7. FAIR VALUE MEASUREMENTS

The Company follows fair value guidance in accordance with GAAP to account for its financial instruments. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

GAAP requires classification of financial instruments into a three-level hierarchy based on the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Financial assets and liabilities recorded at fair value on the Consolidated Statements of Financial Condition or disclosed in the related notes are categorized based on the inputs to the valuation techniques as follows:

Level 1– inputs to the valuation methodology are quoted prices (unadjusted) for identical assets and liabilities in active markets.

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 – inputs to the valuation methodology are unobservable and significant to overall fair value.

The Company designates its financial instruments as available for sale or trading depending upon the type of instrument and the Company’s intent and ability to hold such instrument to maturity. Instruments classified as available for sale and trading are reported at fair value on a recurring basis.

The following is a description of the valuation methodologies used for instruments carried at fair value. These methodologies are applied to assets and liabilities across the three level fair value hierarchy, with the observability of inputs determining the appropriate level.

U.S. Treasury securities and investment in affiliates are valued using quoted prices for identical instruments in active markets. Agency mortgage-backed securities, Agency debentures, interest rate swaps, swaptions and other derivatives are valued using quoted prices or internally estimated prices for similar assets using internal models. The Company incorporates common market pricing methods, including a spread measurement to the Treasury curve as well as underlying characteristics of the particular security including coupon, prepayment speeds, periodic and life caps, rate reset period and expected life of the security in its estimates of fair value. Management reviews the fair values generated by the internal models to determine whether prices are reflective of the current market. Management indirectly corroborates its estimates of the fair value derived using internal models by comparing its results to independent prices provided by dealers in the securities and/or third party pricing services. Certain liquid asset classes, such as Agency fixed-rate pass-throughs, may be priced using independent sources such as quoted prices for TBA securities.

The Agency mortgage-backed securities, interest rate swap and swaption markets are considered to be active markets such that participants transact with sufficient frequency and volume to provide transparent pricing information on an ongoing basis. The liquidity of the Agency mortgage-backed securities, interest rate swaps and swaptions markets and the similarity of the Company’s securities to those actively traded enable the Company to observe quoted prices in the market and utilize those prices as a basis for formulating fair value measurements. Consequently, the Company has classified Agency mortgage-backed securities, interest rate swaps, swaptions, TBA derivatives and MBS options as Level 2 inputs in the fair value hierarchy.

The following table presents the estimated fair values of financial instruments measured at fair value on a recurring basis.

	Level 1		Level 2		Level 3		Total
December 31, 2014	(dollars in thousands)
Assets:
U.S. Treasury securities	$	-	$	-	$	-	$	-
Agency mortgage-backed securities		-		81,565,256		-		81,565,256
Agency debentures		-		1,368,350		-		1,368,350
Investment in affiliates		143,045		-		-		143,045
Interest rate swaps		-		75,225		-		75,225
Other derivatives		117		5,382		-		5,499
Total Assets	$	143,162	$	83,014,213	$	-	$	83,157,375
Liabilities:
U.S. Treasury securities sold, not yet purchased	$	-	$	-	$	-	$	-
Interest rate swaps		-		1,608,286		-		1,608,286
Other derivatives		3,769		4,258		-		8,027
Total Liabilities	$	3,769	$	1,612,544	$	-	$	1,616,313

	Level 1		Level 2		Level 3		Total
At December 31, 2013	(dollars in thousands)
Assets:
U.S. Treasury securities	$	1,117,915	$	-	$	-	$	1,117,915
Agency mortgage-backed securities		-		70,388,949		-		70,388,949
Agency debentures		-		2,969,885		-		2,969,885
Investment in affiliates		139,447		-		-		139,447
Interest rate swaps		-		559,044		-		559,044
Other derivatives		3,487		143,238		-		146,725
Total Assets	$	1,260,849	$	74,061,116	$	-	$	75,321,965
Liabilities:
U.S. Treasury securities sold, not yet purchased	$	1,918,394	$	-	$	-	$	1,918,394
Interest rate swaps		-		1,141,828		-		1,141,828
Other derivatives		439		55,079		-		55,518
Total Liabilities	$	1,918,833	$	1,196,907	$	-	$	3,115,740

GAAP requires disclosure of fair value information about financial instruments, whether or not recognized in the financial statements, for which it is practical to estimate the value. In cases where quoted market prices are not available, fair values are based upon discounted cash flows using market yields or other valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, fair values are not necessarily indicative of the amount the Company would realize on disposition of the financial instruments. The use of different market assumptions or estimation methodologies could have a material effect on the estimated fair value amounts.

The carrying value of short term instruments, including cash and cash equivalents, reverse repurchase agreements and repurchase agreements whose term is less than twelve months, and securities borrowed and securities loaned, generally approximates fair value due to the short term nature of the instruments.

The estimated fair value of commercial real estate debt and preferred equity investments takes into consideration changes in credit spreads and interest rates from the date of origination or purchase to the reporting date. The fair value also reflects consideration of asset-specific maturity dates and other items that could have an impact on the fair value as of the reporting date.

Estimates of fair value of corporate debt require the use of judgments and inputs including, but not limited to, the enterprise value of the borrower (i.e., an estimate of the total fair value of the borrower's debt and equity), the nature and realizable value of any collateral, the borrower’s ability to make payments when due and its earnings history. Management also considers factors that affect the macro and local economic markets in which the borrower operates.

The fair value of repurchase agreements with remaining maturities greater than one year or with embedded optionality are valued as structured notes, with term to maturity, LIBOR rates and the Treasury curve being primary determinants of estimated fair value.

The fair value of mortgages payable is calculated using the estimated yield of a new par loan to value the remaining terms in place. A par loan is created using the identical terms of the existing loan; however, the coupon is derived by using the original spread against the interpolated Treasury. The fair value of mortgages payable also reflects consideration of the value of the underlying collateral and changes in credit risk from the time the debt was originated.

The carrying value of participation sold is based on the loan’s amortized cost. The fair value of participation sold is based on the fair value of the underlying related commercial loan.

The fair value of convertible senior notes is determined using end of day quoted prices in active markets.

The fair value of securitized debt of consolidated VIE is determined using the average of external vendor pricing services.

The following table summarizes the estimated fair value for financial assets and liabilities as of December 31, 2014 and 2013.

		December 31, 2014				December 31, 2013
	Level in Fair Value Hierarchy	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets:		(dollars in thousands)
Cash and cash equivalents	1	$	1,741,244	$	1,741,244	$	552,436	$	552,436
Reverse repurchase agreements	1		100,000		100,000		100,000		100,000
Securities borrowed	1		-		-		2,582,893		2,582,893
U.S. Treasury securities	1		-		-		1,117,915		1,117,915
Agency mortgage-backed securities	2		81,565,256		81,565,256		70,388,949		70,388,949
Agency debentures	2		1,368,350		1,368,350		2,969,885		2,969,885
Investment in affiliates	1		143,045		143,045		139,447		139,447
Commercial real estate debt and preferred equity	3		1,518,165		1,528,444		1,583,969		1,581,836
Corporate debt	2		166,464		166,056		117,687		118,362
Interest rate swaps	2		75,225		75,225		559,044		559,044
Other derivatives	1,2		5,499		5,499		146,725		146,725

Financial liabilities:
U.S. Treasury securities sold, not yet purchased	1	$	-	$	-	$	1,918,394	$	1,918,394
Repurchase agreements	1,2		71,361,926		71,587,222		61,781,001		62,134,133
Securities loaned	1		-		-		2,527,668		2,527,668
Convertible Senior Notes	1		845,295		863,470		825,262		870,199
Securitized debt of consolidated VIE	2		260,700		262,061		-		-
Mortgages payable	2		146,553		146,611		19,332		19,240
Participation sold	3		13,693		13,655		14,065		14,050
Interest rate swaps	2		1,608,286		1,608,286		1,141,828		1,141,828
Other derivatives	1,2		8,027		8,027		55,518		55,518