no
assurance that we will be able to invest additional funds in the PPIF or, if we
are able to participate, that funding will be
available.





Investors
in the legacy loan PPIP must be pre-qualified by the FDIC. The FDIC has complete
discretion regarding the qualification of investors in the legacy loan PPIP and
is under no obligation to approve Invesco’s participation even if it meets all
of the applicable criteria.







25
  Requests for
funding under the PPIP may surpass the amount of funding authorized by the
U.S. Treasury, resulting in an early termination of the PPIP. In addition,
under the terms of the legacy securities PPIP, the U.S. Treasury has the
right to cease funding of committed but undrawn equity capital and debt
financing to a specific fund participating in the legacy securities PPIP in its
sole discretion. We may be unable to obtain capital and debt financing on
similar terms and such actions may adversely affect our ability to purchase
eligible assets and may otherwise affect expected returns on our
investments.





There is no
assurance that we will have sufficient capital to fund our commitment in the
PPIF.





We
committed to invest up to $25.0 million in the Invesco PPIP Fund, which, in
turn, invests in our target assets. As of December 31, 2009, $4.1 million
of the commitment has been called. A call on our commitment would require us to
pay up to $20.9 million in the Invesco Legacy Securities Master Fund, L.P. If we
do not have sufficient capital to meet such a call, we may be forced to sell
assets at significantly depressed prices to meet the call and to maintain
adequate liquidity, which could have a material adverse effect on our results of
operations, financial condition, business, liquidity and ability to make
distributions to our shareholders, and could cause the value of our common stock
to decline. Moreover, to the extent we are forced to sell assets at such time,
given market conditions, we may be selling at the same time as others facing
similar pressures, which could exacerbate a difficult market environment and
which could result in our incurring significantly greater losses on our sale of
such assets. In an extreme case of market duress, a market may not even be
present for certain of our assets at any price.





There is no
assurance that we will be able to obtain any additional TALF
loans.





The TALF
is operated by the FRBNY. The FRBNY has complete discretion regarding the
extension of credit under the TALF and is under no obligation to make any
additional loans to us even if we meet all of the applicable criteria. Requests
for TALF loans may surpass the amount of funding authorized by the Federal
Reserve and the U.S. Treasury, resulting in an early termination of the
TALF. Depending on the demand for TALF loans and the general state of the credit
markets, the Federal Reserve and the U.S. Treasury may decide to modify the
terms and conditions of the TALF. Such actions may adversely affect our ability
to further obtain TALF loans and use the loan leverage to enhance returns, and
may otherwise affect expected returns on our investments.





We could lose our
eligibility as a TALF borrower, which would adversely affect our ability to
fulfill our investment objectives.





Any
U.S. company is permitted to participate in the TALF, provided that it
maintains an account relationship with a primary dealer. An entity is a
U.S. company for purposes of the TALF if it is: (1) a business entity
or institution that is organized under the laws of the United States or a
political subdivision or territory thereof (U.S.-organized) and conducts
significant operations or activities in the United States, including any
U.S.-organized subsidiary of such an entity; (2) a U.S. branch or
agency of a non-U.S. bank (other than a foreign central bank) that
maintains reserves with a Federal Reserve Bank; (3) a U.S. insured
depository institution; or (4) an investment fund that is U.S.-organized
and managed by an investment manager that has its principal place of business in
the United States. An entity that satisfies any one of the requirements above is
a U.S. company regardless of whether it is controlled by, or managed by, a
company that is not U.S.-organized. Notwithstanding the foregoing, a
U.S. company excludes any entity, other than those described in
clauses (2) and (3) above, that is controlled by a
non-U.S. government or is managed by an investment manager controlled by a
non-U.S. government, other than those described in clauses (2) and
(3) above. For these purposes, a non-U.S. government controls a
company if, among other things, such non-U.S. government owns, controls, or
holds with power to vote 25% or more of a class of voting securities of the
company. If for any reason we are deemed not to be eligible to participate in
the TALF, all of our outstanding TALF loans will become immediately due and
payable and we will not be eligible to obtain future TALF
loans.





26


It may be
difficult to acquire sufficient amounts of eligible assets to qualify to
participate in the PPIP or the TALF consistent with our investment
strategy.





Assets to
be used as collateral for PPIP and TALF loans must meet strict eligibility
criteria with respect to characteristics such as issuance date, maturity, and
credit rating and with respect to the origination date of the underlying
collateral. These restrictions may limit the availability of eligible assets,
and it may be difficult to acquire sufficient amounts of assets to obtain
financing under the PPIP and TALF consistent with our investment
strategy.





In the
legacy loan PPIP, eligible financial institutions must consult with the FDIC
before offering an asset pool for sale and there is no assurance that a
sufficient number of eligible financial institutions will be willing to
participate as sellers in the legacy loan PPIP.





Once an
asset pool has been offered for sale by an eligible financial institution, the
FDIC will determine the amount of leverage available to finance the purchase of
the asset pool. There is no assurance that the amount of leverage available to
finance the purchase of eligible assets will be acceptable to our
Manager.





The asset
pools will be purchased through a competitive auction conducted by the FDIC. The
auction process may increase the price of these eligible asset pools. Even if a
fund in which we invest submits the winning bid on an eligible asset pool at a
price that is acceptable to the fund, the selling financial institution may
refuse to sell to the fund the eligible asset pool at that
price.





These
factors may limit the availability of eligible assets, and it may be difficult
to acquire sufficient amounts of assets to obtain financing under the legacy
loan PPIP consistent with our investment strategy.





It may be
difficult to transfer any assets purchased using PPIP and TALF
funding.





Any
assets purchased using TALF funding will be pledged to the FRBNY as collateral
for the TALF loans. Transfer or sale of any of these assets requires repayment
of the related TALF loan or the consent of the FRBNY to assign obligations under
the related TALF loan to the applicable assignee. The FRBNY in its discretion
may restrict or prevent assignment of loan obligations to a third party,
including a third party that meets the criteria of an eligible borrower. In
addition, the FRBNY will not consent to any assignments after the termination
date for making new loans, which is March 31, 2010 for TALF loans against
newly issued asset-backed securities backed by consumer and business loans and
legacy CMBS, and June 30, 2010 for TALF loans against newly issued CMBS,
unless extended by the Federal Reserve.





Any
assets purchased using PPIP funding, to the extent available, will be pledged to
the FDIC as collateral for their guarantee under the legacy loan program and to
the U.S. Treasury as collateral for debt financing under the legacy
securities program. Transfer or sale of any of these assets requires repayment
of the related loan or the consent of the FDIC or the U.S. Treasury to
assign obligations to the applicable assignee. The FDIC or the
U.S. Treasury, each in its discretion, may restrict or prevent assignment
of obligations to a third party, including a third party that meets the criteria
for participation in the PPIP.





These
restrictions may limit our ability to trade or otherwise dispose of our
investments, and may adversely affect our ability to take advantage of favorable
market conditions and make distributions to shareholders.





We may need to
surrender eligible TALF assets to repay TALF loans at
maturity.





Each TALF
loan must be repaid within three to five years. We invested in CMBS that do not
mature within the term of the TALF loan. If we do not have sufficient funds to
repay interest and principal on the related TALF loan at maturity and if these
assets cannot be sold for an amount equal to or greater than the amount owed on
such loan, we must surrender the assets to the FRBNY in lieu of repayment. If we
are forced to sell any assets to repay a TALF loan, we may not be able to obtain
a favorable price which could result in losses. If we default on our obligation
to pay a TALF loan and the FRBNY elects to liquidate the assets used as
collateral to secure such TALF loan, the proceeds from that sale will be
applied, first, to any enforcement costs, second, to unpaid principal and,
finally, to unpaid interest. Under the terms of the TALF, if assets are
surrendered to the FRBNY in lieu of repayment, all assets that collateralize
that loan must be surrendered. In these situations, we would forfeit any equity
that we held in these assets.


27
 FRBNY consent is
required to exercise our voting rights on CMBS.





As a
requirement of the TALF, we must agree not to exercise or refrain from
exercising any voting, consent or waiver rights under a CMBS without the consent
of the FRBNY. During the continuance of a collateral enforcement event, the
FRBNY will have the right to exercise voting rights in the
collateral.


Our ability to
receive the interest earnings may be limited.





We make
interest payments on TALF loans from the interest paid to us on the assets used
as collateral for the TALF loan. To the extent that we receive distributions
from pledged assets in excess of our required interest payments on a TALF loan
during any loan year, the amount of excess interest we may retain will be
limited.





Under certain
conditions, we may be required to provide full recourse for TALF loans or to
make indemnification payments.





To
participate in the TALF, we executed customer agreements with primary dealers
authorizing them, among other things, to act as our agent under TALF and to act
on our behalf under the agreement with the FRBNY and with The Bank of New York
Mellon as administrator and as the FRBNY’s custodian of the CMBS. Under the
agreements, we are required to represent to the primary dealer and to the FRBNY
that, among other things, we are an eligible borrower and that the CMBS that we
pledge meet the TALF eligibility criteria. The FRBNY has full recourse to us for
repayment of the loan for any breach of these representations. Further, the
FRBNY has full recourse to us for repayment of a TALF loan if the eligibility
criteria for collateral under the TALF are considered continuing requirements
and the pledged collateral no longer satisfies such criteria. In addition, we
are required to pay to our primary dealers fees under the customer agreements
and to indemnify our primary dealers for certain breaches under the customer
agreements and to indemnify the FRBNY and its custodian for certain breaches
under the agreement with the FRBNY. Payments made to satisfy such full recourse
requirements and indemnities could have a material adverse effect on our net
income and our distributions to our shareholders.





Risks
Related to Accounting





Changes
in accounting treatment may adversely affect our reported
profitability.





In
February 2008, the Financial Accounting Standards Board (“FASB”) issued final
guidance regarding the accounting and financial statement presentation for
transactions that involve the acquisition of Agency RMBS from a counterparty and
the subsequent financing of these securities through repurchase agreements with
the same counterparty. If we fail to meet the criteria under guidance to account
for the transactions on a gross basis, our accounting treatment would not affect
the economics of these transactions, but would affect how these transactions are
reported on our financial statements. If we are not able to comply with the
criteria under this final guidance for same party transactions we would be
precluded from presenting Agency RMBS and the related financings, as well as the
related interest income and interest expense, on a gross basis on our financial
statements. Instead, we would be required to account for the purchase commitment
and related repurchase agreement on a net basis and record a forward commitment
to purchase Agency RMBS as a derivative instrument. Such forward commitments
would be recorded at fair value with subsequent changes in fair value recognized
in earnings. Additionally, we would record the cash portion of our investment in
Agency RMBS as a mortgage-related receivable from the counterparty on our
balance sheet. Although we would not expect this change in presentation to have
a material impact on our net income, it could have an adverse impact on our
operations. It could have an impact on our ability to include certain Agency
RMBS purchased and simultaneously financed from the same counterparty as
qualifying real estate interests or real estate-related assets used to qualify
under the exemption to not have to register as an investment company under the
1940 Act. It could also limit our investment opportunities as we may need to
limit our purchases of Agency RMBS that are simultaneously financed with the
same counterparty.


28
 We
may fail to qualify for hedge accounting treatment.





We enter
into derivative transactions to reduce the impact changes in interest rates will
have on our net interest margin. According to our accounting policy, we record
these derivatives, known as cash flow hedges, on the balance sheet at fair
market value with the changes in value recorded in equity as other comprehensive
income. This hedge accounting is complex and requires documentation and testing
to ensure the hedges are effective. If we fail to qualify for hedge accounting
treatment, our operating results may suffer because losses on hedges will be
recorded in current period earnings rather than through other comprehensive
income.





We have limited
experience in making critical accounting estimates, and our financial statements
may be materially affected if our estimates prove to be
inaccurate.





Financial
statements prepared in accordance with Accounting Principals Generally Accepted
in the United States of America (“US GAAP”) require the use of estimates,
judgments and assumptions that affect the reported amounts. Different estimates,
judgments and assumptions reasonably could be used that would have a material
effect on the financial statements, and changes in these estimates, judgments
and assumptions are likely to occur from period to period in the future.
Significant areas of accounting requiring the application of management’s
judgment include, but are not limited to determining the fair value of
investment securities. These estimates, judgments and assumptions are inherently
uncertain, and, if they prove to be wrong, then we face the risk that charges to
income will be required. In addition, because we have limited operating history
in some of these areas and limited experience in making these estimates,
judgments and assumptions, the risk of future charges to income may be greater
than if we had more experience in these areas. Any such charges could
significantly harm our business, financial condition, results of operations and
the price of our securities. See “Management’s Discussion and Analysis of
Financial Condition and Results of Operations — Critical Accounting
Policies” for a discussion of the accounting estimates, judgments and
assumptions that we believe are the most critical to an understanding of our
business, financial condition and results of operations.





Risks Related to Our
Investments





We may allocate
our equity to investments with which our shareholders may not
agree.





Our
shareholders will be unable to evaluate the manner in which our equity will be
invested or the economic merit of our expected investments and, as a result, we
may use our equity to invest in investments with which you may not agree. The
failure of our management to apply our equity effectively or find investments
that meet our investment criteria in sufficient time or on acceptable terms
could result in unfavorable returns, could cause a material adverse effect on
our business, financial condition, liquidity, results of operations and ability
to make distributions to our shareholders, and could cause the value of our
common stock to decline.





Because assets we
acquire may experience periods of illiquidity, we may lose profits or be
prevented from earning capital gains if we cannot sell mortgage-related assets
at an opportune time.





We bear
the risk of being unable to dispose of our target assets at advantageous times
or in a timely manner because mortgage-related assets generally experience
periods of illiquidity, including the recent period of delinquencies and
defaults with respect to residential and commercial mortgage loans. The lack of
liquidity may result from the absence of a willing buyer or an established
market for these assets, as well as legal or contractual restrictions on resale
or the unavailability of financing for these assets. As a result, our ability to
vary our portfolio in response to changes in economic and other conditions may
be relatively limited, which may cause us to incur losses.





29


The lack of
liquidity in our investments may adversely affect our
business.





The
assets that comprise our investment portfolio and that we acquire are not
publicly traded. A portion of these securities may be subject to legal and other
restrictions on resale or will otherwise be less liquid than publicly-traded
securities. The illiquidity of our investments may make it difficult for us to
sell such investments if the need or desire arises. In addition, if we are
required to liquidate all or a portion of our portfolio quickly, we may realize
significantly less than the value at which we have previously recorded our
investments. Further, we may face other restrictions on our ability to liquidate
an investment in a business entity to the extent that we or our Manager has or
could be attributed with material, non-public information regarding such
business entity. As a result, our ability to vary our portfolio in response to
changes in economic and other conditions may be relatively limited, which could
adversely affect our results of operations and financial
condition.





Our investments
may be concentrated and will be subject to risk of
default.





While we
diversify and intend to continue to diversify our portfolio of investments in
the manner described in this Report, we are not required to observe specific
diversification criteria, except as may be set forth in the investment
guidelines adopted by our board of directors. Therefore, our investments in our
target assets may at times be concentrated in certain property types that are
subject to higher risk of foreclosure, or secured by properties concentrated in
a limited number of geographic locations. To the extent that our portfolio is
concentrated in any one region or type of security, downturns relating generally
to such region or type of security may result in defaults on a number of our
investments within a short time period, which may reduce our net income and the
value of our common stock and accordingly reduce our ability to pay dividends to
our shareholders.





Difficult
conditions in the mortgage, residential and commercial real estate markets may
cause us to experience market losses related to our holdings, and we do not
expect these conditions to improve in the near future.





Our
results of operations are materially affected by conditions in the mortgage
market, the residential and commercial real estate markets, the financial
markets and the economy generally. Recently, concerns about the mortgage market
and a declining real estate market, as well as inflation, energy costs,
geopolitical issues and the availability and cost of credit, have contributed to
increased volatility and diminished expectations for the economy and markets
going forward. The mortgage market has been severely affected by changes in the
lending landscape and there is no assurance that these conditions have
stabilized or that they will not worsen. The disruption in the mortgage market
has an impact on new demand for homes, which will compress the home ownership
rates and weigh heavily on future home price performance. There is a strong
correlation between home price growth rates and mortgage loan delinquencies. The
further deterioration of the RMBS market may cause us to experience losses
related to our assets and to sell assets at a loss. Declines in the market
values of our investments may adversely affect our results of operations and
credit availability, which may reduce earnings and, in turn, cash available for
distribution to our shareholders.





Dramatic
declines in the residential and commercial real estate markets, with falling
home prices and increasing foreclosures and unemployment, have resulted in
significant asset write-downs by financial institutions, which have caused many
financial institutions to seek additional capital, to merge with other
institutions and, in some cases, to fail. Institutions from which we may seek to
obtain financing may have owned or financed residential or commercial mortgage
loans, real estate-related securities and real estate loans, which have declined
in value and caused them to suffer losses as a result of the recent downturn in
the residential and commercial mortgage markets. Many lenders and institutional
investors have reduced and, in some cases, ceased to provide funding to
borrowers, including other financial institutions. If these conditions persist,
these institutions may become insolvent or tighten their lending standards,
which could make it more difficult for us to obtain financing on favorable terms
or at all. Our profitability may be adversely affected if we are unable to
obtain cost-effective financing for our assets.





30


Continued adverse
developments in the residential and commercial mortgage markets, including
recent increases in defaults, credit losses and liquidity concerns, could make
it difficult for us to borrow money to acquire our target assets on a leveraged
basis, on attractive terms or at all, which could adversely affect our
profitability.





Since
mid-2008, there have been several announcements of proposed mergers,
acquisitions or bankruptcies of investment banks and commercial banks that have
historically acted as repurchase agreement counterparties. This has resulted in
a fewer number of potential repurchase agreement counterparties operating in the
market. In addition, many commercial banks, investment banks and insurance
companies have announced extensive losses from exposure to the residential and
commercial mortgage markets. These losses have reduced financial industry
capital, leading to reduced liquidity for some institutions. Many of these
institutions may have owned or financed assets which have declined in value and
caused them to suffer losses, enter bankruptcy proceedings, further tighten
their lending standards or increase the amount of equity capital or haircut
required to obtain financing. These difficulties have resulted in part from
declining markets for their mortgage loans as well as from claims for
repurchases of mortgage loans previously sold under provisions that require
repurchase in the event of early payment defaults or for breaches of
representations regarding loan quality. In addition, a rising interest rate
environment and declining real estate values may decrease the number of
borrowers seeking or able to refinance their mortgage loans, which would result
in a decrease in overall originations. In addition, the Federal Reserve’s
program to purchase Agency RMBS could cause an increase in the price of Agency
RMBS, which would negatively impact the net interest margin with respect to
Agency RMBS purchase. The general market conditions discussed above may make it
difficult or more expensive for us to obtain financing on attractive terms or at
all, and our profitability may be adversely affected if we were unable to obtain
cost-effective financing for our investments.





We operate in a
highly competitive market for investment opportunities and competition may limit
our ability to acquire desirable investments in our target assets and could also
affect the pricing of these securities.





We
operate in a highly competitive market for investment opportunities. Our
profitability depends, in large part, on our ability to acquire our target
assets at attractive prices. In acquiring our target assets, we compete with a
variety of institutional investors, including other REITs, specialty finance
companies, public and private funds (including other funds managed by Invesco),
commercial and investment banks, commercial finance and insurance companies and
other financial institutions. Many of our competitors are substantially larger
and have considerably greater financial, technical, marketing and other
resources than we do. Several other REITs have recently raised, or are expected
to raise, significant amounts of capital, and may have investment objectives
that overlap with ours, which may create additional competition for investment
opportunities. Some competitors may have a lower cost of funds and access to
funding sources that may not be available to us, such as funding from the
U.S. government, if we are not eligible to participate in programs
established by the U.S. government. Many of our competitors are not subject
to the operating constraints associated with REIT tax compliance or maintenance
of an exemption from the 1940 Act. In addition, some of our competitors may have
higher risk tolerances or different risk assessments, which could allow them to
consider a wider variety of investments and establish more relationships than
us. Furthermore, competition for investments in our target assets may lead to
the price of such assets increasing, which may further limit our ability to
generate desired returns. We cannot assure you that the competitive pressures we
face will not have a material adverse effect on our business, financial
condition and results of operations. Also, as a result of this competition,
desirable investments in our target assets may be limited in the future and we
may not be able to take advantage of attractive investment opportunities from
time to time, as we can provide no assurance that we will be able to identify
and make investments that are consistent with our investment objectives. In
addition, the Federal Reserve’s program to purchase Agency RMBS could cause an
increase in the price of Agency RMBS, which would negatively impact the net
interest margin with respect to Agency RMBS purchase.





31


We invest in
non-Agency RMBS collateralized by Alt A and subprime mortgage loans, which are
subject to increased risks.





We invest
in non-Agency RMBS backed by collateral pools of mortgage loans that have been
originated using underwriting standards that are less restrictive than those
used in underwriting “prime mortgage loans” and “Alt A mortgage loans.” These
lower standards include mortgage loans made to borrowers having imperfect or
impaired credit histories, mortgage loans where the amount of the loan at
origination is 80% or more of the value of the mortgage property, mortgage loans
made to borrowers with low credit scores, mortgage loans made to borrowers who
have other debt that represents a large portion of their income and mortgage
loans made to borrowers whose income is not required to be disclosed or
verified. Due to economic conditions, including increased interest rates and
lower home prices, as well as aggressive lending practices, subprime mortgage
loans have in recent periods experienced increased rates of delinquency,
foreclosure, bankruptcy and loss, and they are likely to continue to experience
delinquency, foreclosure, bankruptcy and loss rates that are higher, and that
may be substantially higher, than those experienced by mortgage loans
underwritten in a more traditional manner. Thus, because of the higher
delinquency rates and losses associated with subprime mortgage loans, the
performance of non-Agency RMBS backed by subprime mortgage loans that we may
acquire could be correspondingly adversely affected, which could adversely
impact our results of operations, financial condition and
business.





The mortgage
loans that we acquire, and the mortgage and other loans underlying the
non-Agency RMBS that we acquire, are subject to defaults, foreclosure timeline
extension, fraud and residential and commercial price depreciation, and
unfavorable modification of loan principal amount, interest rate and
amortization of principal, which could result in losses to
us.





Residential
mortgage loans are secured by single family residential property and are subject
to risks of delinquency and foreclosure and risks of loss. The ability of a
borrower to repay a loan secured by a residential property typically is
dependent upon the income or assets of the borrower. A number of factors,
including a general economic downturn, acts of God, terrorism, social unrest and
civil disturbances, may impair borrowers’ abilities to repay their loans. In
addition, we acquire non-Agency RMBS, which are backed by residential real
property but, in contrast to Agency RMBS, their principal and interest are not
guaranteed by federally chartered entities such as Fannie Mae and Freddie Mac
and, in the case of Ginnie Mae, the U.S. government. The ability of a
borrower to repay these loans or other financial assets is dependent upon the
income or assets of these borrowers.





In the
event of any default under a mortgage loan held directly by us, we bear a risk
of loss of principal to the extent of any deficiency between the value of the
collateral and the principal and accrued interest of the mortgage loan, which
could have a material adverse effect on our cash flow from operations. In the
event of the bankruptcy of a mortgage loan borrower, the mortgage loan to such
borrower will be deemed to be secured only to the extent of the value of the
underlying collateral at the time of bankruptcy (as determined by the bankruptcy
court), and the lien securing the mortgage loan will be subject to the avoidance
powers of the bankruptcy trustee or debtor in possession to the extent the lien
is unenforceable under state law. Foreclosure of a mortgage loan can be an
expensive and lengthy process which could have a substantial negative effect on
our anticipated return on the foreclosed mortgage loan.





Agency RMBS are
subject to risks particular to investments secured by mortgage loans on
residential real property.





Our
investments in Agency RMBS are subject to the risks of defaults, foreclosure
timeline extension, fraud and home price depreciation and unfavorable
modification of loan principal amount, interest rate and amortization of
principal, accompanying the underlying residential mortgage loans. The ability
of a borrower to repay a mortgage loan secured by a residential property is
dependent upon the income or assets of the borrower. A number of factors may
impair borrowers’ abilities to repay their loans, including:


·
            acts
      of God, including earthquakes, floods and other natural disasters, which
      may result in uninsured losses;






32





·
            acts
      of war or terrorism, including the consequences of terrorist attacks, such
      as those that occurred on September 11,
  2001;





·
            adverse
      changes in national and local economic and market
    conditions;





·
            changes
      in governmental laws and regulations, fiscal policies and zoning
      ordinances and the related costs of compliance with laws and regulations,
      fiscal policies and ordinances;





·
            costs
      of remediation and liabilities associated with environmental conditions
      such as indoor mold; and





·
            the
      potential for uninsured or under-insured property
  losses.





In the
event of defaults on the residential mortgage loans that underlie our
investments in Agency RMBS and the exhaustion of any underlying or any
additional credit support, we may not realize our anticipated return on our
investments and we may incur a loss on these investments.





The commercial
mortgage loans we acquire and the commercial mortgage loans underlying the CMBS
we acquire will be subject to defaults, foreclosure timeline extension, fraud
and price depreciation and unfavorable modification of loan principal amount,
interest rate and amortization of principal.





CMBS are
secured by a single commercial mortgage loan or a pool of commercial mortgage
loans. Accordingly, the CMBS we invest in are subject to all of the risks of the
respective underlying commercial mortgage loans. Commercial mortgage loans are
secured by multifamily or commercial property and are subject to risks of
delinquency and foreclosure, and risks of loss that may be greater than similar
risks associated with loans made on the security of single-family residential
property. The ability of a borrower to repay a loan secured by an
income-producing property typically is dependent primarily upon the successful
operation of such property rather than upon the existence of independent income
or assets of the borrower. If the net operating income of the property is
reduced, the borrower’s ability to repay the loan may be impaired. Net operating
income of an income-producing property can be 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 expenses or limit rents that may be
      charged;





·
            any
      need to address environmental contamination at the property or the
      occurrence of any uninsured casualty at the
  property;





·
            changes
      in national, regional or local economic conditions and/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;






33


·
            changes
      in governmental rules, regulations and fiscal policies, including
      environmental legislation; and





·
            acts
      of God, terrorist attacks, social unrest and civil
      disturbances.





In the
event of any default under a mortgage loan held directly by us, we will bear a
risk of loss of principal to the extent of any deficiency between the value of
the collateral and the principal and accrued interest of the mortgage loan,
which could have a material adverse effect on our cash flow from operations and
limit amounts available for distribution to our shareholders. In the event of
the bankruptcy of a mortgage loan borrower, the mortgage loan to such borrower
will be deemed to be secured only to the extent of the value of the underlying
collateral at the time of bankruptcy (as determined by the bankruptcy court),
and the lien securing the mortgage loan will be subject to the avoidance powers
of the bankruptcy trustee or debtor-in-possession to the extent the lien is
unenforceable under state law. Foreclosure of a mortgage loan can be an
expensive and lengthy process, which could have a substantial negative effect on
our anticipated return on the foreclosed mortgage loan.


Our investments
in CMBS are generally subject to losses.





We
acquire CMBS. In general, losses on a mortgaged property securing a mortgage
loan included in a securitization will be borne first by the equity holder of
the property, then by a cash reserve fund or letter of credit, if any, then by
the holder of a mezzanine loan or B-Note, if any, then by the “first loss”
subordinated security holder (generally, the “B-Piece” buyer) and then by the
holder of a higher-rated security. In the event of default and the exhaustion of
any equity support, reserve fund, letter of credit, mezzanine loans or B-Notes,
and any classes of securities junior to those in which we invest, we will not be
able to recover all of our investment in the securities we purchase. In
addition, if the underlying mortgage portfolio has been overvalued by the
originator, or if the values subsequently decline and, as a result, less
collateral is available to satisfy interest and principal payments due on the
related CMBS. The prices of lower credit quality securities are generally less
sensitive to interest rate changes than more highly rated investments, but more
sensitive to adverse economic downturns or individual issuer
developments.





We may not
control the special servicing of the mortgage loans included in the CMBS in
which we invest and, in such cases, the special servicer may take actions that
could adversely affect our interests.





With
respect to each series of CMBS in which we invest, overall control over the
special servicing of the related underlying mortgage loans is held by a
“directing certificateholder” or a “controlling class representative,” which is
appointed by the holders of the most subordinate class of CMBS in such series.
Since we predominantly focus on acquiring classes of existing series of CMBS
originally rated AAA, we may not have the right to appoint the directing
certificateholder. In connection with the servicing of the specially serviced
mortgage loans, the related special servicer may, at the direction of the
directing certificateholder, take actions with respect to the specially serviced
mortgage loans that could adversely affect our interests.





If our Manager
underestimates the collateral loss on our CMBS investments, we may experience
losses.





Our
Manager values our potential CMBS investments based on loss-adjusted yields,
taking into account estimated future losses on the mortgage loans included in
the securitization’s pool of loans, and the estimated impact of these losses on
expected future cash flows. Based on these loss estimates, our Manager may
adjust the pool composition accordingly through loan removals and other credit
enhancement mechanisms or leaves loans in place and negotiates for a price
adjustment. Our Manager’s loss estimates may not prove accurate, as actual
results may vary from estimates. In the event that our Manager underestimates
the pool level losses relative to the price we pay for a particular CMBS
investment, we may experience losses with respect to such
investment.





34


The B-Notes we
acquire are subject to additional risks related to the privately negotiated
structure and terms of the transaction, which may result in losses to
us.





We may
acquire B-Notes. A B-Note is a mortgage loan typically (1) secured by a
first mortgage on a single large commercial property or group of related
properties, and (2) subordinated to an A-Note secured by the same first
mortgage on the same collateral. As a result, if a borrower defaults, there may
not be sufficient funds remaining for B-Note holders after payment to the A-Note
holders. However, because each transaction is privately negotiated, B-Notes can
vary in their structural characteristics and risks. For example, the rights of
holders of B-Notes to control the process following a borrower default may vary
from transaction to transaction. Further, B-Notes typically are secured by a
single property and so reflect the risks associated with significant
concentration. Significant losses related to our B-Notes would result in
operating losses for us and may limit our ability to make distributions to our
shareholders.





Our mezzanine
loan assets involve greater risks of loss than senior loans secured by
income-producing properties.





We may
acquire mezzanine loans, which take the form of subordinated loans secured by
second mortgages on the underlying property or loans secured by a pledge of the
ownership interests of either the entity owning the property or a pledge of the
ownership interests of the entity that owns the interest in the entity owning
the property. These types of assets involve a higher degree of risk than
long-term senior mortgage lending secured by income-producing real property,
because the loan may become unsecured as a result of foreclosure by the senior
lender. In the event of a bankruptcy of the entity providing the pledge of its
ownership interests as security, we may not have full recourse to the assets of
such entity, or the assets of the entity may not be sufficient to satisfy our
mezzanine loan. If a borrower defaults on our mezzanine loan or debt senior to
our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be
satisfied only after the senior debt. As a result, we may not recover some or
all of our initial expenditure. In addition, mezzanine loans may have higher
loan-to-value ratios than conventional mortgage loans, resulting in less equity
in the property and increasing the risk of loss of principal. Significant losses
related to our mezzanine loans would result in operating losses for us and may
limit our ability to make distributions to our shareholders.





Bridge loans
involve a greater risk of loss than traditional investment-grade mortgage loans
with fully insured borrowers.





We may
acquire bridge loans secured by first lien mortgages on a property to borrowers
who are typically seeking short-term capital to be used in an acquisition,
construction or redevelopment of a property. The borrower has usually identified
an undervalued asset that has been under-managed and/or is located in a
recovering market. If the market in which the asset is located fails to recover
according to the borrower’s projections, or if the borrower fails to improve the
quality of the asset’s management and/or the value of the asset, the borrower
may not receive a sufficient return on the asset to satisfy the bridge loan, and
we bear the risk that we may not recover some or all of our initial
expenditure.





In
addition, borrowers usually use the proceeds of a conventional mortgage to repay
a bridge loan. Bridge loans therefore are subject to risks of a borrower’s
inability to obtain permanent financing to repay the bridge loan. Bridge loans
are also subject to risks of borrower defaults, bankruptcies, fraud, losses and
special hazard losses that are not covered by standard hazard insurance. In the
event of any default under bridge loans held by us, we bear the risk of loss of
principal and non-payment of interest and fees to the extent of any deficiency
between the value of the mortgage collateral and the principal amount of the
bridge loan. To the extent we suffer such losses with respect to our bridge
loans, the value of our company and the price of our shares of common stock may
be adversely affected.





Increases in
interest rates could adversely affect the value of our investments and cause our
interest expense to increase, which could result in reduced earnings or losses
and negatively affect our profitability as well as the cash available for
distribution to our shareholders.





We invest
in Agency RMBS, non-Agency RMBS, CMBS and mortgage loans. The relationship
between short-term and longer-term interest rates is often referred to as the
“yield curve.” In a normal yield curve environment, an investment in such assets
will generally decline in value if long-term interest rates increase. Declines
in market value may ultimately reduce earnings or result in losses to us, which
may negatively affect cash available for distribution to our
shareholders.







35


A
significant risk associated with our target assets is the risk that both
long-term and short-term interest rates will increase significantly. If
long-term rates increased significantly, the market value of these investments
would decline, and the duration and weighted average life of the investments
would increase. We could realize a loss if the securities were sold. At the same
time, an increase in short-term interest rates would increase the amount of
interest owed on the repurchase agreements we enter into to finance the purchase
of Agency RMBS.





Market
values of our investments may decline without any general increase in interest
rates for a number of reasons, such as increases or expected increases in
defaults, or increases or expected increases in voluntary prepayments for those
investments that are subject to prepayment risk or widening of credit
spreads.





In
addition, in a period of rising interest rates, our operating results will
depend in large part on the difference between the income from our assets and
financing costs. We anticipate that, in most cases, the income from such assets
will respond more slowly to interest rate fluctuations than the cost of our
borrowings. Consequently, changes in interest rates, particularly short-term
interest rates, may significantly influence our net income. Increases in these
rates will tend to decrease our net income and market value of our
assets.





An increase in
interest rates may cause a decrease in the volume of certain of our target
assets which could adversely affect our ability to acquire target assets that
satisfy our investment objectives and to generate income and pay
dividends.





Rising
interest rates generally reduce the demand for mortgage loans due to the higher
cost of borrowing. A reduction in the volume of mortgage loans originated may
affect the volume of target assets available to us, which could adversely affect
our ability to acquire assets that satisfy our investment objectives. Rising
interest rates may also cause our target assets that were issued prior to an
interest rate increase to provide yields that are below prevailing market
interest rates. If rising interest rates cause us to be unable to acquire a
sufficient volume of our target assets with a yield that is above our borrowing
cost, our ability to satisfy our investment objectives and to generate income
and pay dividends may be materially and adversely affected.





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 (a flattening of the yield curve), our borrowing costs may
increase more rapidly than the interest income earned on our assets. Because we
expect our investments, on average, generally will bear interest based on
longer-term rates than our borrowings, a flattening of the yield curve would
tend to decrease our net income and the market value of our net assets.
Additionally, to the extent cash flows from investments that return scheduled
and unscheduled 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.





Interest rate
fluctuations may adversely affect the level of our net income and the value of
our assets and common stock.





Interest
rates are highly sensitive to many factors, including governmental monetary and
tax policies, domestic and international economic and political considerations
and other factors beyond our control. Interest rate fluctuations present a
variety of risks, including the risk of a narrowing of the difference between
asset yields and borrowing rates, flattening or inversion of the yield curve and
fluctuating prepayment rates, and may adversely affect our income and the value
of our assets and common stock.
   36





Interest rate
mismatches between our Agency RMBS backed by ARMs or hybrid ARMs and our
borrowings used to fund our purchases of these assets may reduce our net
interest income and cause us to suffer a loss during periods of rising interest
rates.





We fund
most of our investments in Agency RMBS with borrowings that have interest rates
that adjust more frequently than the interest rate indices and repricing terms
of Agency RMBS backed by ARMs or hybrid ARMs. Accordingly, if short-term
interest rates increase, our borrowing costs may increase faster than the
interest rates on Agency RMBS backed by ARMs or hybrid ARMs adjust. As a result,
in a period of rising interest rates, we could experience a decrease in net
income or a net loss.





In most
cases, the interest rate indices and repricing terms of Agency RMBS backed by
ARMs or hybrid ARMs and our borrowings will not be identical, thereby
potentially creating an interest rate mismatch between our investments and our
borrowings. While the historical spread between relevant short-term interest
rate indices has been relatively stable, there have been periods when the spread
between these indices was volatile. During periods of changing interest rates,
these interest rate index mismatches could reduce our net income or produce a
net loss, and adversely affect the level of our dividends and the market price
of our common stock.





In
addition, Agency RMBS backed by ARMs or hybrid ARMs are typically subject to
lifetime interest rate caps which limit the amount an interest rate can increase
through the maturity of the Agency RMBS. However, our borrowings under
repurchase agreements typically are not subject to similar restrictions.
Accordingly, in a period of rapidly increasing interest rates, the interest
rates paid on our borrowings could increase without limitation while caps could
limit the interest rates on these types of Agency RMBS. This problem is
magnified for Agency RMBS backed by ARMs or hybrid ARMs that are not fully
indexed. Further, some Agency RMBS backed by ARMs or hybrid ARMs may be subject
to periodic payment caps that result in a portion of the interest being deferred
and added to the principal outstanding. As a result, we may receive less cash
income on these types of Agency RMBS than we need to pay interest on our related
borrowings. These factors could reduce our net interest income and cause us to
suffer a loss during periods of rising interest rates.





Because we
acquire fixed-rate securities, an increase in interest rates on our borrowings
may adversely affect our book value.





Increases
in interest rates may negatively affect the market value of our assets. Any
fixed-rate securities we invest in generally will be more negatively affected by
these increases than adjustable-rate securities. In accordance with accounting
rules, we are required to reduce our book value by the amount of any decrease in
the market value of our assets that are classified for accounting purposes as
available-for-sale. We are required to evaluate our assets on a quarterly basis
to determine their fair value by using third party bid price indications
provided by dealers who make markets in these securities or by third-party
pricing services. If the fair value of a security is not available from a dealer
or third-party pricing service, we estimate the fair value of the security using
a variety of methods including, but not limited to, discounted cash flow
analysis, matrix pricing, option-adjusted spread models and fundamental
analysis. Aggregate characteristics taken into consideration include, but are
not limited to, type of collateral, index, margin, periodic cap, lifetime cap,
underwriting standards, age and delinquency experience. However, the fair value
reflects estimates and may not be indicative of the amounts we would receive in
a current market exchange. If we determine that an agency security is
other-than-temporarily impaired, we would be required to reduce the value of
such agency security on our balance sheet by recording an impairment charge in
our income statement and our shareholders’ equity would be correspondingly
reduced. Reductions in shareholders’ equity decrease the amounts we may borrow
to purchase additional target assets, which could restrict our ability to
increase our net income.





We may experience
a decline in the market value of our assets.





A decline
in the market value of our assets may require us to recognize an
“other-than-temporary” impairment against such assets under US GAAP if we were
to determine that, with respect to any assets in unrealized loss positions, we
do not have the ability and intent to hold such assets to maturity or for a
period of time sufficient to allow for recovery to the amortized cost of such
assets. If such a determination were to be made, we would recognize unrealized
losses through earnings and write down the amortized cost of such assets to a
new cost basis, based on the fair market value of such assets on the date they
are considered to be other-than-temporarily impaired. Such impairment charges
reflect non-cash losses at the time of recognition; subsequent disposition or
sale of such assets could further affect our future losses or gains, as they are
based on the difference between the sale price received and adjusted amortized
cost of such assets at the time of sale.





37


Some of our
portfolio investments are recorded at fair value and, as a result, there is
uncertainty as to the value of these investments.





Some of
our portfolio investments are in the form of securities that are not publicly
traded. The fair value of securities and other investments that are not publicly
traded may not be readily determinable. We value these investments quarterly at
fair value, which may include unobservable inputs. Because such valuations are
subjective, the fair value of certain of our assets may fluctuate over short
periods of time and our determinations of fair value may differ materially from
the values that would have been used if a ready market for these securities
existed. The value of our common stock could be adversely affected if our
determinations regarding the fair value of these investments were materially
higher than the values that we ultimately realize upon their
disposal.


Prepayment
rates may adversely affect the value of our investment
portfolio.





Pools of
residential mortgage loans underlie the RMBS that we acquire. In the case of
residential mortgage loans, there are seldom any restrictions on borrowers’
abilities to prepay their loans. We generally receive payments from principal
payments that are made on these underlying mortgage loans. When borrowers prepay
their mortgage loans faster than expected, this results in prepayments that are
faster than expected on the RMBS. Faster than expected prepayments could
adversely affect our profitability, including in the following
ways:


·
            We
      may purchase RMBS that have a higher interest rate than the market
      interest rate at the time. In exchange for this higher interest rate, we
      may pay a premium over the par value to acquire the security. In
      accordance with US GAAP, we may amortize this premium over the estimated
      term of the RMBS. If the RMBS is prepaid in whole or in part prior to its
      maturity date, however, we may be required to expense the premium that was
      prepaid at the time of the
prepayment.





·
            A
      substantial portion of our adjustable-rate RMBS may bear interest rates
      that are lower than their fully indexed rates, which are equivalent to the
      applicable index rate plus a margin. If an adjustable-rate RMBS is prepaid
      prior to or soon after the time of adjustment to a fully-indexed rate, we
      will have held that RMBS while it was least profitable and lost the
      opportunity to receive interest at the fully indexed rate over the
      remainder of its expected life.





·
            If
      we are unable to acquire new RMBS similar to the prepaid RMBS, our
      financial condition, results of operation and cash flow would suffer.
      Prepayment rates generally increase when interest rates fall and decrease
      when interest rates rise, but changes in prepayment rates are difficult to
      predict. Prepayment rates also may be affected by conditions in the
      housing and financial markets, general economic conditions and the
      relative interest rates on FRMs and
ARMs.





On
February 10, 2010, Fannie Mae and Freddie Mac announced their intention to
purchase delinquent loans from certain mortgage pools guaranteed by
them. For purposes of these purchases, delinquent loans are those that
are 120 days or greater delinquent as of the measurement date. Freddie
Mac stated that it will purchase substantially all of the delinquent
loans, with payments to securities holders on March 15th and
April 15th, 2010. Fannie Mae stated its intention to begin to purchase
delinquent loans in March 2010 and expects to purchase a significant portion of
their current delinquent population within a few month period, subject to
market, servicer capacity and other constraints.  These purchases may
increase prepayment rates on our Agency RMBS, which could negatively impact our
results of operations and financial condition.
   38
  While we
seek to minimize prepayment risk to the extent practical, in selecting
investments we must balance prepayment risk against other risks and the
potential returns of each investment. No strategy can completely insulate us
from prepayment risk.





Recent market
conditions may upset the historical relationship between interest rate changes
and prepayment trends, which would make it more difficult for us to analyze our
investment portfolio.





Our
success depends on our ability to analyze the relationship of changing interest
rates on prepayments of the mortgage loans that underlie our RMBS and mortgage
loans we acquire. Changes in interest rates and prepayments affect the market
price of the target assets that we intend to purchase and any target assets that
we hold at a given time. As part of our overall portfolio risk management, we
analyze interest rate changes and prepayment trends separately and collectively
to assess their effects on our investment portfolio. In conducting our analysis,
we depend on certain assumptions based upon historical trends with respect to
the relationship between interest rates and prepayments under normal market
conditions. If the recent dislocations in the mortgage market or other
developments change the way that prepayment trends have historically responded
to interest rate changes, our ability to (1) assess the market value of our
investment portfolio, (2) implement our hedging strategies, and
(3) implement techniques to reduce our prepayment rate volatility would be
significantly affected, which could materially adversely affect our financial
position and results of operations.





Mortgage loan
modification programs and future legislative action may adversely affect the
value of, and the returns on, the target assets in which we
invest.





The
U.S. government, through the Federal Reserve, the FHA and the FDIC,
commenced implementation of programs designed to provide homeowners with
assistance in avoiding residential or commercial mortgage loan foreclosures. The
programs may involve, among other things, the modification of mortgage loans to
reduce the principal amount of the loans or the rate of interest payable on the
loans, or to extend the payment terms of the loans. In addition, members of
Congress have indicated support for additional legislative relief for
homeowners, including an amendment of the bankruptcy laws to permit the
modification of mortgage loans in bankruptcy proceedings. The servicer will have
the authority to modify mortgage loans that are in default, or for which default
is reasonably foreseeable, if such modifications are in the best interests of
the holders of the mortgage securities and such modifications are done in
accordance with the terms of the relevant agreements. Loan modifications are
more likely to be used when borrowers are less able to refinance or sell their
homes due to market conditions, and when the potential recovery from a
foreclosure is reduced due to lower property values. A significant number of
loan modifications could result in a significant reduction in cash flows to the
holders of the mortgage securities on an ongoing basis. These loan modification
programs, as well as future legislative or regulatory actions, including
amendments to the bankruptcy laws, that result in the modification of
outstanding mortgage loans may adversely affect the value of, and the returns
on, the target assets in which we invest.





Risks Related to Our Common
Stock





The market price
and trading volume of our common stock may be
volatile.





The
market price of our common stock may be highly volatile and be subject to wide
fluctuations. In addition, the trading volume in our common stock may fluctuate
and cause significant price variations to occur. If the market price of our
common stock declines significantly, our shareholders may be unable to resell
their shares at or above the price our shareholders paid for their shares. We
cannot assure you that the market price of our common stock will not fluctuate
or decline significantly in the future. Some of the factors that could
negatively affect our share price or result in fluctuations in the price or
trading volume of our common stock include:





·
            actual
      or anticipated variations in our quarterly operating results or
      distributions;





·
            changes
      in our earnings estimates or publication of research reports about us or
      the real estate or specialty finance
industry;






39





·
            decrease
      in the market valuations of our target
assets;





·
            increased
      difficulty in maintaining or obtaining financing or attractive terms, or
      at all;





·
            increases
      in market interest rates that lead purchasers of our shares of common
      stock to demand a higher yield;





·
            changes
      in market valuations of similar
companies;





·
            adverse
      market reaction to any increased indebtedness we incur in the
      future;





·
            additions
      or departures of key management
personnel;





·
            actions
      by institutional shareholders;





·
            speculation
      in the press or investment
community; and





·
            general
      market and economic conditions.





Common stock
eligible for future sale may have adverse effects on our share
price.





Our
equity incentive plan provides for grants of restricted common stock and other
equity-based awards up to an aggregate of 6% of the issued and outstanding
shares of our common stock (on a fully diluted basis) at the time of the award,
subject to a ceiling of 40 million shares of our common
stock.





We, our
Manager, each of our executive officers and directors, and certain officers of
our Manager and Invesco Investments (Bermuda) Ltd. have agreed with the
underwriters from our IPO to a 90 day lock-up period after the date of our
follow-on offering prospectus dated January 11, 2010 (subject to extension in
certain circumstances), meaning that, until the end of the 90 day lock-up
period, we and they will not, subject to certain exceptions, sell or transfer
any shares of common stock without the prior consent of Credit Suisse Securities
(USA) LLC and Morgan Stanley & Co. Incorporated, the representatives of
the underwriters of our follow-on offering. In addition, each of our Manager and
Invesco Investments (Bermuda) Ltd. agreed that, for a period of one year after
the date of our IPO prospectus dated June 25, 2009, it will not, without
the prior written consent of Credit Suisse Securities (USA) LLC and Morgan
Stanley & Co. Incorporated, dispose of or hedge any of the shares of
our common stock or OP units, respectively, that it purchased in the private
placement completed on July 1, 2009, subject to extension in certain
circumstances. Credit Suisse Securities (USA) LLC or Morgan Stanley &
Co. Incorporated may, in their sole discretion, at any time from time to time
and without notice, waive the terms and conditions of the lock-up agreements to
which they are a party. Additionally, each of our Manager and Invesco
Investments (Bermuda) Ltd. has agreed with us to a further lock-up period that
will expire at the earlier of (i) the date which is one year following the
date of our IPO prospectus dated June 25, 2009 or (ii) the termination
of the management agreement. As of December 31, 2009, approximately 0.73% of our
shares of common stock and 1,425,000 OP units are subject to lock-up agreements.
When the lock-up periods expire, these shares of common stock will become
eligible for sale, in some cases subject to the requirements of Rule 144
under the Securities Act of 1933, as amended (the “Securities
Act”).





We cannot
predict the effect, if any, of future sales of our common stock, or the
availability of shares for future sales, on the market price of our common
stock. The market price of our common stock may decline significantly when the
restrictions on resale by certain of our shareholders lapse. Sales of
substantial amounts of common stock or the perception that such sales could
occur may adversely affect the prevailing market price for our common
stock.





Also, we
may issue additional shares in public offerings or private placements to make
new investments or for other purposes. We are not required to offer any such
shares to existing shareholders on a preemptive basis. Therefore, it may not be
possible for existing shareholders to participate in such future share
issuances, which may dilute the existing shareholders’ interests in
us.







40


We
have not established a minimum distribution payment level, and we cannot assure
you of our ability to pay distributions in the future.





We pay
quarterly distributions and make other distributions to our shareholders in an
amount such that we distribute all or substantially all of our REIT taxable
income in each year, subject to certain adjustments. We have not established a
minimum distribution payment level and our ability to pay distributions may be
adversely affected by a number of factors, including the risk factors described
in this Report. All distributions will be made at the discretion of our board of
directors and will depend on our earnings, our financial condition, debt
covenants, maintenance of our REIT qualification, applicable provisions of
Maryland law and other factors as our board of directors may deem relevant from
time to time. We believe that a change in any one of the following factors could
adversely affect our results of operations and impair our ability to pay
distributions to our shareholders:


·
            the
      profitability of the investment of the net proceeds of our IPO and
      concurrent private placement and our follow-on
  offering;





·
            our
      ability to make profitable
investments;





·
            margin
      calls or other expenses that reduce our cash
  flow;





·
            defaults
      in our asset portfolio or decreases in the value of our
      portfolio; and





·
            the
      fact that anticipated operating expense levels may not prove accurate, as
      actual results may vary from
estimates.





We cannot
assure you that we will achieve investment results that will allow us to make a
specified level of cash distributions or year-to-year increases in cash
distributions in the future. In addition, some of our distributions may include
a return in capital.





Investing in our
common stock may involve a high degree of risk.





The
investments we make in accordance with our investment objectives may result in a
high amount of risk when compared to alternative investment options and
volatility or loss of principal. Our investments may be highly speculative and
aggressive, and therefore an investment in our common stock may not be suitable
for someone with lower risk tolerance.


Future
offerings of debt or equity securities, which would rank senior to our common
stock, may adversely affect the market price of our common
stock.





If we
decide to issue debt or equity securities in the future, which would rank senior
to our common stock, it is likely that they will be governed by an indenture or
other instrument containing covenants restricting our operating flexibility.
Additionally, any convertible or exchangeable securities that we issue in the
future may have rights, preferences and privileges more favorable than those of
our common stock and may result in dilution to owners of our common stock. We
and, indirectly, our shareholders, will bear the cost of issuing and servicing
such securities. Because our decision to issue debt or equity securities in any
future offering will depend on market conditions and other factors beyond our
control, we cannot predict or estimate the amount, timing or nature of our
future offerings. Thus holders of our common stock will bear the risk of our
future offerings reducing the market price of our common stock and diluting the
value of their stock holdings in us.





41


Risks Related to Our Organization and
Structure





Certain
provisions of Maryland law could inhibit changes in
control.





Certain
provisions of the Maryland General Corporation Law (the “MGCL”), may have the
effect of deterring a third party from making a proposal to acquire us or of
impeding a change in control under circumstances that otherwise could provide
the holders of our common stock with the opportunity to realize a premium over
the then-prevailing market price of our common stock. Under the MGCL, certain
“business combinations” (including a merger, consolidation, share exchange, or,
in circumstances specified in the statute, an asset transfer or issuance or
reclassification of equity securities) between us and an “interested
shareholder” (defined generally as any person who beneficially owns 10% or more
of our then outstanding voting capital stock or an affiliate or associate of
ours who, at any time within the two-year period prior to the date in question,
was the beneficial owner of 10% or more of our then outstanding voting capital
stock) or an affiliate thereof are prohibited for five years after the most
recent date on which the shareholder becomes an interested shareholder. After
the five-year prohibition, any business combination between us and an interested
shareholder generally must be recommended by our board of directors and approved
by the affirmative vote of at least (1) 80% of the votes entitled to be
cast by holders of outstanding shares of our voting capital stock; and
(2) two-thirds of the votes entitled to be cast by holders of voting
capital stock of the corporation other than shares held by the interested
shareholder with whom or with whose affiliate the business combination is to be
effected or held by an affiliate or associate of the interested shareholder.
These super-majority vote requirements do not apply if our common shareholders
receive a minimum price, as defined under Maryland law, for their shares in the
form of cash or other consideration in the same form as previously paid by the
interested shareholder for its shares. These provisions of the MGCL do not
apply, however, to business combinations that are approved or exempted by a
board of directors prior to the time that the interested shareholder becomes an
interested shareholder. Pursuant to the statute, our board of directors has by
resolution exempted business combinations between us and any other person,
provided that such business combination is first approved by our board of
directors (including a majority of our directors who are not affiliates or
associates of such person).





The
“control share” provisions of the MGCL provide that “control shares” of a
Maryland corporation (defined as shares which, when aggregated with other shares
controlled by the shareholder (except solely by virtue of a revocable proxy),
entitle the shareholder to exercise one of three increasing ranges of voting
power in electing directors) acquired in a “control share acquisition” (defined
as the direct or indirect acquisition of ownership or control of “control
shares”) have no voting rights except to the extent approved by our shareholders
by the affirmative vote of at least two-thirds of all the votes entitled to be
cast on the matter, excluding votes entitled to be cast by the acquiror of
control shares, our officers and our employees who are also our directors. Our
bylaws contain a provision exempting from the control share acquisition statute
any and all acquisitions by any person of shares of our stock. There can be no
assurance that this provision will not be amended or eliminated at any time in
the future.
 
 The
“unsolicited takeover” provisions of the MGCL permit our board of directors,
without shareholder approval and regardless of what is currently provided in our
charter or bylaws, to implement takeover defenses, some of which (for example, a
classified board) we do not yet have. These provisions may have the effect of
inhibiting a third party from making an acquisition proposal for us or of
delaying, deferring or preventing a change in control of us under circumstances
that otherwise could provide the holders of shares of common stock with the
opportunity to realize a premium over the then current market price. Our charter
contains a provision whereby we have elected to be subject to the provisions of
Title 3, Subtitle 8 of the MGCL relating to the filling of vacancies on our
board of directors.





Our authorized
but unissued shares of common and preferred stock may prevent a change in our
control.





Our
charter authorizes us to issue additional authorized but unissued shares of
common or preferred stock. In addition, our board of directors may, without
shareholder approval, amend our charter to increase the aggregate number of our
shares of stock or the number of shares of stock of any class or series that we
have authority to issue and classify or reclassify any unissued shares of common
or preferred stock and set the preferences, rights and other terms of the
classified or reclassified shares. As a result, our board of directors may
establish a series of shares of common or preferred stock that could delay or
prevent a transaction or a change in control that might involve a premium price
for our shares of common stock or otherwise be in the best interest of our
shareholders.





42


We are the sole
general partner of our operating partnership and could become liable for the
debts and other obligations of our operating partnership beyond the amount of
our initial expenditure.





We are
the sole general partner of our operating partnership, IAS Operating Partnership
LP. As the sole general partner, we are liable for our operating partnership’s
debts and other obligations. Therefore, if our operating partnership is unable
to pay its debts and other obligations, we will be liable for such debts and
other obligations beyond the amount of our expenditure for ownership interests
in our operating partnership. These obligations could include unforeseen
contingent liabilities and could materially adversely affect our financial
condition, operating results and ability to make distributions to our
shareholders.





Ownership
limitations may restrict change of control of business combination opportunities
in which our shareholders might receive a premium for their
shares.





In order
for us to qualify as a REIT for each taxable year after 2008, no more than 50%
in value of our outstanding capital stock may be owned, directly or indirectly,
by five or fewer individuals during the last half of any calendar year.
“Individuals” for this purpose include natural persons, private foundations,
some employee benefit plans and trusts, and some charitable trusts. To preserve
our REIT qualification, among other purposes, our charter generally prohibits
any person from directly or indirectly owning more than 9.8% in value or in
number of shares, whichever is more restrictive, of the outstanding shares of
our capital stock or more than 9.8% in value or in number of shares, whichever
is more restrictive, of the outstanding shares of our common stock. This
ownership limitation could have the effect of discouraging a takeover or other
transaction in which holders of our common stock might receive a premium for
their shares over the then prevailing market price or which holders might
believe to be otherwise in their best interests. Different ownership limits will
apply to Invesco. These ownership limits, which our board of directors has
determined will not jeopardize our REIT qualification, will allow Invesco to
hold up to 25% of our outstanding common stock or up to 25% of our outstanding
capital stock.


Tax
Risks





Investment in our
common stock investment has various U.S. federal income tax
risks.





This
summary of certain tax risks is limited to the U.S. federal tax risks
addressed below. Additional risks or issues may exist that are not addressed in
this Report and that could affect the U.S. federal income tax treatment of
us or our shareholders.





We
strongly urge you to seek advice based on your particular circumstances from an
independent tax advisor concerning the effects of U.S. federal, state and
local income tax law on an investment in our common stock and on your individual
tax situation.





Our failure to
qualify as a REIT would subject us to U.S. federal income tax and potentially
increased state and local taxes, which would reduce the amount of cash available
for distribution to our shareholders.





We have
been organized and we operate in a manner that will enable us to qualify as a
REIT for U.S. federal income tax purposes commencing with our taxable year
ending December 31, 2009. We have not requested and do not intend to
request a ruling from the Internal Revenue Service (the “IRS”), that we qualify
as a REIT. The U.S. federal income tax laws governing REITs are complex.
The complexity of these provisions and of the applicable U.S. Treasury
Department regulations that have been promulgated under the Internal Revenue
Code, or Treasury Regulations, is greater in the case of a REIT that, like us,
holds its assets through a partnership, and judicial and administrative
interpretations of the U.S. federal income tax laws governing REIT
qualification are limited. To qualify as a REIT, we must meet, on an ongoing
basis, various tests regarding the nature of our assets and our income, the
ownership of our outstanding shares, and the amount of our distributions.
Moreover, new legislation, court decisions or administrative guidance, in each
case possibly with retroactive effect, may make it more difficult or impossible
for us to qualify as a REIT. Thus, while we intend to operate so that we will
qualify as a REIT, given the highly complex nature of the rules governing REITs,
the ongoing importance of factual determinations, and the possibility of future
changes in our circumstances, no assurance can be given that we will so qualify
for any particular year. These considerations also might restrict the types of
assets that we can acquire in the future.





43


If we
fail to qualify as a REIT in any taxable year, and we do not qualify for certain
statutory relief provisions, we would be required to pay U.S. federal
income tax on our taxable income, and distributions to our shareholders would
not be deductible by us in determining our taxable income. In such a case, we
might need to borrow money or sell assets in order to pay our taxes. Our payment
of income tax would decrease the amount of our income available for distribution
to our shareholders. Furthermore, if we fail to maintain our qualification as a
REIT, we no longer would be required to distribute substantially all of our
taxable income to our shareholders. In addition, unless we were eligible for
certain statutory relief provisions, we could not re-elect to qualify as a REIT
until the fifth calendar year following the year in which we failed to
qualify.





Complying with
REIT requirements may cause us to forego otherwise attractive investment
opportunities or financing or hedging strategies.





To
qualify as a REIT for U.S. federal income tax purposes, we must continually
satisfy various tests regarding the sources of our income, the nature and
diversification of our assets, and the amounts we distribute to our
shareholders. To meet these tests, we may be required to forego investments we
might otherwise make. We may be required to make distributions to shareholders
at disadvantageous times or when we do not have funds readily available for
distribution. Thus, compliance with the REIT requirements may hinder our
investment performance.





Complying with
REIT requirements may force us to liquidate otherwise attractive
investments.





To
qualify as a REIT, we generally must ensure that at the end of each calendar
quarter at least 75% of the value of our total assets consists of cash, cash
items, government securities and qualifying real estate assets, including
certain mortgage loans and MBS. The remainder of our investment in securities
(other than government securities and qualifying real estate assets) generally
cannot include more than 10% of the outstanding voting securities of any one
issuer or more than 10% of the total value of the outstanding securities of any
one issuer. In addition, in general, no more than 5% of the value of our assets
(other than government securities and qualifying real estate assets) can consist
of the securities of any one issuer, and no more than 25% of the value of our
total securities can be represented by securities of one or more TRSs. If we
fail to comply with these requirements at the end of any quarter, we must
correct the failure within 30 days after the end of such calendar quarter
or qualify for certain statutory relief provisions to avoid losing our REIT
qualification and suffering adverse tax consequences. As a result, we may be
required to liquidate from our portfolio otherwise attractive investments. These
actions could have the effect of reducing our income and amounts available for
distribution to our shareholders.





REIT distribution
requirements could adversely affect our ability to execute our business plan and
may require us to incur debt, sell assets or take other actions to make such
distributions.





To
qualify as a REIT, we must distribute to our shareholders each calendar year at
least 90% of our REIT taxable income (including certain items of non-cash
income), determined without regard to the deduction for dividends paid and
excluding net capital gain. To the extent that we satisfy the 90% distribution
requirement, but distribute less than 100% of our taxable income, we will be
subject to U.S. federal corporate income tax on our undistributed income.
In addition, we will incur a 4% nondeductible excise tax on the amount, if any,
by which our distributions in any calendar year are less than a minimum amount
specified under U.S. federal income tax laws. We intend to make sufficient
distributions to our shareholders to satisfy the 90% distribution requirement
and to avoid both corporate income tax and the 4% nondeductible excise
tax.





44


Our
taxable income may substantially exceed our net income as determined based on US
GAAP. In addition, differences in timing between the recognition of taxable
income and the actual receipt of cash may occur. For example, we may invest in
assets, including debt instruments requiring us to accrue original issue
discount (“OID”) or recognize market discount income that generates taxable
income in excess of economic income or in advance of the corresponding cash flow
from the assets, referred to as “phantom income.” We may also acquire distressed
debt investments that are subsequently modified by agreement with the borrower
either directly or pursuant to our involvement in programs recently announced by
the federal government. If amendments to the outstanding debt are “significant
modifications” under applicable Treasury Regulations, the modified debt may be
considered to have been reissued to us in a debt-for-debt exchange with the
borrower, with gain recognized by us to the extent that the principal amount of
the modified debt exceeds our cost of purchasing it prior to modification.
Finally, we may be required under the terms of the indebtedness that we incur,
whether to private lenders or pursuant to government programs, to use cash
received from interest payments to make principal payment on that indebtedness,
with the effect that we will recognize income but will not have a corresponding
amount of cash available for distribution to our
shareholders.





As a
result of the foregoing, we may generate less cash flow than taxable income in a
particular year and find it difficult or impossible to meet the REIT
distribution requirements in certain circumstances. In such circumstances, we
may be required to (1) sell assets in adverse market conditions,
(2) borrow on unfavorable terms, (3) distribute amounts that would
otherwise be invested in future acquisitions, capital expenditures or repayment
of debt, or (4) make a taxable distribution of our shares of common stock
as part of a distribution in which shareholders may elect to receive shares of
common stock or (subject to a limit measured as a percentage of the total
distribution) cash, in order to comply with the REIT distribution requirements.
Thus, compliance with the REIT distribution requirements may hinder our ability
to grow, which could adversely affect the value of our common
stock.





We may choose to
pay dividends in our own stock, in which case our shareholders may be required
to pay income taxes in excess of the cash dividends
received.





We may
distribute taxable dividends that are payable in cash and shares of our common
stock at the election of each shareholder. Under IRS Revenue Procedure 2009-15,
up to 90% of any such taxable dividend for 2009 could be payable in our stock.
Taxable shareholders receiving such dividends will be required to include the
full amount of the dividend as ordinary income to the extent of our current and
accumulated earnings and profits for federal income tax purposes. As a result, a
U.S. shareholder may be required to pay income taxes with respect to such
dividends in excess of the cash dividends received. If a U.S. shareholder
sells the stock it receives as a dividend in order to pay this tax, the sales
proceeds may be less than the amount included in income with respect to the
dividend, depending on the market price of our stock at the time of the sale.
Furthermore, with respect to non-U.S. shareholders, we may be required to
withhold U.S. tax with respect to such dividends, including in respect of
all or a portion of such dividend that is payable in stock. In addition, if a
significant number of our shareholders determine to sell shares of our common
stock in order to pay taxes owed on dividends, it may put downward pressure on
the trading price of our common stock.





Our ownership of
and relationship with any TRS which we may form or acquire will be limited, and
a failure to comply with the limits would jeopardize our REIT qualification and
may result in the application of a 100% excise tax.





A REIT
may own up to 100% of the stock of one or more TRSs. A TRS may earn income that
would not be qualifying income if earned directly by the parent REIT. Both the
subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS.
Overall, no more than 25% of the value of a REIT’s assets may consist of stock
or securities of one or more TRSs at the end of any calendar quarter. A TRS will
pay federal, state and local income tax at regular corporate rates on any income
that it earns. In addition, the TRS rules impose a 100% excise tax on certain
transactions between a TRS and its parent REIT that are not conducted on an
arm’s length basis.





Any TRS
that we may form would pay U.S. federal, state and local income tax on its
taxable income, and its after-tax net income would be available for distribution
to us but would not be required to be distributed to us. We anticipate that the
aggregate value of the TRS stock and securities owned by us will be less than
25% of the value of our total assets (including the TRS stock and securities).
Furthermore, we will monitor the value of our investments in our TRSs to ensure
compliance with the rule that no more than 25% of the value of our assets may
consist of TRS stock and securities. In addition, we will scrutinize all of our
transactions with TRSs to ensure that they are entered into on arm’s length
terms to avoid incurring the 100% excise tax described above. There can be no
assurance, however, that we will be able to comply with the TRS limitations or
to avoid application of the 100% excise tax discussed above.
   45





Liquidation of
our assets may jeopardize our REIT qualification.





To
qualify as a REIT, we must comply with requirements regarding our assets and our
sources of income. If we are compelled to liquidate our investments to repay
obligations to our lenders, we may be unable to comply with these requirements,
ultimately jeopardizing our qualification as a REIT, or we may be subject to a
100% tax on any resultant gain if we sell assets in transactions that are
considered to be prohibited transactions.





Characterization
of the repurchase agreements we enter into to finance our investments as sales
for tax purposes rather than as secured lending transactions or the failure of a
mezzanine loan to qualify as a real estate asset would adversely affect our
ability to qualify as a REIT.





We may
enter into repurchase agreements with a variety of counterparties to achieve our
desired amount of leverage for the assets in which we invest. When we enter into
a repurchase agreement, we generally sell assets to our counterparty to the
agreement and receive cash from the counterparty. The counterparty is obligated
to resell the assets back to us at the end of the term of the transaction. We
believe that, for U.S. federal income tax purposes, we will be treated as
the owner of the assets that are the subject of repurchase agreements and that
the repurchase agreements will be treated as secured lending transactions
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 successfully assert that we did not own these assets during
the term of the repurchase agreements, in which case we could fail to qualify as
a REIT.
 
 In
addition, we acquire mezzanine loans, which are loans secured by equity
interests in a partnership or limited liability company that directly or
indirectly owns real property. In Revenue Procedure 2003-65, the IRS provided a
safe harbor pursuant to which a mezzanine loan, if it meets each of the
requirements contained in the Revenue Procedure, will be treated by the IRS as a
real estate asset for purposes of the REIT asset tests, and interest derived
from the mezzanine loan will be treated as qualifying mortgage interest for
purposes of the 75% gross income test, discussed below. Although the Revenue
Procedure provides a safe harbor on which taxpayers may rely, it does not
prescribe rules of substantive tax law. We may acquire mezzanine loans that may
not meet all of the requirements for reliance on this safe harbor. In the event
we own a mezzanine loan that does not meet the safe harbor, the IRS could
challenge such loan’s treatment as a real estate asset for purposes of the REIT
asset and income tests, and if such a challenge were sustained, we could fail to
qualify as a REIT.





The “taxable
mortgage pool” rules may limit our financing options.





Securitizations
and certain other financing structures could result in the creation of taxable
mortgage pools for federal income tax purposes. A taxable mortgage pool owned by
our operating partnership would be treated as a corporation for
U.S. federal income tax purposes and may cause us to fail the asset tests,
discussed below. These rules may limit our financing options.





The tax on
prohibited transactions will limit our ability to engage in transactions,
including certain methods of securitizing mortgage loans, which would be treated
as sales for federal income tax purposes.





A REIT’s
net income from prohibited transactions is subject to a 100% tax. In general,
prohibited transactions are sales or other dispositions of property, other than
foreclosure property, but including mortgage loans, held primarily for sale to
customers in the ordinary course of business. We might be subject to this tax if
we were to dispose of or securitize loans in a manner that was treated as a sale
of the loans for federal income tax purposes. Therefore, in order to avoid the
prohibited transactions tax, we may choose not to engage in certain sales of
loans at the REIT level, and may limit the structures we utilize for our
securitization transactions, even though the sales or structures might otherwise
be beneficial to us.




46


Complying with
REIT requirements may limit our ability to hedge
effectively.





The REIT
provisions of the Internal Revenue Code limit our ability to enter into hedging
transactions. Under these provisions, our annual gross income from
non-qualifying hedges, together with any other income not generated from
qualifying real estate assets, cannot exceed 25% of our gross income (excluding
for this purpose, gross income from qualified hedges). In addition, our
aggregate gross income from non-qualifying hedges, fees, and certain other non
qualifying sources cannot exceed 5% of our annual gross income. As a result, we
might have to limit our use of advantageous hedging techniques or implement
those hedges through a TRS, which we may form. This could increase the cost of
our hedging activities or expose us to greater risks associated with changes in
interest rates than we would otherwise want to bear.





Even if we
qualify as a REIT, we may face tax liabilities that reduce our cash
flow.





Even if
we qualify as a REIT, we may be subject to certain U.S. federal, state and
local taxes on our income and assets, including taxes on any undistributed
income, tax on income from some activities conducted as a result of a
foreclosure, and state or local income, franchise, property and transfer taxes,
including mortgage-related taxes. In addition, any TRSs we own will be subject
to U.S. federal, state, and local corporate taxes. In order to meet the
REIT qualification requirements, or to avoid the imposition of a 100% tax that
applies to certain gains derived by a REIT from sales of inventory or property
held primarily for sale to customers in the ordinary course of business, we may
hold some of our assets through taxable subsidiary corporations, including TRSs.
Any taxes paid by such subsidiary corporations would decrease the cash available
for distribution to our shareholders.


We may be subject
to adverse legislative or regulatory tax changes that could reduce the market
price of our common stock.





At any
time, the U.S. federal income tax laws or regulations governing REITs or
the administrative interpretations of those laws or regulations may be amended.
We cannot predict when or if any new U.S. federal income tax law,
regulation or administrative interpretation, or any amendment to any existing
federal income tax law, regulation or administrative interpretation, will be
adopted, promulgated or become effective. Any such law, regulation or
interpretation may take effect retroactively. We and our shareholders could be
adversely affected by any such change in, or any new, federal income tax law,
regulation or administrative interpretation.





Dividends payable
by REITs do not qualify for the reduced tax rates.





Legislation
enacted in 2003 generally reduces the maximum tax rate for dividends payable to
domestic shareholders that are individuals, trusts and estates to 15% (through
2010). Dividends payable by REITs, however, are generally not eligible for the
reduced rates. Although this legislation does not adversely affect the taxation
of REITs or dividends paid by REITs, the more favorable rates applicable to
regular corporate dividends could cause investors who are individuals, trusts
and estates to perceive investments in REITs to be relatively less attractive
than investments in stock of non REIT corporations that pay dividends, which
could adversely affect the value of the stock of REITs, including our common
stock.





Item 1B. Unresolved
Staff Comments.





None.





47


Item 2. Properties.





Our principal executive office is
located at 1555 Peachtree Street, NE, Atlanta, Georgia 30309. As part of our
management agreement, our manager is responsible for providing office space and
office services required in rendering services to us.





Item 3. Legal
Proceedings.





From time to time, we may be involved
in various claims and legal actions arising in the ordinary course of business.
As of December 31, 2009, we were not involved in any such legal
proceedings.





Item 4. Omitted
and Reserved.


48


PART II





Item 5. Market for
Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities.





Market
Information





Our
common stock is traded on the NYSE under the symbol “IVR.” The following table
sets forth, for the periods indicated, the high and low sale price of our common
stock as reported on the NYSE.





High
            
            
            Low2009Second
      quarter
            
            $
            19.80
            
            
            $
            18.73Third
      quarter
            
            $
            22.18
            
            
            $
            19.25Fourth
      quarter
            
            $
            24.92
            
            
            $
            19.34







Holders





As of
March 23, 2010, there were 5 shareholders of record.





Dividends





U.S. federal
income tax law generally requires that a REIT distribute annually at least 90%
of its REIT taxable income, determined without regard to the deduction for
dividends paid and excluding net capital gains, and that it pay tax at regular
corporate rates on its undistributed taxable income. We intend to continue to
pay regular quarterly dividends to our shareholders in an amount equal to our
net taxable income. Before we pay any dividend, whether for U.S. federal
income tax purposes or otherwise, we must first meet both our operating
requirements and debt service on our repurchase agreements and other debt
payable. If our cash available for distribution is less than our net taxable
income, we could be required to sell assets or borrow funds to make cash
distributions, or we may make a portion of the required distribution in the form
of a taxable stock distribution or distribution of debt securities.





The
following table sets forth the dividends declared per share of our common stock
in 2009.








Date
      Declared
            
            Common Dividends
      Declared Per ShareAmount
            
            Date
      of PaymentOctober
      13,
      2009
            
            $
            0.61
            
            November
      12, 2009December
      17,
      2009
            
            $
            1.05
            
            January
      27, 2010








49


Performance
Graph




The following
graph matches the cumulative 6-month total return of holders of Invesco Mortgage
Capital Inc.'s common stock with the cumulative total returns of the S&P 500
index and the FTSE NAREIT Mortgage REITs index. The graph assumes that the value
of the investment in our common stock and in each of the indexes (including
reinvestment of dividends) was $100 on June 26, 2009 and tracks it through
December 31, 2009.











6/26/09
            6/30/09
            9/30/09
            12/31/09Invesco
      Mortgage Capital Inc.
            
            100.00
            100.31
            112.51
            126.21S&P
      500
            
            100.00
            100.20
            115.83
            122.83FTSE
      NAREIT Mortgage REITs
            
            100.00
            109.71
            132.18
            130.53





The stock
price performance included in this graph is not necessarily indicative of future
stock price performance.





Use
of Proceeds





We used
all of the net proceeds from the IPO and private placement, and will use the
proceeds of the follow-on offering, to acquire our target assets in accordance
with our objectives and strategies described above.   See
“Business — Investment Strategy.”  Our focus is on purchasing
Agency RMBS, non-Agency RMBS, CMBS and certain residential and commercial
mortgage loans, subject to our investment guidelines and to the extent
consistent with maintaining our REIT qualification. Our Manager will make
determinations as to the percentage of our equity that will be invested in each
of our target assets.





50


Item 6. Selected
Financial Data.





The
selected historical financial information as of December 31, 2009 and December
31, 2008, for the year ended December 31, 2009 and for the period from
June 5, 2008 (date of inception) to December 31, 2008 presented in the
tables below have been derived from our audited financial statements. The
information presented below is not necessarily indicative of the trends in our
performance or our results for a full fiscal year.





The
information presented below is only a summary and does not provide all of the
information contained in our historical financial statements, including the
related notes. You should read the information below in conjunction with
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and our historical financial statements, including the related
notes, included elsewhere in this Report.





Balance
Sheet Data





$
      in thousands
            
            December
      31,
              2009
            
            
            December 31,
      2008Mortgage-backed
      securities, at fair value
            
            
            802,592
            
            
            
            —Total
      assets
            
            
            853,400
            
            
            
            979Repurchase
      agreements
            
            
            545,975
            
            
            
            —TALF
      financing
            
            
            80,377
            
            
            
            —Total 
      shareholders’ equity (deficit)
            
            
            180,515
            
            
            
            (21
            )Non-controlling
      interest
            
            
            29,795
            
            
            
            —Total
      equity (deficit)
            
            
            210,310
            
            
            
            (21
            )





Statement
of Income Data





$
      in thousands, except per share data
            
            For
      the Year Ended December 31, 2009
            
            
            Period
      from June 5, 2008 (Date of Inception) to December 31, 2008Interest
      income
            
            
            23,529
            
            
            
            —Interest
      expense
            
            
            4,627
            
            
            
            —Net
      interest income
            
            
            18,902
            
            
            
            —Other
      income
            
            
            2,073
            
            
            
            —Operating
      expenses
            
            
            3,464
            
            
            
            22Net
      income (loss)
            
            
            17,511
            
            
            
            (22
            )Net
      income attributable to non-controlling interest
            
            
            2,417
            
            
            
            —Net
      income (loss) attributable to common shareholders
            
            
            15,094
            
            
            
            (22
            )Earnings
      per share:Net
      income attributable to common shareholders (basic/diluted)
            
            
            3.37
            
            
            
            —Dividends
      declared per common share
            
            
            1.66
            
            
            
            —Weighted
      average number of shares of common stock:Basic
            
            
            4,480
            
            
            NMDiluted
            
            
            5,198
            
            
            NM





NM = not
meaningful


51





Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.





The
following discussion should be read in conjunction with our consolidated
financial statements and the accompanying notes to our consolidated financial
statements, which are included in this Report.





Overview





We are a
Maryland corporation focused on investing in, financing and managing residential
and commercial mortgage-backed securities and mortgage loans. We are externally
managed and advised by Invesco Advisers, Inc. (formerly Invesco Institutional
(N.A.), Inc.) (our “Manager”), which is an indirect, wholly-owned subsidiary of
Invesco Ltd. (NYSE:IVZ) (“Invesco”). We intend to qualify to be taxed as a REIT
commencing with our taxable year ended December 31, 2009. Accordingly, we
generally will not be subject to U.S. federal income taxes on our taxable
income that we distribute currently to our shareholders as long as we maintain
our qualification as a REIT. We operate our business in a manner that will
permit us to maintain our exemption from registration under the Investment
Company Act of 1940, as amended (the “1940 Act”).





Our
objective is to provide attractive risk-adjusted returns to our investors,
primarily through dividends and secondarily through capital appreciation. To
achieve this objective, we invest in the following
securities:





·
              Agency
      RMBS, which are residential mortgage-backed securities, for which a
      U.S. government agency such as the Government National Mortgage
      Association (“Ginnie Mae”) or a federally chartered corporation such as
      the Federal National Mortgage Association (“Fannie Mae”) or the Federal
      Home Loan Mortgage Corporation (“Freddie Mac”) guarantees payments of
      principal and interest on the
securities;





·
              Non-Agency
      RMBS, which are RMBS that are not issued or guaranteed by a
      U.S. government agency;





·
              CMBS,
      which are commercial mortgage-backed
  securities; and





·
              Residential
      and commercial mortgage
loans.





We
finance our investments in Agency RMBS, and we may in the future finance our
investments in non-Agency RMBS, primarily through short-term borrowings
structured as repurchase agreements. In addition, we currently finance our
investments in CMBS with financing under the Term Asset-Backed Securities Loan
Facility (“TALF”) and with private financing sources. We also finance our
investments in certain non-Agency RMBS, CMBS and residential and commercial
mortgage loans by investing in a public-private investment fund (“PPIF”) managed
by our Manager (the “Invesco PPIP Fund”), which, in turn, invests in our target
assets, and which receives financing from the U.S. Treasury and from the
FDIC. On September 30, 2009, the Invesco PPIP Fund qualified to obtain
financing under the legacy securities program under the U.S. government’s
Public-Private Investment Program (“PPIP”).  In addition, we may use
other sources of financing including investments in PPIFs, committed borrowing
facilities and other private financing.





Public
Offerings and Private Placement





On
July 1, 2009, we successfully completed our initial public offering (“IPO”)
pursuant to which we sold 8,500,000 shares of our common stock to the
public at a price of $20.00 per share, for net proceeds of $164.8 million.
Concurrent with our IPO, we completed a private offering in which we sold
75,000 shares of our common stock to our Manager at a price of $20.00 per
share and our operating partnership sold 1,425,000 units of limited
partnership interests to Invesco Investments (Bermuda) Ltd., a wholly-owned
subsidiary of Invesco, at a price of $20.00 per unit. The net proceeds to us
from this private offering was $30.0 million. We did not pay any
underwriting discounts or commissions in connection with the private
offering.
  52





On
July 27, 2009, the underwriters in our IPO exercised their over-allotment
option to purchase an additional 311,200 shares of our common stock at a
price of $20.00 per share, for net proceeds of $6.1 million. Collectively,
we received net proceeds from our IPO and the concurrent private offering of
approximately $200.9 million.
 
 On
January 15, 2010, we completed a follow-on public offering of 7,000,000 shares
of common stock and an issuance of additional 1,050,000 shares of common stock
pursuant to the underwriters’ full exercise of their over-allotment option at
$21.25 per share. The net proceeds to us were $162.7 million, net of issuance
costs of approximately $8.4 million.





Portfolio
Ramp-up





Since our
IPO, we have been actively working to deploy our IPO and private placement
proceeds and to commence our operations. As of December 31, 2009, we have
completed the following transactions:


·
              We
      invested the net proceeds from our IPO and concurrent private offering, as
      well as monies that we borrowed under repurchase agreements and TALF, to
      purchase a $802.6 million investment portfolio, which consisted of $556.4
      million in Agency RMBS, $115.3 million in non-Agency RMBS, $101.2 million
      in CMBS and $29.7 million in
CMOs.





·
              We
      entered into master repurchase agreements. As of December 31, 2009,
      we had borrowed $546.0 million under those master repurchase agreements at
      a weighted average rate of 0.26% to finance our purchases of Agency
      RMBS.





·
              We
      entered into three interest rate swap agreements, for a notional amount of
      $375.0 million, designed to mitigate the effects of increases in interest
      rates under a portion of our repurchase
  agreements.





·
              We
      secured borrowings of $80.4 million under the TALF at a weighted average
      interest rate of 3.82%.





·
              We
      committed to invest up to $25.0 million, of which $4.1 million has been
      called by the Invesco PPIP Fund, which, in turn, invests in our target
      assets.





Factors Impacting Our Operating
Results





Our
operating results can be affected by a number of factors and primarily depend
on, among other things, the level of our net interest income, the market value
of our assets and the supply of, and demand for, the target assets in which we
invest. Our net interest income, which includes the amortization of purchase
premiums and accretion of purchase discounts, varies primarily as a result of
changes in market interest rates and prepayment speeds, as measured by the
constant prepayment rate (“CPR”) on our target assets. Interest rates and
prepayment speeds vary according to the type of investment, conditions in the
financial markets, competition and other factors, none of which can be predicted
with any certainty.





Market
Conditions





Beginning
in the summer of 2007, significant adverse changes in financial market
conditions resulted in a deleveraging of the entire global financial system. As
part of this process, residential and commercial mortgage markets in the United
States experienced a variety of difficulties, including loan defaults, credit
losses and reduced liquidity. As a result, many lenders tightened their lending
standards, reduced lending capacity, liquidated significant portfolios or exited
the market altogether, and therefore, financing with attractive terms was
generally unavailable. In response to these unprecedented events, the
U.S. government has taken a number of actions to stabilize the financial
markets and encourage lending. Significant measures include the enactment of the
Emergency Economic Stabilization Act of 2008 to, among other things, establish
the Troubled Asset Relief Program, or TARP, the enactment of the Housing and
Economic Recovery Act of 2008, which established a new regulator for Fannie Mae
and Freddie Mac and the establishment of the TALF and the
PPIP.







53


We have
elected to participate in programs established by the U.S. government,
including the TALF and the PPIP, in order to increase our ability to acquire our
target assets and to provide a source of financing for such acquisitions. The
TALF is intended to make credit available to consumers and businesses on more
favorable terms by facilitating the issuance of asset-backed securities and
improving the market conditions for asset-backed securities generally. The
Federal Reserve Bank of New York (“FRBNY”) will make up to $200 billion of
loans under the TALF. The PPIP is designed to encourage the transfer of certain
illiquid legacy real estate-related assets off of the balance sheets of
financial institutions, restarting the market for these assets and supporting
the flow of credit and other capital into the broader economy. See
“Business — Our Investments — Financing Strategy — The Term-Asset
Backed Securities Loan Facility” and “Business — Our Investments —
Financing Strategy — The Public-Private Investment Program” for a detailed
description of the TALF and the PPIP.


Investment
Activities





As of
December 31, 2009, 19.1% of our equity was invested in Agency RMBS, 54.8%
in non-Agency RMBS, 9.9% in CMBS, 2.0% in the Invesco PPIP Fund and 14.2% in
other assets (including cash and restricted cash). We use leverage on our target
assets to achieve our return objectives. For our investments in Agency RMBS, we
focus on securities we believe provide attractive returns when levered
approximately 6 to 8 times. For our investments in non-Agency RMBS, we primarily
focus on securities we believe provide attractive unlevered returns, however, in
the future we may employ leverage of up to 1 time. We leverage our CMBS 3 to 5
times. In addition, we may use other financing, including other PPIP funds and
private financing.
 
 As of
December 31, 2009, we had approximately $161.1 million in 30-year fixed
rate securities that offered higher coupons and call protection based on the
collateral attributes. We balanced this with approximately $261.8 million in
15-year fixed rate, approximately $123.5 million in hybrid adjustable-rate
mortgages (“ARMs”) and approximately $10.0 million in ARMs we believe to have
similar durations based on prepayment speeds. As of December 31, 2009, we
had purchased approximately $115.3 million non-Agency RMBS.





Our
investments in CMBS are currently limited to securities for which we are able to
obtain financing under the TALF. Our primary focus is on investing in AAA-rated
securities issued prior to 2008. As of December 31, 2009, we had purchased
approximately $101.1 million in CMBS and financed such purchases with an $80.4
million TALF loan. In addition, as of December 31, 2009, we had purchased
approximately $29.7 million in CMOs.





54


Investment
Portfolio





The
following table summarizes certain characteristics of our investment portfolio
as of December 31, 2009:





$
      in thousands
            
            Principal
      Balance
            
            
            Unamortized
      Premium (Discount)
            
            
            Amortized
      Cost
            
            
            Unrealized
                Gain/
                (Loss)
            
            
            Fair
                Value
            
            
            Net
      Weighted Average Coupon (1)
            
            
            Average
      Yield (2)Agency
      RMBS:15
      year fixed-rate
            
            
            251,752
            
            
            
            9,041
            
            
            
            260,793
            
            
            
            1,023
            
            
            
            261,816
            
            
            
            4.82
            %
            
            
            3.80
            %30
      year fixed-rate
            
            
            149,911
            
            
            
            10,164
            
            
            
            160,075
            
            
            
            990
            
            
            
            161,065
            
            
            
            6.45
            %
            
            
            5.02
            %ARM
            
            
            10,034
            
            
            
            223
            
            
            
            10,257
            
            
            
            (281
            )
            
            
            9,976
            
            
            
            2.52
            %
            
            
            1.99
            %Hybrid
      ARM
            
            
            117,163
            
            
            
            5,767
            
            
            
            122,930
            
            
            
            597
            
            
            
            123,527
            
            
            
            5.14
            %
            
            
            3.55
            %Total
      Agency RMBS
            
            
            528,860
            
            
            
            25,195
            
            
            
            554,055
            
            
            
            2,329
            
            
            
            556,384
            
            
            
            5.31
            %
            
            
            4.07
            %MBS-CMO
            
            
            27,819
            
            
            
            978
            
            
            
            28,797
            
            
            
            936
            
            
            
            29,733
            
            
            
            6.34
            %
            
            
            4.83
            %Non-Agency
      RMBS
            
            
            186,682
            
            
            
            (79,341
            )
            
            
            107,341
            
            
            
            7,992
            
            
            
            115,333
            
            
            
            4.11
            %
            
            
            17.10
            %CMBS
            
            
            104,512
            
            
            
            (4,854
            )
            
            
            99,658
            
            
            
            1,484
            
            
            
            101,142
            
            
            
            4.93
            %
            
            
            5.97
            %Total
            
            
            847,873
            
            
            
            (58,022
            )
            
            
            789,851
            
            
            
            12,741
            
            
            
            802,592
            
            
            
            5.03
            %
            
            
            6.10
            %


_____________________


(1)           Weighted
average coupon is presented net of servicing and other fees.


(2)           Average
yield incorporates future prepayment assumptions.





The
following table summarizes certain characteristics of our investment portfolio,
at fair value, according to their estimated weighted average life
classifications as of December 31, 2009:





$
      in thousandsLess
      than one year
            
            
            —Greater
      than one year and less than five years
            
            
            483,540Greater
      than or equal to five years
            
            
            319,052Total
            
            
            802,592





The
following table presents certain information about the carrying value of our
available for sale mortgage-backed securities (“MBS”) as of December 31,
2009:





$
      in thousandsPrincipal
      balance
            
            
            847,873Unamortized
      premium
            
            
            26,174Unamortized
      discount
            
            
            (84,196
            )Gross
      unrealized gains
            
            
            14,595Gross
      unrealized losses
            
            
            (1,854
            )Carrying
      value/estimated fair value
            
            
            802,592





Financing and Other Liabilities.Following the closing of our IPO, we entered into repurchase agreements
to finance the majority of our Agency RMBS. These agreements are secured by our
Agency RMBS and bear interest at rates that have historically moved in close
relationship to the London Interbank Offer Rate (“LIBOR”). As of
December 31, 2009, we had entered into repurchase agreements totaling
$546.0 million. In addition, we funded our CMBS portfolio with borrowings of
$80.4 million under the TALF. The TALF loans are non-recourse and mature in
July, August and December 2014. Finally, we committed to invest up to $25.0
million in the Invesco PPIP Fund, which, in turn, invests in our target assets.
As of December 31, 2009, $4.1 million of our commitment to the Invesco PPIP Fund
has been called.





Hedging Instruments.We
generally hedge as much of our interest rate risk as we deem prudent in light of
market conditions. No assurance can be given that our hedging activities will
have the desired beneficial impact on our results of operations or financial
condition. Our investment policies do not contain specific requirements as to
the percentages or amount of interest rate risk that we are required to
hedge.
  
 
 55
 Interest rate hedging may fail to protect or could adversely affect us because,
among other things:





·
              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
      liability;





·
              the
      party owing money in the hedging transaction may default on its obligation
      to pay;





·
              the
      credit quality of the party owing money on the hedge may be downgraded to
      such an extent that it impairs our ability to sell or assign our side of
      the hedging
transaction; and





·
              the
      value of derivatives used for hedging may be adjusted from time to time in
      accordance with accounting rules to reflect changes in fair value.
      Downward adjustments, or mark-to-market losses would reduce our
      shareholders’ equity.





As of
December 31, 2009, we had entered into three interest rate swap agreements
designed to mitigate the effects of increases in interest rates under a portion
of our repurchase agreements. These swap agreements provide for fixed interest
rates indexed off of one-month LIBOR and effectively fix the floating interest
rates on $375.0 million of borrowings under our repurchase agreements. We intend
to continue to add interest rate hedge positions according to our hedging
strategy.
 
 
 The
following table summarizes our hedging activity as of December 31,
2009:





Swap
Transactions





Counterparty
            
            Notional
      Amount
              $
      in thousands
            
            Maturity
      Date
            
            Fixed
      Interest Rate in ContractThe
      Bank of New York Mellon
            
            
            175,000
            
            08/05/2012
            
            
            2.07
            %SunTrust
      Bank
            
            
            100,000
            
            07/15/2014
            
            
            2.79
            %Credit
      Suisse International
            
            
            100,000
            
            02/24/2015
            
            
            3.26
            %Total/Weighted
      Average
            
            
            375,000
            
            
            
            
            2.58
            %





Book
Value per Share





As of
December 31, 2009, our book value per common share was $20.31 and on a
fully diluted basis, after giving effect to our units of limited partnership
interest in our operating partnership (which may be converted to common shares
at the sole election of the Company) the book value per common share was
$20.39.





Critical Accounting
Policies





Our
consolidated financial statements are prepared in accordance with US GAAP, which
requires the use of estimates and assumptions that involve the exercise of
judgment and use of assumptions as to future uncertainties. Our most critical
accounting policies involve decisions and assessments that could affect our
reported assets and liabilities, as well as our reported revenues and expenses.
We believe that all of the decisions and assessments upon which our consolidated
financial statements are based are reasonable at the time made and based upon
information available to us at that time. We rely upon independent pricing of
our assets at each quarter’s end to arrive at what we believe to be reasonable
estimates of fair market value. For a discussion of our critical accounting
policies, see “Notes to Consolidated Financial Statements” in the financial
statements accompanying this Report.







56


Results of
Operations





The table
below presents certain information from our Consolidated Statement of Operations
for the year ended December 31, 2009 and for the period from June 5, 2008
(date of inception) to December 31, 2008:


$
      in thousands, except per share data
            
            Year
      Ended December 31, 2009
            
            
            Period
      from June 5, 2008 (Date of Inception) to December 31, 2008RevenuesInterest
      income
            
            
            23,529
            
            
            
            —Interest
      expense
            
            
            4,627
            
            
            
            —Net
      interest income
            
            
            18,902
            
            
            
            —Other
      incomeGain
      on sale of investments
            
            
            2,002Equity
      in earnings and fair value change in unconsolidated limited
      partnerships
            
            
            71
            
            
            
            —Total
      other income
            
            
            2,073
            
            
            
            —ExpensesManagement
      fee – related party
            
            
            1,513
            
            
            
            —General
      and administrative
            
            
            499
            
            
            
            22Insurance
            
            
            723
            
            
            
            —Professional
      Fees
            
            
            729
            
            
            
            —Total
      expenses
            
            
            3,464
            
            
            
            22Net
      income (loss)
            
            
            17,511
            
            
            
            (22
            )Net
      income attributable to non-controlling interest
            
            
            2,417
            
            
            
            —Net
      income (loss) attributable to common shareholders
            
            
            15,094
            
            
            
            (22
            )Earnings
      per share:Net
      income attributable to common shareholders (basic/diluted)
            
            
            3.37
            
            
            NMDividends
      declared per common share
            
            
            1.66
            
            
            
            —Weighted
      average number of shares of common stock:Basic
            
            
            4,480
            
            
            NMDiluted
            
            
            5,198
            
            
            NM


NM = not
meaningful





57


Net
Income Summary





For the
year ended December 31, 2009, our net income was $15.1 million, or $3.37 basic
and diluted net income per average share available to common
shareholders.





Interest
Income and Average Earning Asset Yield





We had
average earning assets of $866.4 million for the year ended December 31, 2009.
Our primary source of income is interest income. Our interest income was $23.5
million for the year ended December 31, 2009. The yield on our average
investment portfolio was 6.10%. The CPR of our portfolio impacts the amount of
premium and discount on the purchase of securities that is recognized into
income. At December 31, 2009, our 15-year Agency RMBS had a 3-month CPR of 15.0,
the 30-year Agency RMBS portfolio had a 3-month CPR of 22.7, and our Agency
hybrid ARMs portfolio prepaid at a 19.5 CPR. Our non-Agency RMBS portfolio paid
at a 3-month CPR of 16.0 and our CMBS had no prepayment of principal. Overall,
the weighted average 3-month CPR on our investment portfolio was
15.7.





Interest
Expense and the Cost of Funds





Our
largest expense is the interest expense on borrowed funds. We had average
borrowed funds of $626.0 million and total interest expense of $4.6 million
for the year ended December 31, 2009.





Our
average cost of funds was 1.45% for the year ended December 31, 2009. Since a
substantial portion of our repurchase agreements are short term, changes in
market rates are directly reflected in our interest expense. Interest expense
includes borrowing costs under repurchase agreements, the TALF borrowings, as
well as hedging costs for our interest rate hedges.





Net
Interest Income





Our net
interest income, which equals interest income less interest expense, totaled
$18.9 million for the year ended December 31, 2009. Our net interest rate
margin, which equals the yield on our average assets for the period less the
average cost of funds for the period, was 4.65% for the year ended December 31,
2009.





Gain
on Sale of Investments
  For the year ended December 31, 2009,
we realized a gain on sale of investments of $2.0 million. The gain was
primarily due to the rebalancing of the portfolio during the fourth quarter of
2009 as we acquired more non-Agency RMBS and CMBS and sold a portion of our
Agency RMBS.
 
 Equity
in Earnings and Change in Fair Value of Unconsolidated Limited
Partnerships
 
 For the year ended December 31, 2009,
we recognized equity in earnings and unrealized appreciation on the change in
fair value of our investment in the Invesco PPIP Fund of approximately $63,000
and $8,000, respectively.





Expenses





We
incurred management fees of $1.5 million for the year ended December 31, 2009,
which are payable to our Manager under our management agreement. See “Certain
Relationships, Related Transactions, and Director Independence” for a discussion
of the management fee and our relationship with our Manager.





Our
general and administrative expense of $499,000 for the year ended December 31,
2009, includes the salary and the bonus of our Chief Financial Officer,
amortization of equity based compensation related to anticipated quarterly
grants of our stock to our independent directors, payable subsequent to each
calendar quarter, cash-based payments to our independent directors, derivative
transaction fees, software licensing, industry memberships, filing fees, travel
and entertainment and other miscellaneous general and administrative costs. Our
insurance expense of $723,000 for the year ended December 31, 2009, represents
the cost of liability insurance to indemnify our directors and
officers.





58


Our
professional fees of $729,000 for the year ended December 31, 2009 represents
the cost of legal, accounting, auditing and consulting services provided to us
by third party service providers.





Net
Income and Return on Average Equity





Our net
income was $17.5 million for the year ended December 31, 2009. Our
annualized return on average equity was 19.35% for the year ended December 31,
2009.





Liquidity and Capital
Resources





Liquidity
is a measurement of our ability to meet potential cash requirements, including
ongoing commitments to pay dividends, fund investments, repayment of borrowings
and other general business needs. Our primary sources of funds for liquidity
consists of the net proceeds from our common equity offerings, net cash provided
by operating activities, cash from repurchase agreements and other financing
arrangements and future issuances of common equity, preferred equity,
convertible securities and/or equity or debt securities. We also have sought,
and may continue to finance our assets under, and may otherwise participate in,
programs established by the U.S. government.





We
currently believe that we have sufficient liquidity and capital resources
available for the acquisition of additional investments, repayments on
borrowings and the payment of cash dividends as required for continued
qualification as a REIT.  We generally maintain liquidity to pay down
borrowings under repurchase arrangements to reduce borrowing costs and otherwise
efficiently manage our long-term investment capital. Because the level of these
borrowings can be adjusted on a daily basis, the level of cash and cash
equivalents carried on our balance sheet is significantly less important than
our potential liquidity available under borrowing arrangements.





As of
December 31, 2009, we had entered into repurchase agreements with various
counterparties for total borrowings of $546.0 million at a weighted average
interest rate of 0.26% to finance our purchases of Agency RMBS. We generally
target a debt-to-equity ratio with respect to our Agency RMBS of 6 to 8
times.  As of December 31, 2009, we had a ratio of 13.6 times
which was related to the timing of cash received and the maturity of the
repurchase agreements. The counterparty with the highest percentage of
repurchase agreement balance had 32.1%. The repurchase obligations mature and
reinvest every thirty to ninety days. See “— Contractual Obligations”
below. Additionally, as of December 31, 2009, we had secured borrowings of
$80.4 million under the TALF at a weighted average interest rate of 3.82% to
finance our purchase of CMBS. We generally seek to borrow (on a non-recourse
basis) between 3 and 5 times the amount of our shareholders’ equity and as of
December 31, 2009, had a ratio of 3.9 times, which is consistent with funding
limits under the TALF. The TALF loans are non-recourse and mature in July,
August and December 2014.





As of
December 31, 2009, the weighted average margin requirement, or the
percentage amount by which the collateral value must exceed the loan amount,
which we also refer to as the “haircut,” under all of our repurchase agreements
was approximately 5.6%. Across all of our repurchase facilities, the haircuts
range from a low of 5.0% to a high of 8.0%. Declines in the value of our
securities portfolio can trigger margin calls by our lenders under our
repurchase agreements. An event of default or termination event would give some
of our counterparties the option to terminate all repurchase transactions
existing with us and require any amount due by us to the counterparties to be
payable immediately.





As
discussed above under “—Market Conditions,” the residential mortgage market in
the United States has experienced difficult economic conditions
including:


·
            increased
      volatility of many financial assets, including agency securities and other
      high-quality RMBS assets, due to potential security
      liquidations;








59


·
            increased
      volatility and deterioration in the broader residential mortgage and RMBS
      markets; and





·
            significant
      disruption in financing of RMBS.





If these
conditions persist, then our lenders may be forced to exit the repurchase
market, become insolvent or further tighten lending standards or increase the
amount of required equity capital or haircut, any of which could make it more
difficult or costly for us to obtain financing.





Effects of Margin
Requirements, Leverage and Credit Spreads





Our
securities have values that fluctuate according to market conditions and, as
discussed above, the market value of our securities will decrease as prevailing
interest rates or credit spreads increase. When the value of the securities
pledged to secure a repurchase loan decreases to the point where the positive
difference between the collateral value and the loan amount is less than the
haircut, our lenders may issue a “margin call,” which means that the lender will
require us to pay the margin call in cash or pledge additional collateral to
meet that margin call. Under our repurchase facilities, our lenders have full
discretion to determine the value of the securities we pledge to them. Most of
our lenders will value securities based on recent trades in the market. Lenders
also issue margin calls as the published current principal balance factors
change on the pool of mortgages underlying the securities pledged as collateral
when scheduled and unscheduled paydowns are announced
monthly.





We
experience margin calls in the ordinary course of our business. In seeking to
manage effectively the margin requirements established by our lenders, we
maintain a position of cash and unpledged securities. We refer to this position
as our “liquidity.” The level of liquidity we have available to meet margin
calls is directly affected by our leverage levels, our haircuts and the price
changes on our securities. If interest rates increase as a result of a yield
curve shift or for another reason or if credit spreads widen, then the prices of
our collateral (and our unpledged assets that constitute our liquidity) will
decline, we will experience margin calls, and we will use our liquidity to meet
the margin calls. There can be no assurance that we will maintain sufficient
levels of liquidity to meet any margin calls. If our haircuts increase, our
liquidity will proportionately decrease. In addition, if we increase our
borrowings, our liquidity will decrease by the amount of additional haircut on
the increased level of indebtedness.





We intend
to maintain a level of liquidity in relation to our assets that enables us to
meet reasonably anticipated margin calls but that also allows us to be
substantially invested in securities. We may misjudge the appropriate amount of
our liquidity by maintaining excessive liquidity, which would lower our
investment returns, or by maintaining insufficient liquidity, which would force
us to liquidate assets into unfavorable market conditions and harm our results
of operations and financial condition.





Forward-Looking
Statements Regarding Liquidity





Based
upon our current portfolio, leverage rate and available borrowing arrangements,
we believe that the net proceeds of our common equity offerings, combined with
cash flow from operations and available borrowing capacity, are sufficient to
enable us to meet anticipated short-term (one year or less) liquidity
requirements to fund our investment activities, pay fees under our management
agreement, fund our distributions to shareholders and for other general
corporate expenses.





Our
ability to meet our long-term (greater than one year) liquidity and capital
resource requirements will be subject to obtaining additional debt financing and
equity capital. We may increase our capital resources by obtaining long-term
credit facilities or making additional public or private offerings of equity or
debt securities, possibly including classes of preferred stock, common stock,
and senior or subordinated notes. Such financing will depend on market
conditions for capital raises and for the investment of any proceeds. If we are
unable to renew, replace or expand our sources of financing on substantially
similar terms, it may have an adverse effect on our business and results of
operations.


60


Contractual
Obligations





On
July 1, 2009, we entered into an agreement with our Manager pursuant to
which our Manager is entitled to receive a management fee and the reimbursement
of certain expenses. The management fee will be calculated and payable quarterly
in arrears in an amount equal to 1.50% of our shareholders’ equity, per annum,
calculated and payable quarterly in arrears. Our Manager will use the proceeds
from its management fee in part to pay compensation to its officers and
personnel who, notwithstanding that certain of those individuals are also our
officers, will receive no cash compensation directly from us. We are required to
reimburse our Manager for operating expenses incurred by our Manager, including
certain salary expenses and other expenses relating to legal, accounting, due
diligence and other services. Expense reimbursements to our Manager are made in
cash on a monthly basis following the end of each month. Our reimbursement
obligation is not subject to any dollar limitation.





As of
December 31, 2009, we committed to contribute up to $25.0 million to the
Invesco PPIP Fund, which, in turn, invests in our target assets, and may seek
additional investments in this or a similar PPIP managed by our Manager. As of
December 31, 2009, $4.1 million of the commitment has been called. Pursuant
to the terms of the management agreement, we pay our Manager a management fee.
As a result, we do not pay any management or investment fees with respect to our
investment in the Invesco PPIP Fund managed by our Manager. Our Manager waives
all such fees.





Contractual
Commitments





As of
December 31, 2009, we had the following contractual commitments and
commercial obligations:





Payments
      Due by PeriodTotal
            
            
            Less
      than 1 year
            
            
            1-3
      years
            
            
            3-5
      years
            
            
            After
      5 years$ in thousandsRepurchase
      agreements
            
            
            545,975
            
            
            
            545,975
            
            
            
            —
            
            
            
            —
            
            
            
            —TALF
      financing
            
            
            80,377
            
            
            
            —
            
            
            
            —
            
            
            
            80,377
            
            
            
            —Invesco
      PPIP Fund investment
            
            
            20,943
            
            
            
            —
            
            
            
            20,943
            
            
            
            —
            
            
            
            —Total
      contractual obligations
            
            
            647,295
            
            
            
            545,975
            
            
            
            20,943
            
            
            
            80,377
            
            
            
            —










Off-Balance
Sheet Arrangements





We
committed to invest up to $25.0 million in the Invesco PPIP Fund, which, in
turn, invests in our target assets, and may seek additional investments in this
or a similar PPIP managed by our Manager. As of December 31, 2009, $4.1
million of the commitment has been called.





Shareholders’
Equity (Deficit)





On
July 1, 2009, we successfully completed our IPO, pursuant to which we sold
8,500,000 shares of our common stock to the public at a price of $20.00 per
share for net proceeds of $164.8 million. Concurrent with our IPO, we
completed a private placement in which we sold 75,000 shares of our common
stock to our Manager at a price of $20.00 per share and our operating
partnership sold 1,425,000 units of limited partnership interests in our
operating partnership to Invesco Investments (Bermuda) Ltd., a wholly-owned
subsidiary of Invesco, at a price of $20.00 per unit. The net proceeds to us
from this private offering was $30.0 million. We did not pay any
underwriting discounts or commissions in connection with the private
placement.





61


On
July 27, 2009, the underwriters of our IPO exercised their over-allotment
option to purchase an additional 311,200 shares of our common stock at a
price of $20.00 per share for net proceeds of $6.1 million. Collectively,
we received net proceeds from our IPO and the concurrent private offerings of
approximately $200.9 million.





On
January 15, 2010, we completed a follow-on public offering of 7,000,000 shares
of common stock and an issuance of an additional 1,050,000 shares of common
stock pursuant to the underwriters’ full exercise of their over-allotment option
at $21.25 per share. The net proceeds to us were $162.7 million, net of issuance
costs of approximately $8.4 million.





Unrealized Gains and
Losses





Unrealized
fluctuations in market values of assets do not impact our US GAAP income but
rather are reflected on our balance sheet by changing the carrying value of the
asset and shareholders’ equity under “Accumulated Other Comprehensive Income
(Loss).” We account for our investment securities as “available-for-sale.” In
addition, unrealized fluctuations in market values of our cash flow hedges that
qualify for hedge accounting, are also reflected in “Accumulated Other
Comprehensive Income (Loss).”
 
 As a
result of this mark-to-market accounting treatment, our book value and book
value per share are likely to fluctuate far more than if we used historical
amortized cost accounting. As a result, comparisons with companies that use
historical cost accounting for some or all of their balance sheet may not be
meaningful.





Share-Based
Compensation


We
established the 2009 Equity Incentive Plan for grants of restricted common stock
and other equity based awards to our independent, non-executive directors, and
to the officers and employees of the Manager (the “Incentive Plan”). Under the
Incentive Plan a total of 1,000,000 shares are currently reserved for issuance.
Unless terminated earlier, the Incentive Plan will terminate in 2019, but will
continue to govern the unexpired awards. Our three independent, non-executive
directors are each eligible to receive $25,000 in restricted common stock
annually. We recognized compensation expense of approximately $38,000 for the
year ended December 31, 2009 and issued 912 shares of restricted stock to
our  independent, non-executive directors pursuant to the Incentive
Plan in 2009 related to shares earned for the third quarter of 2009. The number
of shares issued was determined based on the closing price on the NYSE on the
actual date of grant.


Dividends





We intend
to continue to make regular quarterly distributions to holders of our common
stock. U.S. federal income tax law generally requires that a REIT
distribute annually at least 90% of its REIT taxable income, without regard to
the deduction for dividends paid and excluding net capital gains, and that it
pay tax at regular corporate rates to the extent that it annually distributes
less than 100% of its taxable income. We intend to continue to pay regular
quarterly dividends to our shareholders in an amount equal at least 90% of our
taxable income. Before we pay any dividend, whether for U.S. federal income
tax purposes or otherwise, we must first meet both our operating requirements
and debt service on our repurchase agreements and other debt payable. If our
cash available for distribution is less than our taxable income, we could be
required to sell assets or borrow funds to make cash distributions, or we may
make a portion of the required distribution in the form of a taxable stock
distribution or distribution of debt securities.





On
October 13, 2009, we declared a dividend of $0.61 per share of common
stock. The dividend was paid on November 12, 2009 to shareholders of record
as of the close of business on October 23, 2009. On December 17, 2009,
we declared a dividend of $1.05 per share of common stock to shareholders of
record as of December 31, 2009, which was paid on January 27,
2010.





62


Inflation





Virtually
all of our assets and liabilities are interest rate sensitive in nature. As a
result, interest rates and other factors influence our performance far more than
inflation. Changes in interest rates do not necessarily correlate with inflation
rates or changes in inflation rates.





Other
Matters





We
believe that at least 75% of our assets were qualified REIT assets, as defined
in the Internal Revenue Code of 1986, as amended (the “Code”), for the year
ended December 31, 2009. We also believe that our revenue qualifies for the
75% source of income test and for the 95% source of income test rules for the
year ended December 31, 2009. Consequently, we met the REIT income and
asset test. We also met all REIT requirements regarding the ownership of our
common stock. Therefore, as of December 31, 2009, we believe that we were
in a position to qualify as a REIT under the Code.





Item 7A. Quantitative
and Qualitative Disclosures About Market Risk.





The
primary components of our market risk are related to interest rate, prepayment
and market value. While we do not seek to avoid risk completely, we believe the
risk can be quantified from historical experience and we seek to actively manage
that risk, to earn sufficient compensation to justify taking those risks and to
maintain capital levels consistent with the risks we
undertake.





Interest Rate
Risk





Interest
rate risk is highly sensitive to many factors, including governmental, monetary
and tax policies, domestic and international economic and political
considerations, and other factors beyond our control. We are subject to interest
rate risk in connection with our investments and our repurchase agreements. Our
repurchase agreements are typically of limited duration and will be periodically
refinanced at current market rates. We mitigate this risk through utilization of
derivative contracts, primarily interest rate swap agreements, interest rate
caps and interest rate floors.





Interest Rate
Effect on Net Interest Income





Our
operating results depend in large part upon differences between the yields
earned on our investments and our costs of borrowing and interest rate hedging
activities. Most of our repurchase agreements provide financing based on a
floating rate of interest calculated on a fixed spread over LIBOR. The fixed
spread will vary depending on the type of underlying asset which collateralizes
the financing. Accordingly, the portion of our portfolio which consists of
floating interest rate assets are match-funded utilizing our expected sources of
short-term financing, while our fixed interest rate assets are not match-funded.
During periods of rising interest rates, the borrowing costs associated with our
investments tend to increase while the income earned on our fixed interest rate
investments may remain substantially unchanged. This increase in borrowing costs
results in the narrowing of the net interest spread between the related assets
and borrowings and may result in losses. Further, during this portion of the
interest rate and credit cycles, defaults could increase and result in credit
losses to us, which could adversely affect our liquidity and operating results.
Such delinquencies or defaults could also have an adverse effect on the spread
between interest-earning assets and interest-bearing
liabilities.








Hedging
techniques are partly based on assumed levels of prepayments of our RMBS. If
prepayments are slower or faster than assumed, the life of the RMBS will be
longer or shorter, which would reduce the effectiveness of any hedging
strategies we may use and may cause losses on such transactions. Hedging
strategies involving the use of derivative securities are highly complex and may
produce volatile returns.








63


Interest Rate
Effects on Fair Value





Another
component of interest rate risk is the effect that changes in interest rates
will have on the market value of the assets that we acquire. We face the risk
that the market value of our assets will increase or decrease at different rates
than those of our liabilities, including our hedging instruments.





We
primarily assess our interest rate risk by estimating the duration of our assets
and the duration of our liabilities. Duration measures the market price
volatility of financial instruments as interest rates change. We generally
calculate duration using various financial models and empirical data. Different
models and methodologies can produce different duration numbers for the same
securities.








It is
important to note that the impact of changing interest rates on fair value can
be significant when interest rates change materially. Therefore, the volatility
in the fair value of our assets could increase significantly when interest rates
change materially. In addition, other factors impact the fair value of our
interest rate-sensitive investments and hedging instruments, such as the shape
of the yield curve, market expectations as to future interest rate changes and
other market conditions. Accordingly, changes in actual interest rates may have
a material adverse effect on us.





Prepayment
Risk





As we
receive prepayments of principal on our investments, premiums paid on these
investments are amortized against interest income. In general, an increase in
prepayment rates will accelerate the amortization of purchase premiums, thereby
reducing the interest income earned on the investments. Conversely, discounts on
such investments are accreted into interest income. In general, an increase in
prepayment rates will accelerate the accretion of purchase discounts, thereby
increasing the interest income earned on the investments.





Extension
Risk





We
compute the projected weighted-average life of our investments based upon
assumptions regarding the rate at which the borrowers will prepay the underlying
mortgages. In general, when a fixed-rate or hybrid adjustable-rate security is
acquired with borrowings, we may, but are not required to, enter into an
interest rate swap agreement or other hedging instrument that effectively fixes
our borrowing costs for a period close to the anticipated average life of the
fixed-rate portion of the related assets. This strategy is designed to protect
us from rising interest rates, because the borrowing costs are fixed for the
duration of the fixed-rate portion of the related target
asset.





However,
if prepayment rates decrease in a rising interest rate environment, then the
life of the fixed-rate portion of the related assets could extend beyond the
term of the swap agreement or other hedging instrument. This could have a
negative impact on our results from operations, as borrowing costs would no
longer be fixed after the end of the hedging instrument, while the income earned
on the hybrid adjustable-rate assets would remain fixed. This situation could
also cause the market value of our hybrid adjustable-rate assets to decline,
with little or no offsetting gain from the related hedging transactions. In
extreme situations, we could be forced to sell assets to maintain adequate
liquidity, which could cause us to incur losses.





Market
Risk








Market Value
Risk





Our
available-for-sale securities are reflected at their estimated fair value with
unrealized gains and losses excluded from earnings and reported in other
comprehensive income. The estimated fair value of these securities fluctuates
primarily due to changes in interest rates and other factors. Generally, in a
rising interest rate environment, the estimated fair value of these securities
would be expected to decrease; conversely, in a decreasing interest rate
environment, the estimated fair value of these securities would be expected to
increase.





64


The
sensitivity analysis table presented below shows the estimated impact of an
instantaneous parallel shift in the yield curve, up and down 50 and
100 basis points, on the market value of our interest rate-sensitive
investments and net interest income, at December 31, 2009, assuming a
static portfolio. When evaluating the impact of changes in interest rates,
prepayment assumptions and principal reinvestment rates are adjusted based on
our Manager’s expectations. The analysis presented utilized assumptions, models
and estimates of our Manager based on our Manager’s judgment and
experience.





Change
      in Interest Rates
            
            Percentage
      Change in Projected Net Interest Income
            
            Percentage
      Change in Projected Portfolio Value+1.00%
            
            7.79%
            
            (1.71)%+0.50%
            
            5.76%
            
            (0.73)%-0.50%
            
            (4.25)%
            
            0.32%-1.00%
            
            (14.67)%
            
            0.12%





Real Estate Risk





Residential
and commercial property values are subject to volatility and may be affected
adversely by a number of factors, including, but not limited to: national,
regional and local economic conditions (which may be adversely affected by
industry slowdowns and other factors); local real estate conditions (such as the
housing supply); changes or continued weakness in specific industry segments;
construction quality, age and design; demographic factors; and retroactive
changes to building or similar codes. In addition, decreases in property values
reduce the value of the collateral and the potential proceeds available to a
borrower to repay our loans, which could also cause us to suffer
losses.





Credit
Risk





We
believe that our investment strategy will generally keep our credit losses and
financing costs low. However, we retain the risk of potential credit losses on
all of the residential and commercial mortgage loans, as well as the loans
underlying the non-Agency RMBS and CMBS in our portfolio. We seek to manage this
risk through our pre-acquisition due diligence process and through the use of
non-recourse financing, which limits our exposure to credit losses to the
specific pool of mortgages that are subject to the non-recourse financing. In
addition, with respect to any particular asset, our Manager’s investment team
evaluates, among other things, relative valuation, supply and demand trends,
shape of yield curves, prepayment rates, delinquency and default rates, recovery
of various sectors and vintage of collateral.


Risk Management


To the
extent consistent with maintaining our REIT qualification, we seek to manage
risk exposure to protect our investment portfolio against the effects of major
interest rate changes. We generally seek to manage this risk by:


·
              monitoring
      and adjusting, if necessary, the reset index and interest rate related to
      our target assets and our
financings;
 
 ·
              structuring
      our financing agreements to have a range of maturity terms, amortizations
      and interest rate adjustment
periods;
 
 ·
              using
      hedging instruments, primarily interest rate swap agreements but also
      financial futures, options, interest rate cap agreements, floors and
      forward sales to adjust the interest rate sensitivity of our target assets
      and our borrowings; and
 
 ·
              actively
      managing, on an aggregate basis, the interest rate indices, interest rate
      adjustment periods, and gross reset margins of our target assets and the
      interest rate indices and adjustment periods of our
      financings.











65


Item 8. Financial
Statements and Supplementary Data.





The
financial statements and supplementary data are included under Item 15 of
this Report.





Item 9. Changes in and
Disagreements With Accountants on Accounting and Financial
Disclosure.





None.





Item 9A(T). Controls
and Procedures.





Disclosure
Controls and Procedures





Our
management is responsible for establishing and maintaining disclosure controls
and procedures that are designed to ensure that information we are required to
disclose in the reports that we file or submit under the Securities Exchange Act
of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and
reported, within the time periods specified in the SEC’s rules and forms.
Disclosure controls and procedures include controls and procedures designed to
ensure that the required information is accumulated and communicated to our
management, including our principal executive and principal financial officer,
as appropriate, to allow timely decisions regarding required
disclosure.





We have
evaluated, with the participation of our principal executive officer and
principal financial officer, the effectiveness of our disclosure controls and
procedures as of December 31, 2009. There are inherent limitations to the
effectiveness of any system of disclosure controls and procedures, including the
possibility of human error and the circumvention or overriding of the controls
and procedures. Accordingly, even effective disclosure controls and procedures
can only provide reasonable assurance of achieving their control objectives.
Based upon our evaluation, our principal executive officer and principal
financial officer concluded that our disclosure controls and procedures were
effective to provide reasonable assurance that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified
in the applicable rules and forms, and that it is accumulated and communicated
to our management, including our principal executive officer and principal
financial officer, as appropriate to allow timely decisions regarding required
disclosure.





Management’s
Annual Report on Internal Control Over Financial Reporting





This
Report does not include a report of management’s assessment regarding internal
control over financial reporting or an attestation report of the company’s
registered public accounting firm due to a transition period established by
rules of the Securities and Exchange Commission for newly public
companies.





Item 9B. Other
Information.





None.





66


PART III





Item 10. Directors,
Executive Officers and Corporate Governance.





We will
provide information that is responsive to this Item 10 in our definitive
proxy statement or in an amendment to this Report not later than 120 days after
the end of the fiscal year covered by this Report, in either case under the
captions “Information about Director Nomineees,” “Information about the
Executive Officers of the Company,” “Corporate Governance,” “Information about
the Board and its Committees,” “Section 16(a) Beneficial Ownership Reporting
Compliance,” and possibly elsewhere therein. That information is incorporated
into this Item 10 by reference.





Item 11. Executive
Compensation.





We will
provide information that is responsive to this Item 11 in our definitive
proxy statement or in an amendment to this Report not later than 120 days after
the end of the fiscal year covered by this Report, in either case under the
captions “Director Compensation,” “Executive Compensation,” “Compensation
Committee Interlocks and Insider Participation,” and possibly elsewhere therein.
That information is incorporated into this Item 11 by
reference.





Item 12. Security Ownership
of Certain Beneficial Owners and Management and Related Stockholder
Matters.







We will
provide information that is responsive to this Item 12 in our definitive
proxy statement or in an amendment to this Report not later than 120 days after
the end of the fiscal year covered by this Report, in either case under the
caption “Security Ownership of Principal Shareholders,” “Security Ownership of
Management,” and possibly elsewhere therein. That information is incorporated
into this Item 12 by reference.





Item 13. Certain
Relationships and Related Transactions, and Director Independence.





We will
provide information that is responsive to this Item 13 in our definitive
proxy statement or in an amendment to this Report not later than 120 days after
the end of the fiscal year covered by this Report, in either case under the
captions “Corporate Governance,” “Certain Relationships and Related
Transactions,” “Related Person Transaction Policy,” and possibly elsewhere
therein. That information is incorporated into this Item 13 by
reference.





Item 14.  Principal
Accountant Fees and Services.





We will
provide information that is responsive to this Item 14 in our definitive
proxy statement or in an amendment to this Report not later than 120 days after
the end of the fiscal year covered by this Report, in either case under the
captions “Fees Paid to Independent Registered Public Accounting Firm,”
“Pre-Approval Process and Policy,” and possibly elsewhere therein. That
information is incorporated into this Item 14 by
reference.


67


PART IV





Item 15.  Exhibits,
Financial Statement Schedules.





(a)(1)
Financial Statements:The financial statements contained herein are set forth on
pages 71-91 of this Report.





(a)(2)
Financial Statement
Schedules:





(a)(3)
Exhibits:


EXHIBIT
      INDEX3.1
            
            Articles
      of Amendment and Restatement of Invesco Mortgage Capital Inc.,
      incorporated by reference to Exhibit 3.1 to our Quarterly Report on Form
      10-Q, filed with the SEC on August 12, 2009.3.2
            
            Amended
      and Restated Bylaws of Invesco Mortgage Capital Inc., incorporated by
      reference to Exhibit 3.2 to Amendment No. 8 to our Registration Statement
      on Form S-11 (No. 333-151665), filed with the SEC on June 18, 2009
      (“Pre-Effective Amendment No. 8”).4.1
            
            Specimen
      Common Stock Certificate of Invesco Mortgage Capital Inc., incorporated by
      reference to Exhibit 4.1 to Pre-Effective Amendment No. 8.10.1
            
            Registration
      Rights Agreement, dated as of July 1, 2009, among Invesco Mortgage Capital
      Inc. (formally known as Invesco Agency Securities Inc.), Invesco Advisers,
      Inc. (formally known as Invesco Institutional (N.A.), Inc.) and Invesco
      Investments (Bermuda) Ltd., incorporated by reference to Exhibit 10.1 to
      our Quarterly Report on Form 10-Q, filed with the SEC on August 12,
      2009.10.2
            
            Management
      Agreement, dated as of July 1, 2009, among Invesco Advisers, Inc.
      (formally known as Invesco Institutional (N.A.), Inc.), Invesco Mortgage
      Capital Inc. and IAS Operating Partnership LP., incorporated by reference
      to Exhibit 10.2 to our Quarterly Report on Form 10-Q, filed with the SEC
      on August 12, 2009.10.3
            
            First
      Amended and Restated Agreement of Limited Partnership, dated as of July 1,
      2009, of IAS Operating Partnership LP., incorporated by reference to
      Exhibit 10.3 to our Quarterly Report on Form 10-Q, filed with the SEC on
      August 12, 2009.10.4§
            
            Invesco
      Mortgage Capital Inc. 2009 Equity Incentive Plan, incorporated by
      reference to Exhibit 10.4 to our Quarterly Report on Form 10-Q, filed with
      the SEC on November 9, 2009.10.5§
            
            Form
      of Restricted Common Stock Award Agreement, incorporated by reference to
      Exhibit 4.1 to Pre-Effective Amendment No. 8.10.6§
            
            Form
      of Stock Option Award Agreement, incorporated by reference to Exhibit 4.1
      to Pre-Effective Amendment No. 8.10.7§
            
            Form
      of Restricted Stock Unit Award Agreement.21.1
            
            Subsidiaries
      of the Registrant.23.1
            
            Consent
      of Grant Thornton LLP.





68


31.1
              
              Certification
      of Richard J. King pursuant to Rule 13a-14(a), as adopted pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.31.2
              
              Certification
      of Donald R. Ramon pursuant to Rule 13a-14(a), as adopted pursuant to
      Section 302 of the Sarbanes-Oxley Act of 2002.32.1
              
              Certification
      of Richard J. King pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350,
      as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.32.2
              
              Certification
      of Donald R. Ramon pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350,
      as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.
  §
Management contract or compensatory plan or arrangement.
   (b)
Exhibits: See (a)(3) above.
   (c)
Financial Statement Schedules: See (a)(2) above.




















69





INDEX
TO FINANCIAL STATEMENTS





PageReport
      of Independent Registered Public Accounting Firm
            71Consolidated
      Balance Sheets as of December 31, 2009 and December 31,
    2008
            72Consolidated
      Statements of Operations for the year ended December 31, 2009 and the
      period from June 5, 2008 (Date of Inception) to December 31,
      2008
            73Consolidated
      Statement Changes in Equity (Deficit) for the year ended December 31, 2009
      and for the period from June 5, 2008 (Date of Inception) to December 31,
      2008
            74Consolidated
      Statements of Cash Flows for the year ended December 31, 2009 and the
      period from June 5, 2008 (Date of Inception) to December 31,
      2008
            75Notes
      to Consolidated Financial Statements
            76





70











Report
of Independent Registered Public Accounting Firm





Board of
Directors and Shareholders


Invesco
Mortgage Capital Inc.








We have
audited the accompanying consolidated balance sheets of Invesco Mortgage Capital
Inc. (a
Maryland corporation) and subsidiaries as of December 31, 2009 and 2008, and the
related consolidated statements of operations, equity (deficit) and cash flows
for the year ended December 31, 2009 and for the period from June 5, 2008
(date of inception) to December 31, 2008.  These financial
statements are the responsibility of Invesco Mortgage Capital Inc.’s
management.  Our responsibility is to express an opinion on these
financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Invesco Mortgage Capital
Inc. and subsidiaries as of December 31, 2009 and 2008, and the results of its
consolidated operations and its cash flows for the year ended December 31, 2009
and for the period from June 5, 2008 (date of inception) to
December 31, 2008 in conformity with accounting principles generally
accepted in the United States of America.











/s/ GRANT
THORNTON LLP











Philadelphia,
Pennsylvania




March
­­23, 2010




71











INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
 CONSOLIDATED
BALANCE SHEETS











$
      in thousands, except per share amountsASSETS
            
            December 31,
              2009
            
            
            December 31,
      2008Mortgage-backed
      securities, at fair value
            
            
            802,592
            
            
            
            —Cash
            
            
            24,041
            
            
            
            1Restricted
      cash
            
            
            14,432
            
            
            
            —Principal
      paydown receivable
            
            
            2,737
            
            
            
            —Investments
      in unconsolidated limited partnerships, at fair value
            
            
            4,128
            
            
            
            —Accrued
      interest receivable
            
            
            3,518
            
            
            
            —Prepaid
      insurance
            
            
            681
            
            
            
            —Deferred
      offering costs
            
            
            288
            
            
            
            978Other
      assets
            
            
            983
            
            
            
            —Total
      assets
            
            
            853,400
            
            
            
            979LIABILITIES
      AND EQUITY (DEFICIT)Liabilities:Repurchase
      agreements
            
            
            545,975
            
            
            
            —TALF
      financing
            
            
            80,377
            
            
            
            —Derivative
      liability, at fair value
            
            
            3,782
            
            
            
            —Dividends
      and distributions payable
            
            
            10,828
            
            
            
            —Accrued
      interest payable
            
            
            598
            
            
            
            —Accounts
      payable and accrued expenses
            
            
            665
            
            
            
            —Due
      to affiliate
            
            
            865
            
            
            
            1,000Total
      liabilities
            
            
            643,090
            
            
            
            1,000Equity
      (Deficit):Preferred
      Stock: par value $0.01 per share; 50,000,000 shares authorized, 0 shares
      issued and outstanding
            
            
            —
            
            
            
            —Common
      Stock: par value $0.01 per share; 450,000,000 shares authorized, 8,887,212
      shares issued and outstanding
            
            
            89
            
            
            
            —Additional
      paid in capital
            
            
            172,385
            
            
            
            1Accumulated
      other comprehensive income
            
            
            7,721
            
            
            
            —Retained
      earnings (accumulated deficit)
            
            
            320
            
            
            
            (22
            )Total
      shareholders’ equity (deficit)
            
            
            180,515
            
            
            
            (21
            )Non-controlling
      interest
            
            
            29,795
            
            
            
            —Total
      equity (deficit)
            
            
            210,310
            
            
            
            (21
            )Total
      liabilities and equity
            
            
            853,400
            
            
            
            979


The
accompanying notes are an integral part of these consolidated financial
statements.


72


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS OF OPERATIONS








$
      in thousands, except per share data
            
            Year
      Ended December 31, 2009
            
            
            Period
      from June 5, 2008 (Date of Inception) to December 31, 2008RevenuesInterest
      income
            
            
            23,529
            
            
            
            —Interest
      expense
            
            
            4,627
            
            
            
            —Net
      interest income
            
            
            18,902
            
            
            
            —Other
      incomeGain
      on sale of investments
            
            
            2,002Equity
      in earnings and fair value change in unconsolidated limited
      partnerships
            
            
            71
            
            
            
            —Total
      other income
            
            
            2,073
            
            
            
            —ExpensesManagement
      fee – related party
            
            
            1,513
            
            
            
            —General
      and administrative
            
            
            499
            
            
            
            22Insurance
            
            
            723
            
            
            
            —Professional
      Fees
            
            
            729
            
            
            
            —Total
      expenses
            
            
            3,464
            
            
            
            22Net
      income (loss)
            
            
            17,511
            
            
            
            (22
            )Net
      income attributable to non-controlling interest
            
            
            2,417
            
            
            
            —Net
      income (loss) attributable to common shareholders
            
            
            15,094
            
            
            
            (22
            )Earnings
      per share:Net
      income attributable to common shareholders (basic/diluted)
            
            
            3.37
            
            
            NMWeighted
      average number of shares of common stock:Dividends
      declared per common share
            
            
            1.66
            
            
            
            —Basic
            
            
            4,480
            
            
            NMDiluted
            
            
            5,198
            
            
            NM





NM = not
meaningful


The
accompanying notes are an integral part of these consolidated financial
statements.


73


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENT OF CHANGES IN EQUITY (DEFICIT)


Year
Ended December 31, 2009 and for the Period from June 5, 2008 (Date of Inception)
to December 31, 2008





Attributable
      to Common Shareholders$
      in thousands, except per share amounts
            
            Common
      Stock
              Shares
      Amount
            
            
            Additional
      Paid in Capital
            
            
            Accumulated
      Other Comprehensive Income (Loss)
            
            
            Retained
      Earnings (Accumulated Deficit)
            
            
            Total
      Shareholders
              Equity
      (Deficit)
            
            
            Non-Controlling
      Interest
            
            
            Total
      Equity
            
            
            Comprehensive
      Income (Loss)Balance
      at June 5, 2008
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Issuance
      of common stock
            
            
            100
            
            
            
            —
            
            
            
            1
            
            
            
            —
            
            
            
            —
            
            
            
            1
            
            
            
            —
            
            
            
            1
            
            
            
            —Net
      loss
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (22
            )
            
            
            (22
            )
            
            
            —
            
            
            
            (22
            )
            
            
            (22
            )Balance
      at December 31, 2008
            
            
            100
            
            
            
            —
            
            
            
            1
            
            
            
            —
            
            
            
            (22
            )
            
            
            (21
            )
            
            
            —
            
            
            
            (21
            )
            
            
            (22
            )Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            15,094
            
            
            
            15,094
            
            
            
            2,417
            
            
            
            17,511
            
            
            
            17,511Comprehensive
      incomeChange
      in net unrealized gains and losses on available for sale
      securities
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            10,980
            
            
            
            —
            
            
            
            10,980
            
            
            
            1,761
            
            
            
            12,741
            
            
            
            12,741Change
      in net unrealized gains and losses on derivatives
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (3,259
            )
            
            
            —
            
            
            
            (3,259
            )
            
            
            (523
            )
            
            
            (3,782
            )
            
            
            (3,782
            )Total
      comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            26,470Net
      proceeds from common stock, net of offering costs
            
            
            8,886,200
            
            
            
            89
            
            
            
            172,352
            
            
            
            —
            
            
            
            —
            
            
            
            172,441
            
            
            
            —
            
            
            
            172,441Proceeds
      from private placement of OP units
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            28,500
            
            
            
            28,500Common
      stock dividends
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (14,752
            )
            
            
            (14,752
            )
            
            
            —
            
            
            
            (14,752
            )Common
      unit dividends
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,366
            )
            
            
            (2,366
            )Amortization
      of equity-based compensation
            
            
            912
            
            
            
            —
            
            
            
            32
            
            
            
            —
            
            
            
            —
            
            
            
            32
            
            
            
            6
            
            
            
            38Balance
      at December 31, 2009
            
            
            8,887,212
            
            
            
            89
            
            
            
            172,385
            
            
            
            7,721
            
            
            
            320
            
            
            
            180,515
            
            
            
            29,795
            
            
            
            210,310


The
accompanying notes are an integral part of this consolidated financial
statement.


74


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF CASH FLOWS


$
      in thousands
            
            Year
      Ended December 31, 2009
            
            
            Period
      from June 5, 2008 (Date of Inception) to December 31, 2008Cash
      Flows from Operating ActivitiesNet
      income (loss)
            
            
            17,511
            
            
            
            (22
            )Adjustments
      to reconcile net income to net cash provided by operating
      activitiesAmortization
      of mortgage-backed securities premiums and discounts, net
            
            
            (1,764
            )
            
            
            —Gain
      on sale of mortgage-backed securities
            
            
            (2,002
            )
            
            
            —Equity
      in earnings and fair value change in unconsolidated limited
      partnerships
            
            
            (71
            )
            
            
            —Amortization
      of equity-based compensation
            
            
            38
            
            
            
            —Changes
      in operating assets and liabilitiesIncrease
      in accrued interest
            
            
            (3,518
            )
            
            
            —Increase
      in prepaid insurance
            
            
            (681
            )
            
            
            —Decrease
      (increase) in deferred offering costs
            
            
            973
            
            
            
            (978
            )Increase
      in other assets
            
            
            (682
            )
            
            
            —Increase
      in accrued interest payable
            
            
            598
            
            
            
            —Increase
      in due to affiliate
            
            
            756
            
            
            
            1,000Increase
      in accounts payable and accrued expenses
            
            
            320
            
            
            
            —Net
      cash provided by operating activities
            
            
            11,478
            
            
            
            —Cash
      Flows from Investing ActivitiesPurchase
      of mortgage-backed securities
            
            
            (961,356
            )
            
            
            —Investment
      in PPIP
            
            
            (4,359
            )
            
            
            —Principal
      payments of mortgage-backed securities
            
            
            71,961
            
            
            
            —Proceeds
      from sale of mortgage-backed securities
            
            
            100,573
            
            
            
            —Net
      cash used in investing activities
            
            
            (793,181
            )
            
            
            —Cash
      Flows from Financing ActivitiesProceeds
      from issuance of common stock
            
            
            171,613
            
            
            
            1Restricted
      cash
            
            
            (14,432
            )
            
            
            —Proceeds
      from private placement of OP units
            
            
            28,500
            
            
            
            —Proceeds
      from repurchase agreements
            
            
            2,766,266
            
            
            
            —Principal
      repayments of repurchase agreements
            
            
            (2,220,291
            )
            
            
            —Proceeds
      from TALF financing
            
            
            80,407
            
            
            
            —Principal
      payments of TALF financing
            
            
            (30
            )
            
            
            —Payments
      of dividends and distributions
            
            
            (6,290
            )
            
            
            —Net
      cash provided by financing activities
            
            
            805,743
            
            
            
            1Net
      increase in cash
            
            
            24,040
            
            
            
            1Cash,
      Beginning of Period
            
            
            1
            
            
            
            —Cash,
      End of Period
            
            
            24,041
            
            
            
            1Supplement
      disclosure of cash flow informationInterest
      paid
            
            
            4,030
            
            
            
            —Non-cash
      investing and financing activities informationNet
      change in unrealized gain on available-for-sale securities and
      derivatives
            
            
            8,959
            
            
            
            —Net
      change in investment in PPIP
            
            
            302
            
            
            
            —Dividends
      and distributions declared not paid
            
            
            10,828
            
            
            
            —





The
accompanying notes are an integral part of these consolidated financial
statements.


75







INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS











Note 1 - Organization and Business
Operations





Invesco
Mortgage Capital Inc. (“Company”) is a Maryland corporation focused on investing
in, financing and managing residential and commercial mortgage-backed securities
and mortgage loans. The Company invests in residential mortgage-backed
securities (“RMBS”) for which a U.S. Government agency such as the
Government National Mortgage Association (“Ginnie Mae”), the Federal National
Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage
Corporation (“Freddie Mac”) guarantees payments of principal and interest on the
securities (collectively “Agency RMBS”). The Company’s Agency RMBS investments
include mortgage pass-through securities and collateralized mortgage obligations
(“CMOs”). The Company also invests in residential mortgage-backed securities
that are not issued or guaranteed by a U.S. government agency (“Non-Agency
RMBS”), commercial mortgage-backed securities (“CMBS”), and residential and
commercial mortgage loans. The Company is externally managed and advised by
Invesco Advisers, Inc. (the “Manager”), a registered investment adviser and an
indirect, wholly-owned subsidiary of Invesco Ltd. (“Invesco”), a global
investment management company.





The
Company conducts its business through IAS Operating Partnership LP (the
“Operating Partnership”) and as its sole general partner. As of December 31,
2009, the Company owned 86.2% of the Operating Partnership and Invesco
Investments (Bermuda) Ltd. owned the remaining 13.8%.





The
Company finances its Agency RMBS, and may in the future finance its Non-Agency
RMBS investments, primarily through short-term borrowings structured as
repurchase agreements. The Manager has secured commitments for the Company with
a number of repurchase agreement counterparties. In addition, the Company
finances its CMBS portfolio with financings under the Term Asset-Backed
Securities Lending Facility (“TALF”). The Company may finance its investments in
certain Non-Agency RMBS, CMBS and residential and commercial mortgage loans by
contributing capital to a partnership that invests in public-private investment
funds (“PPIF”) managed by the Company’s Manager. In addition, the Company may
use other sources of financing including investments in PPIFs, committed
borrowing facilities and other private financing.





The
Company intends to elect and qualify to be taxed as a real estate investment
trust (“REIT”) for U.S. federal income tax purposes under the provisions of
the Internal Revenue Code of 1986, as amended (“Code”), commencing with the
Company’s taxable year ended December 31, 2009. To maintain the Company’s
REIT qualification, the Company is generally required to distribute at least 90%
of its net income (excluding net capital gains) to its shareholders
annually.








Note 2 - Summary of Significant
Accounting Policies


Principles
of Consolidation


The
consolidated financial statements include the accounts of the Company and its
subsidiaries. All intercompany balances and transactions have been
eliminated.


Development
Stage Company


Through
June 30, 2009, the Company complied with the reporting requirements for
development stage enterprises. The Company incurred organizational, accounting
and offering costs in connection with the Company’s initial public offering (the
“IPO”) of its common stock. The offering and other organization costs of the
IPO, which were advanced by the Manager, were paid out of the proceeds of the
IPO on July 1, 2009, at which time the Company ceased reporting as a development
stage company.





76


Use of
Estimates





The
accounting and reporting policies of the Company conform to Accounting
Principals Generally Accepted in the United States of America (“US GAAP”). The
preparation of consolidated financial statements in conformity with US GAAP
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes.
Examples of estimates include, but are not limited to, estimates of the fair
values of financial instruments and interest income on mortgage-backed
securities (“MBS”). Actual results may differ from those
estimates.





Cash
and Cash Equivalents





The
Company considers all highly liquid investments that have original or remaining
maturity dates of three months or less when purchased to be cash equivalents. At
December 31, 2009, the Company had cash and cash equivalents, including amounts
restricted, in excess of the Federal Deposit Insurance Corporation deposit
insurance limit of $250,000 per institution. The Company mitigates its risk by
placing cash and cash equivalents with major financial
institutions.





Deferred
Offering Costs





The
Company records costs associated with stock offerings as a reduction in
additional paid in capital.  Deferred offering costs consist of legal
and other costs of approximately $1.0 million and $0.3 million incurred through
December 31, 2008 and 2009 that are related to the IPO and a follow-on equity
offering, respectively. Costs related to the IPO of approximately $13.9 million
incurred through December 31, 2009, were charged to capital upon the completion
of the IPO on July 1, 2009. The costs incurred in connection with the follow-on
offering of $0.3 million are currently being deferred, but will be charged to
capital upon the closing of the follow-on offering.





Underwriting
Commissions and Costs





Underwriting
commissions and direct costs incurred in connection with the Company’s IPO are
reflected as a reduction of additional paid-in-capital.


Repurchase
Agreements





The
Company finances its Agency RMBS and Non-Agency RMBS investment portfolio
through the use of repurchase agreements. Repurchase agreements are treated as
collateralized financing transactions and are carried at their contractual
amounts, including accrued interest, as specified in the respective
agreements.





In
instances where the Company acquires Agency RMBS or Non-Agency RMBS through
repurchase agreements with the same counterparty from whom the Agency RMBS or
Non-Agency RMBS were purchased, the Company accounts for the purchase commitment
and repurchase agreement on a net basis and records a forward commitment to
purchase Agency RMBS or Non-Agency RMBS as a derivative instrument the
transaction does not comply with the criteria for gross presentation. All of the
following criteria must be met for gross presentation in the circumstance where
the repurchased assets are financed with the same
counterparty:





·
              the
      initial transfer of and repurchase financing cannot be contractually
      contingent;


·
              the
      repurchase financing entered into between the parties provides full
      recourse to the transferee and the repurchase price is
    fixed;


·
              the
      financial asset has an active market and the transfer is executed at
      market rates; and
 ·
              the
      repurchase agreement and financial asset do not mature
      simultaneously.





77


For
assets representing available-for-sale investment securities, which are the case
with respect to the Company’s portfolio of investments, any change in fair value
is reported through consolidated other comprehensive income (loss) with the
exception of impairment losses, which are recorded in the consolidated statement
of operations.





If the
transaction complies with the criteria for gross presentation, the Company
records the assets and the related financing on a gross basis on its balance
sheet, and the corresponding interest income and interest expense in its
statements of operations. Such forward commitments are recorded at fair value
with subsequent changes in fair value recognized in income. Additionally, the
Company records the cash portion of its investment in Agency RMBS and Non-Agency
RMBS as a mortgage related receivable from the counterparty on its balance
sheet.


Fair
Value Measurements





The
Company discloses the fair value of its financial instruments according to a
fair value hierarchy (levels 1, 2, and 3, as defined). In accordance with US
GAAP, the Company is required to provide enhanced disclosures regarding
instruments in the level 3 category (which require significant management
judgment), including a separate reconciliation of the beginning and ending
balances for each major category of assets and liabilities.





Additionally,
US GAAP permits entities to choose to measure many financial instruments and
certain other items at fair value (the “fair value option”). Unrealized gains
and losses on items for which the fair value option has been elected are
irrevocably recognized in earnings at each subsequent reporting
date.





During
2009, the Company elected the fair value option for its investments in
unconsolidated limited partnerships. The Company has the one-time option to
elect fair value for these financial assets on the election date. The changes in
the fair value of these instruments are recorded in equity in earnings and fair
value change in unconsolidated limited partnerships in the consolidated
statements of operations.





Securities





The
Company designates securities as held-to-maturity, available-for-sale, or
trading depending on its ability and intent to hold such securities to maturity.
Trading and securities, available-for-sale, are reported at fair value, while
securities held-to-maturity are reported at amortized cost. Although the Company
generally intends to hold most of its RMBS and CMBS until maturity, the Company
may, from time to time, sell any of its RMBS or CMBS as part of its overall
management of its investment portfolio and as such will classify its RMBS and
CMBS as available-for-sale securities.





All
securities classified as available-for-sale are reported at fair value, based on
market prices from third-party sources, with unrealized gains and losses
excluded from earnings and reported as a separate component of shareholders’
equity.





The
Company evaluates securities for other-than-temporary impairment at least on a
quarterly basis, and more frequently when economic or market conditions warrant
such evaluation. The determination of whether a security is
other-than-temporarily impaired involves judgments and assumptions based on
subjective and objective factors. Consideration is given to (i) the length
of time and the extent to which the fair value has been less than cost,
(ii) the financial condition and near-term prospects of recovery in fair
value of the security and (iii) the Company’s intent and ability to retain
its investment in the security for a period of time sufficient to allow for any
anticipated recovery in fair value. For debt securities, the amount of the
other-than-temporary impairment related to a credit loss or impairments on
securities that the Company has the intent or for which it is more likely than
not that the Company will need to sell before recovery are recognized in
earnings and reflected as a reduction in the cost basis of the security. The
amount of the other-than-temporary impairment on debt securities related to
other factors is recorded consistent with changes in the fair value of all other
available-for-sale securities as a component of consolidated shareholders’
equity in other comprehensive income with no change to the cost basis of the
security.





78
 
 
 
 Interest Income
Recognition





Interest
income on available-for-sale MBS, which includes accretion of discounts and
amortization of premiums on such MBS, is recognized over the life of the
investment using the effective interest method. Management estimates, at the
time of purchase, the future expected cash flows and determines the effective
interest rate based on these estimated cash flows and the Company’s purchase
price. These estimated cash flows are updated and a revised yield is computed
based on the current amortized cost of the investment. In estimating these cash
flows, there are a number of assumptions subject to uncertainties and
contingencies, including the rate and timing of principal payments (prepayments,
repurchases, defaults and liquidations), the pass through or coupon rate and
interest rate fluctuations. In addition, interest payment shortfalls due to
delinquencies on the underlying mortgage loans have to be judgmentally
estimated. These uncertainties and contingencies are difficult to predict and
are subject to future events that may impact management’s estimates and its
interest income. Security transactions are recorded on the trade date. Realized
gains and losses from security transactions are determined based upon the
specific identification method and recorded as gain (loss) on sale of
available-for-sale securities in the consolidated statement of
operations.





Investments
in Unconsolidated Limited Partnerships





The
Company has investments in unconsolidated limited partnerships. In circumstances
where the Company has a non-controlling interest but are deemed to be able to
exert influence over the affairs of the enterprise the Company utilizes the
equity method of accounting. Under the equity method of accounting, the initial
investment is increased each period for additional capital contributions and a
proportionate share of the entity’s earnings and decreased for cash
distributions and a proportionate share of the entity’s losses.





The
Company elected the fair value option for investments in unconsolidated limited
partnerships. The election for investments in unconsolidated limited
partnerships was made upon their initial recognition in the financial
statements. The Company has elected the fair value option for the investments in
unconsolidated limited partnerships for the purpose of enhancing the
transparency of its financial condition.





The
Company measures the fair value of the investments in unconsolidated limited
partnerships on the basis of the net asset value per share of the investments as
permitted in guidance effective for the interim and annual periods ending after
December 15, 2009.





Dividends
and distributions payable


Dividends and distributions payable
represent dividends declared at the balance sheet date which are payable to
common shareholders and distributions declared at the balance sheet date which
are payable to non-controlling interest common unit holders of the Operating
Partnership, respectively.
 
 Earnings
per Share





The
Company calculates basic earnings per share by dividing net income for the
period by weighted-average shares of the Company’s common stock outstanding for
that period. Diluted income per share takes into account the effect of dilutive
instruments, such as units of limited partnership interest in the Operating
Partnership (“OP Units”), stock options and unvested restricted stock, but uses
the average share price for the period in determining the number of incremental
shares that are to be added to the weighted-average number of shares
outstanding. For the period from June 5, 2008 (date of inception) to December
31, 2008, earnings per share is not presented because it is not a meaningful
measure of the Company’s performance.


Comprehensive
Income





Comprehensive
income is comprised of net income, as presented in the consolidated statements
of operations, adjusted for changes in unrealized gains or losses on available
for sale securities and changes in the fair value of derivatives accounted for
as cash flow hedges.





79


Accounting
for Derivative Financial Instruments





US GAAP
provides disclosure requirements for derivatives and hedging activities with the
intent to provide users of financial statements with an enhanced understanding
of: (i) how and why an entity uses derivative instruments; (ii) how derivative
instruments and related hedged items are accounted for; and (iii) how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance, and cash flows. US GAAP requires qualitative disclosures
about objectives and strategies for using derivatives, quantitative disclosures
about the fair value of and gains and losses on derivative instruments, and
disclosures about credit-risk-related contingent features in derivative
instruments.





The
Company records all derivatives on the balance sheet at fair value. The
accounting for changes in the fair value of derivatives depends on the intended
use of the derivative, whether the Company has elected to designate a derivative
in a hedging relationship and apply hedge accounting and whether the hedging
relationship has satisfied the criteria necessary to apply hedge accounting.
Derivatives designated and qualifying as a hedge of the exposure to changes in
the fair value of an asset, liability, or firm commitment attributable to a
particular risk, such as interest rate risk, are considered fair value hedges.
Derivatives designated and qualifying as a hedge of the exposure to variability
in expected future cash flows, or other types of forecasted transactions, are
considered cash flow hedges. Derivatives may also be designated as hedges of the
foreign currency exposure of a net investment in a foreign operation. Hedge
accounting generally provides for the matching of the timing of gain or loss
recognition on the hedging instrument with the recognition of the changes in the
fair value of the hedged asset or liability that are attributable to the hedged
risk in a fair value hedge or the earnings effect of the hedged forecasted
transactions in a cash flow hedge. The Company may enter into derivative
contracts that are intended to economically hedge certain of its risk, even
though hedge accounting does not apply or the Company elects not to apply hedge
accounting.


Income
Taxes





The
Company intends to elect and qualify to be taxed as a REIT, commencing with the
Company’s taxable year ended December 31, 2009. Accordingly, the Company
will generally not be subject to U.S. federal and applicable state and
local corporate income tax to the extent that the Company makes qualifying
distributions to its shareholders and provided the Company satisfies, on a
continuing basis through actual investment and operating results, the REIT
requirements including certain asset, income, distribution and stock ownership
tests. If the Company fails to qualify as a REIT, and does not qualify for
certain statutory relief provisions, it will be subject to U.S. federal, state
and local income taxes and may be precluded from qualifying as a REIT for the
subsequent four taxable years following the year in which the Company lost its
REIT qualification. Accordingly, the Company’s failure to qualify as a REIT
could have a material adverse impact on its results of operations and amounts
available for distribution to its shareholders.





A REIT’s
dividend paid deduction for qualifying dividends to the Company’s shareholders
is computed using its taxable income as opposed to net income reported on the
consolidated financial statements. Taxable income, generally, will differ from
net income reported on the consolidated financial statements because the
determination of taxable income is based on tax regulations and not financial
accounting principles.





The
Company may elect to treat certain of its future subsidiaries as taxable REIT
subsidiaries (“TRSs”). In general, a TRS may hold assets and engage in
activities that the Company cannot hold or engage in directly and generally may
engage in any real estate or non-real estate-related business. A TRS is subject
to U.S. federal, state and local corporate income taxes.





While a
TRS will generate net income, a TRS can declare dividends to the Company which
will be included in its taxable income and necessitate a distribution to its
shareholders. Conversely, if the Company retains earnings at a TRS level, no
distribution is required and the Company can increase book equity of the
consolidated entity. The Company has no adjustments regarding its tax accounting
treatment of any uncertainties. The Company expects to recognize interest and
penalties related to uncertain tax positions, if any, as income tax expense,
which will be included in general and administrative expense.








80


Share-Based
Compensation





Share-based
compensation arrangements include share options, restricted share plans,
performance-based awards, share appreciation rights, and employee share purchase
plans. Compensation cost relating to share-based payment transactions are
recognized in the consolidated financial statements, based on the fair value of
the equity or liability instruments issued on the date of
grant.





On July 1, 2009, the Company adopted an
equity incentive plan under which its independent directors, as part of their
compensation for serving as directors, are eligible to receive quarterly
restricted stock awards. In addition, the Company may compensate its officers
under this plan pursuant to the management agreement.





Recent
Accounting Pronouncements





In
January 2009, the FASB issued an accounting pronouncement which amends
previously issued impairment guidance to achieve more consistent determination
of whether an other-than-temporary impairment has occurred. The pronouncement
also retains and emphasizes the objective of an other-than-temporary impairment
assessment and the related disclosure requirements in other related guidance.
The pronouncement is effective and should be applied prospectively for financial
statements issued for fiscal years and interim periods ending after December 15,
2008. The Company's adoption of the pronouncement did not have a material effect
on the Company’s consolidated financial statements.





In April
2009, the FASB issued an accounting pronouncement which is intended to provide
greater clarity to investors about the credit and noncredit component of an
other-than-temporary event and to more effectively communicate when an
other-than-temporary event has occurred. The pronouncement applies to debt
securities and requires that the total other-than-temporary impairment be
presented in the statement of income with an offset for the amount of impairment
that is recognized in other comprehensive income, which is the noncredit
component. Noncredit component losses are to be recorded in other comprehensive
income if an investor can assess that (a) it does not have the intent to sell or
(b) it is not more likely than not that it will have to sell the security prior
to its anticipated recovery. The pronouncement is effective for interim and
annual periods ending after June 15, 2009. The pronouncement will be applied
prospectively with a cumulative effect transition adjustment as of the beginning
of the period in which it is adopted. The Company's adoption of the
pronouncement did not have a material effect on the Company’s consolidated
financial statements.





In April
2009, the FASB issued an accounting pronouncement which provides additional
guidance on determining whether a market for a financial asset is not active and
a transaction is not distressed for fair value measurements. The pronouncement
will be applied prospectively and retrospective application is not permitted.
The pronouncement is effective for interim and annual periods ending after June
15, 2009. The Company's adoption of the pronouncement did not have a material
effect on the Company’s consolidated financial statements.





In April
2009, the FASB issued an accounting pronouncement which will require an entity
to provide disclosures about the fair value of financial instruments in interim
financial information. The pronouncement would apply to certain financial
instruments and will require entities to disclose the method(s) and significant
assumptions used to estimate the fair value of financial instruments, in both
interim financial statements as well as annual financial statements. The
pronouncement is effective for interim and annual periods ending after June 15,
2009. The Company's adoption of the pronouncement did not have a material effect
on the Company’s consolidated financial statements





In March
2008, the FASB issued an accounting pronouncement which requires enhanced
disclosures for derivative instruments, including those used in hedging
activities. It is effective for fiscal years and interim periods beginning after
November 15, 2008 and became applicable to the Company beginning in the
first quarter of 2009. The Company's adoption of the pronouncement did not have
a material effect on the Company’s consolidated financial statements, but did
require additional disclosures in Note 6, “Derivatives and Hedging
Activities.”








81




In May
2009, the FASB issued an accounting pronouncement which establishes general
standards of accounting for, and requires disclosure of, events that occur after
the balance sheet date but before financial statements are issued or are
available to be issued. The Company adopted the pronouncement for the quarter
ended June 30, 2009. The Company's adoption of the pronouncement did not have a
material effect on its financial condition, results of operations, or cash
flows. In February 2010, the SEC rescinded the disclosure requirement for public
companies. In June 2009, the FASB issued an accounting pronouncement which
requires additional information regarding transfers of financial assets,
including securitization transactions, and where companies have continuing
exposure to the risks related to transferred financial assets. The pronouncement
eliminates the concept of a "qualifying special-purpose entity," changes the
requirements for derecognizing financial assets, and requires additional
disclosures. The pronouncement is effective for fiscal years beginning after
November 15, 2009. The Company will adopt the pronouncement in fiscal 2010
and is evaluating the impact it will have on the results of operations and
financial position of the Company.




In June
2009, the FASB amended the guidance for determining whether an entity is a
variable interest entity. The amendments include: (i) the elimination of the
exemption for qualifying special purpose entities; (ii) a new approach for
determining who should consolidate a variable-interest entity; and (iii) changes
to when it is necessary to reassess who should consolidate a variable-interest
entity. The guidance is effective for the first annual reporting period
beginning after November 15, 2009 and for interim periods within that first
annual reporting period. The Company will adopt the pronouncement in fiscal 2010
and is evaluating the impact it will have on the results of operations and
financial position of the Company.





In June
2009, the FASB issued an accounting pronouncement which approved the Accounting
Standards Codification (the “Codification”) as the single source of
authoritative accounting principles recognized by the FASB to be applied by
nongovernmental entities in the preparation of financial statements in
conformity with US GAAP. The Codification does not change current US GAAP, but
is intended to simplify user access to all authoritative U.S. US GAAP by
providing all the authoritative literature related to a particular topic in one
place. All existing accounting standard documents are superseded and all other
accounting literature not included in the Codification is considered
nonauthoritative. The pronouncement is effective for interim and annual periods
ending after September 15, 2009. The Company began to use the Codification
when referring to US GAAP in the Company’s Quarterly Report on Form 10-Q for the
interim period ended September 30, 2009. The adoption of these provisions did
not have a material effect on the Company’s consolidated financial
statements.





In
September 2009, the FASB issued guidance on Fair Value Measurements and
Disclosures. Overall, for the fair value measurement of investments in certain
entities that calculates net asset value per share (or its equivalent). The
amendments in this update permit, as a practical expedient, a reporting entity
to measure the fair value of an investment that is within the scope of the
amendments in this update on the basis of the net asset value per share of the
investment (or its equivalent) if the net asset value of the investment (or its
equivalent) is calculated in a manner consistent with the measurement principles
as of the reporting entity’s measurement date, including measurement of all or
substantially all of the underlying investments of the. The amendments in this
update also require disclosures by major category of investment about the
attributes of investments within the scope of the amendments in this update,
such as the nature of any restrictions on the investor’s ability to redeem its
investments at the measurement date, any unfunded commitments (for example, a
contractual commitment by the investor to invest a specified amount of
additional capital at a future date to fund investments that will be made by the
investee), and the investment strategies of the investees. The major category of
investment is required to be determined on the basis of the nature and risks of
the investment in a manner consistent with the guidance for major security types
in US GAAP on investments in debt and equity securities. The disclosures are
required for all investments within the scope of the amendments in this update
regardless of whether the fair value of the investment is measured using the
practical expedient. The amendments in this update apply to all reporting
entities that hold an investment that is required or permitted to be measured or
disclosed at fair value on a recurring or non recurring basis and, as of the
reporting entity’s measurement date, if the investment meets certain criteria
The amendments in this update are effective for the interim and annual periods
ending after December 15, 2009.





82


Recent
Accounting Pronouncement Not Yet Adopted





In
January 2010, the FASB updated guidance on, Improving Disclosures about Fair
Value Measurements. The guidance required a number of additional disclosures
regarding fair value measurements. Specifically, entities should disclose: (1)
the amount of significant transfers between Level 1 and Level 2 of the fair
value hierarchy and the reasons for these transfers; (2) the reasons for any
transfers in or out of Level 3; and (3) information in the reconciliation of
recurring Level 3 measurements about purchases, sales, issuances and settlements
on a gross basis. Except for the requirement to disclose information about
purchases, sales, issuances, and settlements in the reconciliation of recurring
Level 3 measurements on a gross basis, all the amendments are effective for
interim and annual reporting periods beginning after December 15, 2009. As such,
for the company, the new disclosures will be required in the Form 10-Q for the
quarter ended March 31, 2010.





Note 3 -
Mortgage-Backed Securities







All of
the Company’s MBS are classified as available-for-sale and, as such, are
reported at fair value determined by obtaining valuations from an independent
source. If the fair value of a security is not available from a dealer or
third-party pricing service or such data appears unreliable, the Company may
estimate the fair value of the security using a variety of methods including
other pricing services, repurchase agreement pricing, discounted cash flow
analysis, matrix pricing, option adjusted spread models and other fundamental
analysis of observable market factors. At December 31, 2009, all of the
Company’s MBS values were based on third-party values. The following table
presents certain information related to the Company’s investment portfolio at
December 31, 2009.


$
      in thousands
            
            Principal
      Balance
            
            
            Unamortized
      Premium (Discount)
            
            
            Amortized
      Cost
            
            
            Unrealized
                Gain/
                (Loss)
            
            
            Fair
                Value
            
            
            Net
      Weighted Average Coupon (1)
            
            
            Average
      Yield (2)Agency
      RMBS:15
      year fixed-rate
            
            
            251,752
            
            
            
            9,041
            
            
            
            260,793
            
            
            
            1,023
            
            
            
            261,816
            
            
            
            4.82
            %
            
            
            3.80
            %30
      year fixed-rate
            
            
            149,911
            
            
            
            10,164
            
            
            
            160,075
            
            
            
            990
            
            
            
            161,065
            
            
            
            6.45
            %
            
            
            5.02
            %ARM
            
            
            10,034
            
            
            
            223
            
            
            
            10,257
            
            
            
            (281
            )
            
            
            9,976
            
            
            
            2.52
            %
            
            
            1.99
            %Hybrid
      ARM
            
            
            117,163
            
            
            
            5,767
            
            
            
            122,930
            
            
            
            597
            
            
            
            123,527
            
            
            
            5.14
            %
            
            
            3.55
            %Total
      Agency
            
            
            528,860
            
            
            
            25,195
            
            
            
            554,055
            
            
            
            2,329
            
            
            
            556,384
            
            
            
            5.31
            %
            
            
            4.07
            %MBS
      – CMO
            
            
            27,819
            
            
            
            978
            
            
            
            28,797
            
            
            
            936
            
            
            
            29,733
            
            
            
            6.34
            %
            
            
            4.83
            %Non-Agency
      MBS
            
            
            186,682
            
            
            
            (79,341
            )
            
            
            107,341
            
            
            
            7,992
            
            
            
            115,333
            
            
            
            4.11
            %
            
            
            17.10
            %CMBS
            
            
            104,512
            
            
            
            (4,854
            )
            
            
            99,658
            
            
            
            1,484
            
            
            
            101,142
            
            
            
            4.93
            %
            
            
            5.97
            %Total
            
            
            847,873
            
            
            
            (58,022
            )
            
            
            789,851
            
            
            
            12,741
            
            
            
            802,592
            
            
            
            5.03
            %
            
            
            6.10
            %


_____________________


(1)  Net
weighted average coupon (“WAC”) is presented net of servicing and other
fees.


(2)  Average
yield incorporates future prepayment and loss assumptions.





The
components of the carrying value of the Company’s investment portfolio at
December 31, 2009 are presented below.





$ in
      thousandsPrincipal
      balance
            
            
            847,873Unamortized
      premium
            
            
            26,174Unamortized
      discount
            
            
            (84,196
            )Gross
      unrealized gains
            
            
            14,595Gross
      unrealized losses
            
            
            (1,854
            )Carrying
      value/estimated fair value
            
            
            802,592





83




The
following table summarizes the Company’s investment portfolio, at fair value,
according to estimated weighted average life classifications as of December 31,
2009:




$ in
      thousandsLess
      than one year
            
            
            —Greater
      than one year and less than five years
            
            
            483,540Greater
      than or equal to five years
            
            
            319,052Total
            
            
            802,592





The
Company assesses its investment securities for other-than-temporary impairment
on at least a quarterly basis. When the fair value of an investment is less
than its amortized cost at the balance sheet date of the reporting period for
which impairment is assessed, the impairment is designated as either “temporary”
or “other-than-temporary.” In deciding on whether or not a security is
other-than-temporarily impaired, the Company considers several factors,
including the nature of the investment, the severity and duration of the
impairment, the cause of the impairment, and the Company’s intent that it is
more likely than not that the Company can hold the security until recovery of
its cost basis. At December 31, 2009, the Company considered none of its
investment securities to be other-than-temporarily impaired. Twelve securities
that have unrealized losses have been in an unrealized loss position for less
than twelve months.





Note
4 – Investments in Unconsolidated Limited Partnerships – Related
Party





Invesco
Mortgage Recovery Feeder Fund, L.P. and Invesco Mortgage Recovery Loans AIV,
L.P.





The Company invested in certain
Non-Agency RMBS, CMBS and residential and commercial mortgage loans by
contributing equity capital to a legacy securities PPIF managed by the Manager,
Invesco Mortgage Recovery Feeder Fund, L.P. (the “Fund”). In addition the
Manager identified a whole loan transaction, which resulted in the Company being
admitted into an alternative investment vehicle, the Invesco Mortgage Recovery
Loans AIV, L.P. (an “AIV”). The Company’s overall commitment in the Fund and AIV
is $25.0 million, of which $4.1 million has been called as of December 31, 2009.
The Fund and AIV limited partnership agreements provide for additional
subscriptions of limited partners within six months of the initial closing. As
of December 31, 2009, the Fund and AIV have accepted additional subscriptions,
which effectively dilute the Company’s initial ownership interest in the Fund
and AIV. In connection, with the dilution of the Company’s interest in the Fund
and AIV the Company is entitled to receive approximately $1.0 million as a
return of capital, which is subject to future capital calls. The Company
realized approximately $63,000 of equity in earnings and $8,000 of unrealized
appreciation from these investments for the year ended December 31,
2009.





The
non-controlling, unconsolidated ownership interests in these entities are
accounted for under the equity method. Capital contributions, distributions, and
profit and losses of the entity are allocated in accordance with the terms of
the partnership agreement. Such allocations may differ from the stated
percentage interests, if any, as a result of preferred returns and allocation
formulas as described in such agreements. The Company has made the fair value
election for both investments in unconsolidated limited partnerships. The fair
value measurement for the investment in unconsolidated limited partnerships is
based on the net asset value per share of the investment, or its
equivalent.





Note
5 – Borrowings





Repurchase
Agreements





The
Company has entered into repurchase agreements to finance a portion of its
portfolio of investments. The repurchase agreements bear interest at a
contractually agreed rate. The repurchase obligations mature and reinvest every
thirty to ninety days and have a weighted average aggregate interest rate of
0.26% at December 31, 2009. These repurchase agreements are being accounted for
as secured borrowings since the Company maintains effective control of the
financed assets.





84


Under the
repurchase agreements, the respective lender retains the right to mark the
underlying collateral to fair value. A reduction in the value of pledged assets
would require the Company to provide additional collateral or fund margin
calls.





The
following table summarizes certain characteristics of the Company’s repurchase
agreements at December 31, 2009:





$
      in thousands
              Purchase
      Agreement Counterparties
            
            Amount
      Outstanding
            
            
            Percent
      of Total Amount Outstanding
            
            
            Company
      MBS Held as CollateralCredit
      Suisse
            
            
            109,697
            
            
            
            20
            %
            
            
            110,501Barclay's
      Bank
            
            
            62,279
            
            
            
            12
            %
            
            
            64,228RBS
      Securities
            
            
            83,093
            
            
            
            15
            %
            
            
            86,503Deutsche
      Bank
            
            
            115,764
            
            
            
            21
            %
            
            
            113,804Goldman
      Sachs
            
            
            175,142
            
            
            
            32
            %
            
            
            182,731Total
            
            
            545,975
            
            
            
            100
            %
            
            
            557,767





TALF
Financing





Under the
TALF, the Federal Reserve makes non-recourse loans to borrowers to fund
purchases of asset-backed securities. The Company has secured borrowings of
$80.4 million under the TALF at a weighted average interest rate of 3.82% at
December 31, 2009. The TALF loans are non-recourse, however they are secured by
$101.1 million of CMBS, and mature in July, August and December
2014.





At
December 31, 2009, the TALF financing agreements had the following remaining
maturities:





$
      in thousands2010
            
            
            —2011
            
            
            —2012
            
            
            —2013
            
            
            —2014
            
            
            80,377Thereafter
            
            
            —Total
            
            
            80,377





Note
6 - Derivatives and Hedging Activities





Risk
Management Objective of Using Derivatives





The Company is exposed to certain risks
arising from both its business operations and economic conditions. The Company
principally manages its exposures to a wide variety of business and operational
risks through management of its core business activities. The Company manages
economic risks, including interest rate, liquidity, and credit risk primarily by
managing the amount, sources, and duration of its investments, debt funding, and
the use of derivative financial instruments. Specifically, the Company enters
into derivative financial instruments to manage exposures that arise from
business activities that result in the receipt or payment of future known and
uncertain cash amounts, the value of which are determined by interest rates. The
Company’s derivative financial instruments are used to manage differences in the
amount, timing, and duration of the Company’s known or expected cash receipts
and its known or expected cash payments principally related to the Company’s
investments and borrowings.





Cash
Flow Hedges of Interest Rate Risk





The
Company finances its activities primarily through repurchase agreements, which
are generally settled on a short-term basis, usually from one to three months.
At each settlement date, the Company refinances each repurchase agreement at the
market interest rate at that time. Since the interest rate on its repurchase
agreements change on a one to three month basis, the Company is exposed to
changing interest rates. The Company’s objectives in using interest rate
derivatives are to add stability to interest expense and to manage its exposure
to interest rate movements. To accomplish this objective, the Company primarily
uses interest rate swaps as part of its interest rate risk management strategy.
Interest rate swaps designated as cash flow hedges involve the receipt of
variable-rate amounts from a counterparty in exchange for the Company making
fixed-rate payments over the life of the agreements without exchange of the
underlying notional amount.








85


The
effective portion of changes in the fair value of derivatives designated and
qualifying as cash flow hedges is recorded in accumulated other comprehensive
income and is subsequently reclassified into earnings in the period that the
hedged forecasted transaction affects earnings. The ineffective portion of the
change in fair value of the derivatives is recognized directly in earnings. For
the year ended December 31, 2009, the Company recorded no unrealized swap gain /
losses in earnings as hedge ineffectiveness.





Amounts
reported in accumulated other comprehensive income related to derivatives will
be reclassified to interest expense as interest is accrued and paid on the
Company’s repurchase agreements. During the next twelve months, the Company
estimates that an additional $7.2 million will be reclassified as an increase to
interest expense.




The
Company is hedging its exposure to the variability in future cash flows for
forecasted transactions over a maximum period of 62 months.




As of
December 31, 2009, the Company had the following outstanding interest rate
derivatives that were designated as cash flow hedges of interest rate
risk:





Counterparty
            
            Notional Amount
              $in
    thousands
            
            Maturity
      Date
            
            Fixed
      Interest Rate in ContractThe
      Bank of New York Mellon
            
            175,000
            
            08/05/2012
            
            2.07%SunTrust
      Bank
            
            100,000
            
            07/15/2014
            
            2.79%Credit
      Suisse International
            
            100,000
            
            02/24/2015
            
            3.26%Total/Weighted
      Average
            
            375,000
            
            
            
            2.58%







At
December 31, 2009, the Company’s counterparties hold approximately $14.4 million
of cash margin deposits and approximately $6.4 million in agency RMBS as
collateral against its swap contracts.  The cash is classified as
restricted cash and the agency RMBS is included in the total mortgage-backed
securities on our consolidated balance sheet.




The table
below presents the fair value of the Company’s derivative financial instruments,
as well as their classification on the balance sheet as of December 31, 2009 and
December 31, 2008.





$
in thousands


Asset
      Derivatives
            Liability
      DerivativesAs of December 31,
      2009
            As of December
      31, 2008
            As of December 31,
      2009
            
            As of December 31,
      2008BalanceSheet
            Fair Value
            BalanceSheet
            Fair Value
            BalanceSheet
            Fair Value
            
            BalanceSheet
            Fair ValueInterest rate
      swap asset
            —
            Interest
      rate swap asset
            —
            Interest
      rate swap liability
            3,782
            
            Interest
      rate swap liability
            —





86


Tabular
Disclosure of the Effect of Derivative Instruments on the Income
Statement




The table
below presents the effect of the Company’s derivative financial instruments on
the statement of operations for the year ended December 31, 2009.





$
in thousands


Derivative
              type
      for
              cash
      flow
              Hedge
            
            Amount of loss recognized
              in
      OCI on derivative
              (effective
      portion)
            
            Location of loss
              reclassified from
              accumulated
              OCI
      into
              income
              (effective
              portion)
            
            Amount of loss
              reclassified from
              accumulated OCI into
              income
      (effective
              portion)
            
            Location of loss
              recognized
      in
              income
      on
              derivative
              (ineffective
              portion)
            
            Amount of loss
              recognized in income
              on
      derivative
              (ineffective
      portion)Interest
      Rate Swap
            
            
            6,420
            
            Interest Expense
            
            
            2,638
            
            Other
      Expense
            
            
            —





Credit-risk-related
Contingent Features





The
Company has agreements with each of its derivative counterparties. Some of those
agreements contain a provision where if the Company defaults on any of its
indebtedness, including default where repayment of the indebtedness
has not been accelerated by the lender, then the company could also be
declared in default on its derivative obligations.





The
Company has an agreement with one of its derivative counterparties that contains
a provision where if the Company’s net asset value declines by certain
percentages over specified time periods, then the Company could be declared in
default on its derivative obligations. The Company also has an agreement with
one of its derivative counterparties that contains a provision where if the
Company’s shareholders’ equity declines by certain percentages over specified
time periods, then the Company could be declared in default on its derivative
obligations.





The
Company has an agreement with one of its derivative counterparties that contain
a provision where if the Company fails to maintain a minimum shareholders’
equity or market value of $100 million, then the Company could be declared in
default on its derivative obligations.





As of
December 31, 2009, the fair value of derivatives in a net liability position,
which includes accrued interest but excludes any adjustment for nonperformance
risk, related to these agreements was $3.8 million. The Company has minimum
collateral posting thresholds with certain of its derivative counterparties and
has posted collateral of approximately $14.4 million. If the Company had
breached any of these provisions at December 31, 2009, it could have been
required to settle its obligations under the agreements at their termination
value.





Note
7 - Financial Instruments





US GAAP
defines fair value, provides a consistent framework for measuring fair value
under US GAAP and ASC 820 expands fair value financial statement disclosure
requirements. ASC 820 does not require any new fair value measurements and only
applies to accounting pronouncements that already require or permit fair value
measures, except for standards that relate to share-based payments.





Valuation
techniques are based on observable and unobservable inputs. Observable inputs
reflect readily obtainable data from independent sources, while unobservable
inputs reflect the Company’s market assumptions. These inputs into the following
hierarchy:




·  Level 1 Inputs – Quoted
prices for identical instruments in active markets.




87


·  Level 2 Inputs – Quoted
prices for similar instruments in active markets; quoted prices for identical or
similar instruments in markets that are not active; and model-derived valuations
whose inputs are observable or whose significant value drivers are
observable.




·  Level 3 Inputs – Instruments
with primarily unobservable value drivers.





The fair
values, on a recurring basis, of the Company’s MBS, investments in
unconsolidated limited partnerships and interest rate hedges based on the level
of inputs are summarized below:





December
      31, 2009Fair
      Value Measurements Using$
      in thousands
            
            Level 1
            
            
            Level
      2
            
            
            Level 3
            
            
            Total
      at Fair ValueAssetsMortgage-backed
      securities
            
            
            —
            
            
            
            802,592
            
            
            
            —
            
            
            
            802,592Investments
      in unconsolidated limited partnerships
            
            
            —
            
            
            
            —
            
            
            
            4,128
            
            
            
            4,128Total
            
            
            —
            
            
            
            802,592
            
            
            
            4,128
            
            
            
            806,720LiabilitiesDerivatives
            
            
            —
            
            
            
            3,782
            
            
            
            —
            
            
            
            3,782Total
            
            
            —
            
            
            
            3,782
            
            
            
            —
            
            
            
            3,782





The fair
value of the TALF debt and repurchase agreements are based on an expected
present value technique. This method discounts future estimated cash flows using
rates the Company determined best reflect current market interest rates that
would be offered for loans with similar characteristics and credit quality. At
December 31, 2009 the TALF debt had a fair value of $80.0 million and a carrying
value of $80.4 million and the repurchase agreements had a fair value of $546.1
million and a carrying value of $546.0 million.





Changes
in assets measured at fair value using Level 3 inputs for the year ended
December 31, 2009 include unrealized gains of $71,000.





Note 8 - Related Party
Transactions





The
Company is externally managed and advised by the Manager. Pursuant to the terms
of the management agreement, effective July 1, 2009, the Manager provides the
Company with its management team, including its officers, along with appropriate
support personnel. Each of the Company’s officers is an employee of Invesco or
one of Invesco’s affiliates. The Company does not have any employees. With the
exception of the Company’s Chief Financial Officer, the Manager is not obligated
to dedicate any of its employees exclusively to the Company, nor is the Manager
or its employees obligated to dedicate any specific portion of its or their time
to the Company’s business. The Manager is at all times subject to the
supervision and oversight of the Company’s board of directors and has only such
functions and authority as the Company delegates to it.





Management
Fee





The Company pays the Manager a
management fee equal to 1.50% of the Company’s shareholders’ equity per annum,
which is calculated and payable quarterly in arrears. For purposes of
calculating the management fee, shareholders’ equity is equal to the sum of the
net proceeds from all issuances of equity securities since inception (allocated
on a pro rata daily basis for such issuances during the fiscal quarter of any
such issuance), plus retained earnings at the end of the most recently completed
calendar quarter (without taking into account any non-cash equity compensation
expense incurred in current or prior periods), less any amount paid to
repurchase common stock since inception, and excluding any unrealized gains,
losses or other items that do not affect realized net income (regardless of
whether such items are included in other comprehensive income or loss, or in net
income). This amount will be adjusted to exclude one-time events pursuant to
changes in US GAAP, and certain non-cash items after discussions between the
Manager and the Company’s independent directors and approval by a majority of
the Company’s independent directors.






88


Shareholders’ equity, for purposes of
calculating the management fee, could be greater or less than the amount of
shareholders’ equity shown on the Company’s consolidated financial statements.
The Company treats outstanding limited partner interests (not held by the
Company) as outstanding shares of capital stock for purposes of calculating the
management fee.





The Manager has agreed to reduce the
management fee payable in respect of any equity investment the Company may
decide to make in any legacy securities or legacy loan PPIF if managed by the
Manager or any of its affiliates. However, the Manager’s management fee will not
be reduced in respect of any equity investment the Company may decide to make in
a legacy securities or legacy loan PPIF managed by an entity other than the
Manager or any of its affiliates. Because the Company pays the Manager a
management fee pursuant to the management agreement, the Company does not pay
any management or investment fees with respect to the investment in the Invesco
PPIP Fund managed by the Manager. The Manager waives all such fees.





For the year ended December 31, 2009,
the Company incurred management fees of approximately $1.5 million of which
approximately $756,000 was accrued but had not been paid.





Expense
Reimbursement





Pursuant to the management agreement,
the Company is required to reimburse the Manager for operating expenses related
to the Company incurred by the Manager, including certain salary expenses and
other expenses related to legal, accounting, due diligence and other services.
The Company’s reimbursement obligation is not subject to any dollar
limitation.





The Company incurred costs, originally
paid by Invesco, of approximately $1.1 million and $1.0 million for the years
ended December 31, 2009 and 2008, respectively. Included in these costs $92,000
was capitalized as deferred offering costs for the year ended December 31, 2009.
In addition, approximately $366,000 and $22,000 were expensed for the year ended
December 31, 2009 and 2008, respectively and approximately $660,000 was charged
against equity as a cost of raising capital for the year ended December 31,
2009. As of December 31, 2009, the Company owed the Manager approximately
$109,000 for these expenses.





Termination
Fee





A termination fee is due to the Manager
upon termination of the management agreement by the Company equal to three times
the sum of the average annual management fee earned by the Manager during the
24-month period prior to such termination, calculated as of the end of the most
recently completed fiscal quarter.





Note
9 – Shareholders’ Equity (Deficit)





Securities Convertible into Shares of
Common Stock





As of the
completion of the Company’s IPO on July 1, 2009, (i) the limited partners
who hold OP Units of the Operating Partnership have the right to cause the
Operating Partnership to redeem their OP Units for cash equal to the market
value of an equivalent number of shares of common stock, or at the Company’s
sole discretion, it may purchase their OP Units by issuing one share of common
stock for each OP Unit redeemed, and (ii) the Company adopted an equity
incentive plan which includes the ability of the Company to grant securities
convertible to the Company’s common stock to the executive officers, independent
directors and personnel of the Manager.






89
  Registration
Rights





The
Company entered into a registration rights agreement with regard to the common
stock and OP Units owned by the Manager and Invesco Investments (Bermuda) Ltd.,
respectively, upon completion of the Company’s IPO and any shares of common
stock that the Manager may elect to receive under the management agreement or
otherwise. Pursuant to the registration rights agreement, the Company has
granted to the Manager and Invesco Investments (Bermuda) Ltd.,
(i) unlimited demand registration rights to have the shares purchased by
the Manager or granted to it in the future and the shares that the Company may
issue upon redemption of the OP Units purchased by Invesco Investments (Bermuda)
Ltd. registered for resale, and (ii) in certain circumstances, the right to
“piggy-back” these shares in registration statements the Company might file in
connection with any future public offering so long as the Company retains the
Manager under the management agreement. The registration rights of the Manager
and Invesco Investments (Bermuda) Ltd., with respect to the common stock and OP
Units that they purchased simultaneously with the Company’s IPO, will only begin
to apply on and after June 25, 2010.





Public
Offerings and Private Placement





On June
25, 2009, the Company entered into (i) a binding underwriting agreement with a
group of underwriters to sell 8,500,000 shares of the Company’s common stock for
$20.00 per share for an aggregate offering price of $170 million, and (ii) a
share purchase agreement with the Manager to purchase 75,000 shares of the
Company’s common stock at $20.00 per share or for an aggregate offering price of
$1.5 million. Concurrently, Invesco Investments (Bermuda) Ltd. entered into a
securities purchase agreement with the Operating Partnership to purchase
1,425,000 OP Units at $20.00 per unit for an aggregate offering price of $28.5
million.





On July
1, 2009, the Company completed its IPO pursuant to which it sold 8,500,000
shares of common stock to the public at a price of $20.00 per share, for net
proceeds of $164.8 million. Concurrent with the IPO, the Company completed a
private offering in which it sold 75,000 shares of common stock to the Manager
at a price of $20.00 per share and the Operating Partnership sold 1,425,000
units of limited partnership interest to Invesco Investments (Bermuda) Ltd., a
wholly-owned subsidiary of Invesco, at a price of $20.00 per unit. The net
proceeds to the Company from this private offering was $30.0 million. The
Company did not pay any underwriting discounts or commissions in connection with
the private offering.





On
July 27, 2009, the underwriters in the Company’s IPO exercised their
over-allotment option to purchase an additional 311,200 shares of common
stock at a price of $20.00 per share, for net proceeds of $6.1 million.
Collectively, the Company received net proceeds from the IPO and the concurrent
private offering of approximately $200.9 million.





Share-Based
Compensation





The
Company established the 2009 Equity Incentive Plan for grants of restricted
common stock and other equity based awards to the directors, officers and
employees of the Manager (the “Incentive Plan”). Under the Incentive Plan, a
total of 1,000,000 shares are reserved for issuance. Unless terminated earlier,
the Incentive Plan will terminate in 2019, but will continue to govern the
unexpired awards. The Company recognized compensation expense of approximately
$38,000 for the year ended December 31, 2009. The Company issued 912 shares of
restricted stock pursuant to this plan to the Company’s non-executive directors.
The fair market value of the shares granted was determined by the closing stock
market price on the date of grant.





Dividends





On
October 13, 2009, the Company declared a dividend of $0.61 per share of common
stock. The dividend was paid on November 12, 2009 to shareholders of record as
of the close of business on October 23, 2009.
  90


On
December 17, 2009, the Company declared a dividend of $1.05 per share of common
stock. The dividend was paid on January 27, 2010 to shareholders of record as of
the close of business on December 31, 2009.





Note
10 – Earnings per Share





Earnings
per share for the year ended December 31, 2009 is computed as
follows:




$
      in thousandsNumerator
      (Income)Basic
      EarningsNet
      income available to common shareholders
            
            
            15,094Effect
      of dilutive securities:Income
      allocated to non-controlling interest
            
            
            2,417Dilutive
      net income available to shareholders
            
            
            17,511Denominator
      (Weighted Average Shares)Basic
      Earnings:Shares
      available to common shareholders
            
            
            4,480Effect
      of dilutive securities:OP
      Units
            
            
            718Dilutive
      Shares
            
            
            5,198





Note
11 – Non-controlling Interest - Operating Partnership





Non-controlling
interest represents the aggregate OP Units in the Operating Partnership held by
limited partners (the “Unit Holders”). Income allocated to the non-controlling
interest is based on the Unit Holders ownership percentage of the Operating
Partnership. The ownership percentage is determined by dividing the numbers of
OP Units held by the Unit Holders by the total number of dilutive shares. The
issuance of additional shares of beneficial interest (the “Common Shares” or
“Share”) or OP Units changes the percentage ownership of both the Unit Holders
and the Company. Since a unit is generally redeemable for cash or Shares at the
option of the Company, it is deemed to be equivalent to a Share. Therefore, such
transactions are treated as capital transactions and result in an allocation
between shareholders’ equity and non-controlling interest in the accompanying
consolidated balance sheet to account for the change in the ownership of the
underlying equity in the Operating Partnership. As of December 31, 2009,
non-controlling interest related to the aggregate limited partnership units of
1,425,000, represented a 13.8% interest in the Operating Partnership. Income
allocated to the Operating Partnership non-controlling interest for the year
ended December 31, 2009 was approximately $2.4 million. Distributions paid and
payable to the non-controlling interest was approximately $0.9 million and $1.5
million, respectively.





91


Note 12
- Summarized Quarterly (Unaudited)





The
following is a presentation of the quarterly results of operations for the year
ended December 31, 2009 (summarized quarterly results for 2008 are not
meaningful and are therefore omitted).





$
      in thousands, except per share data
              Quarter
      Ended 2009
            
            December
      31
            
            
            September
      30
            
            
            June
      30
            
            March
      31RevenuesInterest
      income
            
            
            12,546
            
            
            
            10,983
            
            
            
            —
            
            
            
            —Interest
      expense
            
            
            2,557
            
            
            
            2,070
            
            
            
            —
            
            
            
            —Net
      interest income
            
            
            9,989
            
            
            
            8,913
            
            
            
            —
            
            
            
            —Other
      income (loss)Gain
      on sale of investments
            
            
            2,002
            
            
            
            —
            
            
            
            —
            
            
            
            —Other
      Income (expense)
            
            
            84
            
            
            
            (13
            )
            
            
            —
            
            
            
            —Total
      other income (loss)
            
            
            2,086
            
            
            
            (13
            )
            
            
            —
            
            
            
            —Expenses
            
            
            1,605
            
            
            
            1,727
            
            
            
            84
            
            
            
            48Net
      income (loss)
            
            
            10,470
            
            
            
            7,173
            
            
            
            (84
            )
            
            
            (48
            )Net
      income attributable to non-controlling interest
            
            
            1,447
            
            
            
            970
            
            
            
            —
            
            
            
            —Net
      income (loss) attributable to common shareholders
            
            
            9,023
            
            
            
            6,203
            
            
            
            (84
            )
            
            
            (48
            )Earnings
      per share:Net
      income attributable to common shareholders (basic/diluted)
            
            
            1.02
            
            
            
            0.70
            
            
            NM
            
            
            NM


NM = not
meaningful





Note 13 - Subsequent
Events


Dividends


On
December 17, 2009, the Company declared a dividend of $1.05 per share of common
stock for the fourth quarter 2009. The dividend was paid on January 27, 2010 to
shareholders of record as of the close of business on December 31,
2009.


Follow-on
Public Offering


On
January 15, 2010, the Company completed a public offering of 7,000,000 shares of
common stock and an issuance of additional 1,050,000 shares of common stock
pursuant to the underwriters’ full exercise of their over-allotment option at
$21.25 per share. Net proceeds to the Company were $162.7 million, net of
issuance costs of approximately $8.4 million.


Share-Based Compensation


The
Company issued 834 shares of restricted stock pursuant to the Incentive Plan to
the Company’s non-executive directors on February 19, 2010. The fair market
value of the shares granted was determined by the closing stock market price on
the date of grant.


92





SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.





Invesco
      Mortgage Capital Inc.By:
            /s/  Richard
      J. KingRichard
      J. KingPresident
      and Chief Executive OfficerDate:
            March
      24, 2010





Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.





Signatures
            Title
            DateBy:
            /s/  Richard J.
      King
              Richard
      J. King
            President
      and Chief Executive Officer (principal executive officer)
            March
      24, 2010By:
            /s/  Donald
      R. Ramon
              Donald
      R. Ramon
            Chief
      Financial Officer
              (principal
      financial and accounting officer)
            March
      24, 2010By:
            /s/  G.
      Mark Armour
              G.
      Mark Armour
            Director
            March
      24, 2010By:
            /s/  Karen
      Dunn Kelley
              Karen
      Dunn Kelley
            Director
            March
      24, 2010By:
            /s/  James
      S. Balloun
              James
      S. Balloun
            Director
            March
      24, 2010By:
            /s/  John
      S. Day
              John
      S. Day
            Director
            March
      24, 2010By:
            /s/  Neil
      Williams
              Neil
      Williams
            Director
            March
      24, 2010






































93