MBS

6 Months Ended

Jun. 30, 2014

Investments, Debt and Equity Securities [Abstract]

MBS

MBS

The Company’s MBS are comprised of Agency MBS and Non-Agency MBS.  These MBS are secured by:  (i) hybrid mortgages (“Hybrids”), which have interest rates that are fixed for a specified period of time and, thereafter, generally adjust annually to an increment over a specified interest rate index; (ii) adjustable-rate mortgages (“ARMs”); (iii) mortgages that have interest rates that reset more frequently (collectively, “ARM-MBS”); and (iv) 15 year and longer-term fixed rate mortgages.  MBS do not have a single maturity date, and further, the mortgage loans underlying ARM-MBS do not all reset at the same time.

The Company pledges a significant portion of its MBS as collateral against its borrowings under repurchase agreements and Swaps.  Non-Agency MBS that are accounted for as components of Linked Transactions are not reflected in the tables set forth in this note, as they are accounted for as derivatives.  (See Notes 5 and 7)

Agency MBS:  Agency MBS are guaranteed as to principal and/or interest by a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae.  The payment of principal and/or interest on Ginnie Mae MBS is explicitly backed by the full faith and credit of the U.S. Government.  Since the third quarter of 2008, Fannie Mae and Freddie Mac have been under the conservatorship of the Federal Housing Finance Agency, which significantly strengthened the backing for these government-sponsored entities.

Non-Agency MBS (including Non-Agency MBS transferred to consolidated VIEs):  The Company’s Non-Agency MBS are secured by pools of residential mortgages, which are not guaranteed by an agency of the U.S. Government or any federally chartered corporation.  Credit risk associated with Non-Agency MBS is regularly assessed as new information regarding the underlying collateral becomes available and based on updated estimates of cash flows generated by the underlying collateral.

The following tables present certain information about the Company’s MBS at June 30, 2014 and December 31, 2013:

June 30, 2014

	Principal/ Current Face		Purchase Premiums		Accretable Purchase Discounts			Discount Designated as Credit Reserve and OTTI (1)			Amortized Cost (2)		Fair Value		Gross Unrealized Gains		Gross Unrealized Losses			Net Unrealized Gain/(Loss)
(In Thousands)
Agency MBS:
Fannie Mae	$	5,128,686	$	195,467	$	(74	)	$	—		$	5,324,079	$	5,403,241	$	106,337	$	(27,175	)	$	79,162
Freddie Mac	1,094,460		42,075		—			—			1,137,853		1,133,670		11,652		(15,835		)	(4,183		)
Ginnie Mae	12,001		206		—			—			12,207		12,540		333		—			333
Total Agency MBS	6,235,147		237,748		(74		)	—			6,474,139		6,549,451		118,322		(43,010		)	75,312
Non-Agency MBS:
Expected to Recover Par (3)	313,136		524		(29,593		)	—			284,067		310,586		27,653		(1,134		)	26,519
Expected to Recover    Less Than Par (3)(4)	5,280,238		—		(406,518		)	(986,842		)	3,886,878		4,690,751		804,953		(1,080		)	803,873
Total Non-Agency MBS	5,593,374		524		(436,111		)	(986,842		)	4,170,945		5,001,337		832,606		(2,214		)	830,392
Total MBS	$	11,828,521	$	238,272	$	(436,185	)	$	(986,842	)	$	10,645,084	$	11,550,788	$	950,928	$	(45,224	)	$	905,704

December 31, 2013

	Principal/ Current Face		Purchase Premiums		Accretable Purchase Discounts			Discount Designated as Credit Reserve and OTTI (1)			Amortized Cost (2)		Fair Value		Gross Unrealized Gains		Gross Unrealized Losses			Net Unrealized Gain/(Loss)
(In Thousands)
Agency MBS:
Fannie Mae	$	5,092,410	$	181,710	$	(87	)	$	—		$	5,274,033	$	5,315,363	$	96,516	$	(55,186	)	$	41,330
Freddie Mac	1,171,841		44,967		—			—			1,217,927		1,190,670		9,842		(37,099		)	(27,257		)
Ginnie Mae	12,668		218		—			—			12,886		13,188		302		—			302
Total Agency MBS	6,276,919		226,895		(87		)	—			6,504,846		6,519,221		106,660		(92,285		)	14,375
Non-Agency MBS:
Expected to Recover Par (3)	234,187		638		(24,450		)	—			210,375		230,738		21,720		(1,357		)	20,363
Expected to Recover    Less Than Par (3)(4)	5,381,851		—		(435,589		)	(1,043,037		)	3,903,225		4,621,399		720,566		(2,392		)	718,174
Total Non-Agency MBS	5,616,038		638		(460,039		)	(1,043,037		)	4,113,600		4,852,137		742,286		(3,749		)	738,537
Total MBS	$	11,892,957	$	227,533	$	(460,126	)	$	(1,043,037	)	$	10,618,446	$	11,371,358	$	848,946	$	(96,034	)	$	752,912

(1) Discount designated as Credit Reserve and amounts related to OTTI are generally not expected to be accreted into interest income.  Amounts disclosed at June 30, 2014 reflect Credit Reserve of $942.7 million and OTTI of $44.1 million.  Amounts disclosed at December 31, 2013 reflect Credit Reserve of $998.5 million and OTTI of $44.5 million.

(2) Includes principal payments receivable of $1.3 million and $1.1 million at June 30, 2014 and December 31, 2013, respectively, which are not included in the Principal/Current Face.

(3) Based on management’s current estimates of future principal cash flows expected to be received.

(4) At June 30, 2014 and December 31, 2013, the Company expected to recover approximately 82% and 81%, respectively, of the then-current face amount of Non-Agency MBS.

Unrealized Losses on MBS and Impairments

The following table presents information about the Company’s MBS that were in an unrealized loss position at June 30, 2014:

Unrealized Loss Position For:

	Less than 12 Months					12 Months or more					Total
	Fair Value		Unrealized Losses		Number of Securities	Fair Value		Unrealized Losses		Number of Securities	Fair Value		Unrealized Losses
(In Thousands)
Agency MBS:
Fannie Mae	$	407,252	$	2,013	35	$	1,383,328	$	25,162	147	$	1,790,580	$	27,175
Freddie Mac	9,980		34		2	733,159		15,801		103	743,139		15,835
Total Agency MBS	417,232		2,047		37	2,116,487		40,963		250	2,533,719		43,010
Non-Agency MBS:
Expected to Recover Par (1)	1,357		10		1	23,335		1,124		8	24,692		1,134
Expected to Recover Less Than Par (1)	17,668		118		3	29,241		962		8	46,909		1,080
Total Non-Agency MBS	19,025		128		4	52,576		2,086		16	71,601		2,214
Total MBS	$	436,257	$	2,175	41	$	2,169,063	$	43,049	266	$	2,605,320	$	45,224

(1) Based on management’s current estimates of future principal cash flows expected to be received.

At June 30, 2014, the Company did not intend to sell any of its MBS that were in an unrealized loss position, and it is “more likely than not” that the Company will not be required to sell these MBS before recovery of their amortized cost basis, which may be at their maturity.  With respect to Non-Agency MBS held by consolidated VIEs, the ability of any entity to cause the sale by the VIE prior to the maturity of these Non-Agency MBS is either specifically precluded, or is limited to specified events of default, none of which has occurred to date.

Gross unrealized losses on the Company’s Agency MBS were $43.0 million at June 30, 2014.  Agency MBS are issued by Government Sponsored Entities (“GSEs”) that enjoy either the implicit or explicit backing of the full faith and credit of the U.S. Government. While the Company’s Agency MBS are not rated by any rating agency, they are currently perceived by market participants to be of high credit quality, with risk of default limited to the unlikely event that the U.S. Government would not continue to support the GSEs. In addition, the GSEs are currently profitable on a stand-alone basis with such profits being remitted to the U.S. Treasury. Given the credit quality inherent in Agency MBS, the Company does not consider any of the current impairments on its Agency MBS to be credit related. In assessing whether it is more likely than not that it will be required to sell any impaired security before its anticipated recovery, which may be at its maturity, the Company considers for each impaired security, the significance of each investment, the amount of impairment, the projected future performance of such impaired securities, as well as the Company’s current and anticipated leverage capacity and liquidity position. Based on these analyses, the Company determined that at June 30, 2014 any unrealized losses on its Agency MBS were temporary.

Unrealized losses on the Company’s Non-Agency MBS (including Non-Agency MBS transferred to consolidated VIEs) were $2.2 million at June 30, 2014.  Based upon the most recent evaluation, the Company does not consider these unrealized losses to be indicative of OTTI and does not believe that these unrealized losses are credit related, but are rather due to non-credit related factors.  The Company has reviewed its Non-Agency MBS that are in an unrealized loss position to identify those securities with losses that are other-than-temporary based on an assessment of changes in expected cash flows for such MBS, which considers recent bond performance and expected future performance of the underlying collateral.

The Company did not recognize any credit-related OTTI losses through earnings related to its MBS during the three and six months ended June 30, 2014 and 2013.

Non-Agency MBS on which OTTI is recognized have experienced, or are expected to experience, credit-related adverse cash flow changes.  The Company’s estimate of cash flows for its Non-Agency MBS is based on its review of the underlying mortgage loans securing these MBS.  The Company considers information available about the structure of the securitization, including structural credit enhancement, if any, and the past and expected future performance of underlying mortgage loans, including timing of expected future cash flows, prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, FICO scores at loan origination, year of origination, loan-to-value ratios, geographic concentrations, as well as Rating Agency reports, general market assessments, and dialogue with market participants.  Changes in the Company’s evaluation of each of these factors impacts the cash flows expected to be collected at the OTTI assessment date. For Non-Agency MBS purchased at a discount to par that were assessed for OTTI during the quarter, such cash flow estimates indicated that the amount of expected losses decreased compared to the previous OTTI assessment date. These positive cash flow changes are primarily driven by recent improvements in loan-to-value ratios due to loan amortization and home price appreciation, which, in turn, positively impacts the Company’s estimates of default rates and loss severities for the underlying collateral. In addition, voluntary prepayments (i.e. loans that prepay in full with no loss) have generally trended higher for these MBS which also positively impacts the Company’s estimate of expected loss. Overall, the combination of higher voluntary prepayments and lower loan-to-value ratios supports the Company’s assessment that such MBS are not other-than-temporarily impaired. Significant judgment is used in both the Company’s analysis of the expected cash flows for its Non-Agency MBS and any determination of the credit component of OTTI.

The following table presents a roll-forward of the credit loss component of OTTI on the Company’s Non-Agency MBS for which a non-credit component of OTTI was previously recognized in OCI.  Changes in the credit loss component of OTTI are presented based upon whether the current period is the first time OTTI was recorded on a security or a subsequent OTTI charge was recorded.

	Three Months Ended   June 30, 2014		Six Months Ended   June 30, 2014
(In Thousands)
Credit loss component of OTTI at beginning of period	$	36,115	$	36,115
Additions for credit related OTTI not previously recognized	—		—
Subsequent additional credit related OTTI recorded	—		—
Credit loss component of OTTI at end of period	$	36,115	$	36,115

Purchase Discounts on Non-Agency MBS

The following tables present the changes in the components of the Company’s purchase discount on its Non-Agency MBS between purchase discount designated as Credit Reserve and OTTI and accretable purchase discount for the three and six months ended June 30, 2014 and 2013:

	Three Months Ended   June 30, 2014						Three Months Ended   June 30, 2013
	Discount Designated as Credit Reserve and OTTI (1)			Accretable Discount (1)(2)			Discount Designated as Credit Reserve and OTTI (1)			Accretable Discount (1)(2)
(In Thousands)
Balance at beginning of period	$	(1,041,933	)	$	(442,156	)	$	(1,312,952	)	$	(381,913	)
Accretion of discount	—			25,766			—			16,698
Realized credit losses	23,359			—			38,375			—
Purchases	(3,018		)	1,636			(49,852		)	18,425
Sales	10,269			3,124			4,689			4,978
Transfers/release of credit reserve	24,481			(24,481		)	54,769			(54,769		)
Balance at end of period	$	(986,842	)	$	(436,111	)	$	(1,264,971	)	$	(396,581	)

	Six Months Ended   June 30, 2014						Six Months Ended   June 30, 2013
	Discount Designated as Credit Reserve and OTTI (3)			Accretable Discount (2)(3)			Discount Designated as Credit Reserve and OTTI (3)			Accretable Discount (2)(3)
(In Thousands)
Balance at beginning of period	$	(1,043,037	)	$	(460,039	)	$	(1,380,506	)	$	(371,626	)
Accretion of discount	—			53,197			—			28,749
Realized credit losses	48,396			—			88,682			—
Purchases	(66,335		)	25,042			(73,387		)	29,654
Sales	13,756			6,067			10,972			5,910
Transfers/release of credit reserve	60,378			(60,378		)	89,268			(89,268		)
Balance at end of period	$	(986,842	)	$	(436,111	)	$	(1,264,971	)	$	(396,581	)

(1) The Company did not reallocate any purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions during the three months ended June 30, 2014. The Company reallocated $116,000 of purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions during the three months ended June 30, 2013.

(2) Together with coupon interest, accretable purchase discount is recognized as interest income over the life of the security.

(3) In addition, the Company reallocated $115,000 and $129,000 of purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions during the six months ended June 30, 2014 and 2013, respectively.

Impact of MBS on AOCI

The following table presents the impact of the Company’s MBS on its AOCI for the three and six months ended June 30, 2014 and 2013:

	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2014			2013			2014			2013
AOCI from MBS:
Unrealized gain on MBS at beginning of period	$	819,222		$	942,887		$	752,912		$	824,808
Unrealized gain/(loss) on Agency MBS, net	43,094			(140,480		)	60,937			(167,771		)
Unrealized gain/(loss) on Non-Agency MBS, net	50,136			(98,282		)	101,554			48,388
Reclassification adjustment for MBS sales included in net income	(6,748		)	(3,254		)	(9,699		)	(4,554		)
Change in AOCI from MBS	86,482			(242,016		)	152,792			$	(123,937	)
Balance at end of period	$	905,704		$	700,871		$	905,704		$	700,871

Sales of MBS

During the three and six months ended June 30, 2014, the Company sold certain Non-Agency MBS for $26.5 million and $42.0 million, realizing gross gains of $7.9 million and $11.4 million, respectively.  During the three and six months ended June 30, 2013, the Company sold certain Non-Agency MBS for $9.9 million and $16.0 million, realizing gross gains of $4.4 million and $6.0 million, respectively. The Company has no continuing involvement with any of the sold MBS.

 MBS Interest Income

The following table presents the components of interest income on the Company’s Agency MBS for the three and six months ended June 30, 2014 and 2013:

	Three Months Ended June 30,						Six Months Ended June 30,
(In Thousands)	2014			2013			2014			2013
Coupon interest	$	49,836		$	54,485		$	99,335		$	111,989
Effective yield adjustment (1)	(12,227		)	(16,448		)	(22,397		)	(31,165		)
Agency MBS interest income	$	37,609		$	38,037		$	76,938		$	80,824

(1)  Includes amortization of premium paid net of accretion of purchase discount.  For Agency MBS, interest income is recorded at an effective yield, which reflects net premium amortization based on actual prepayment activity.

The following table presents components of interest income for the Company’s Non-Agency MBS (including MBS transferred to consolidated VIEs) for the three and six months ended June 30, 2014 and 2013:

	Three Months Ended June 30,				Six Months Ended June 30,
(In Thousands)	2014		2013		2014		2013
Coupon interest	$	55,322	$	65,954	$	109,752	$	133,887
Effective yield adjustment (1)	25,694		16,644		53,083		28,626
Non-Agency MBS interest income	$	81,016	$	82,598	$	162,835	$	162,513

(1)  The effective yield adjustment is the difference between the net income calculated using the net yield, which is based on management’s estimates of future cash flows for Non-Agency MBS, less the current coupon yield.