MBS and CRT Securities

Agency and Non-Agency MBS

The Company’s MBS are comprised of Agency MBS and Non-Agency MBS which include MBS issued prior to 2008 (“Legacy Non-Agency MBS”) and MBS backed by re-performing/non-performing loans (“RPL/NPL 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.

The Company pledges a significant portion of its MBS as collateral against its borrowings under repurchase agreements, FHLB advances and Swaps. Non-Agency MBS that were accounted for as components of Linked Transactions prior to 2015 are not reflected in the tables for prior periods set forth in this note, as they were accounted for as derivatives. New accounting guidance that was effective for the Company on January 1, 2015 prospectively eliminated the use of Linked Transaction accounting. (See Notes 2(t), 6 and 9)

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.

CRT Securities

CRT securities are debt obligations issued by Fannie Mae and Freddie Mac. While the coupon payments are paid by Fannie Mae or Freddie Mac on a monthly basis, the payment of principal is dependent on the performance of loans in a reference pool of MBS securitized by Fannie Mae or Freddie Mac. As principal on loans in the reference pool are paid, principal payments on the securities are made and the principal balances of the securities are reduced. Consequently, CRT securities mirror the payment and prepayment behavior of the mortgage loans in the reference pool. As an investor in a CRT security, the Company may incur a loss if certain defined credit events occur, including if the loans in the reference pool experience delinquencies exceeding specified thresholds. The Company assesses the credit risk associated with CRT securities by assessing the current and expected future performance of the associated reference pool. CRT securities that were accounted for as components of Linked Transactions prior to 2015 are not reflected in the tables for prior periods set forth in this note, as they were accounted for as derivatives. (See Notes 2(t), 6 and 9)

The following tables present certain information about the Company’s MBS and CRT securities at September 30, 2015 and December 31, 2014:

September 30, 2015



(In Thousands)	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)
Agency MBS:
Fannie Mae	$	3,875,329	$	146,519	$	(61	)	$	—		$	4,021,787	$	4,086,523	$	79,498	$	(14,762	)	$	64,736
Freddie Mac	887,904		34,118		—			—			923,134		923,872		8,796		(8,058		)	738
Ginnie Mae	9,666		169		—			—			9,835		10,082		247		—			247
Total Agency MBS	4,772,899		180,806		(61		)	—			4,954,756		5,020,477		88,541		(22,820		)	65,721
Non-Agency MBS:
Expected to Recover Par (3)(4)	2,764,021		232		(31,691		)	—			2,732,562		2,755,036		27,326		(4,853		)	22,473
Expected to Recover Less than Par (3)	4,271,588		—		(304,016		)	(815,397		)	3,152,175		3,769,186		621,564		(4,553		)	617,011
Total Non-Agency MBS (5)	7,035,609		232		(335,707		)	(815,397		)	5,884,737		6,524,222		648,890		(9,406		)	639,484
Total MBS	11,808,508		181,038		(335,768		)	(815,397		)	10,839,493		11,544,699		737,431		(32,226		)	705,205
CRT securities (6)	156,000		—		(5,072		)	—			150,928		149,968		788		(1,748		)	(960		)
Total MBS and CRT securities	$	11,964,508	$	181,038	$	(340,840	)	$	(815,397	)	$	10,990,421	$	11,694,667	$	738,219	$	(33,974	)	$	704,245

December 31, 2014



(In Thousands)	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)
Agency MBS:
Fannie Mae	$	4,587,823	$	174,245	$	(71	)	$	—		$	4,761,997	$	4,843,084	$	102,187	$	(21,100	)	$	81,087
Freddie Mac	1,011,659		38,895		—			—			1,051,096		1,049,854		11,280		(12,522		)	(1,242		)
Ginnie Mae	10,811		189		—			—			11,000		11,269		269		—			269
Total Agency MBS	5,610,293		213,329		(71		)	—			5,824,093		5,904,207		113,736		(33,622		)	80,114
Non-Agency MBS:
Expected to Recover Par (3)(4)	431,788		461		(29,501		)	—			402,748		428,431		26,735		(1,052		)	25,683
Expected to Recover Less than Par (3)	4,888,113		—		(370,063		)	(900,557		)	3,617,493		4,327,001		712,168		(2,660		)	709,508
Total Non-Agency MBS (5)	5,319,901		461		(399,564		)	(900,557		)	4,020,241		4,755,432		738,903		(3,712		)	735,191
Total MBS	10,930,194		213,790		(399,635		)	(900,557		)	9,844,334		10,659,639		852,639		(37,334		)	815,305
CRT securities	109,500		—		(4,727		)	—			104,773		102,983		324		(2,114		)	(1,790		)
Total MBS and CRT securities	$	11,039,694	$	213,790	$	(404,362	)	$	(900,557	)	$	9,949,107	$	10,762,622	$	852,963	$	(39,448	)	$	813,515


(1)	Discount designated as Credit Reserve and amounts related to OTTI are generally not expected to be accreted into interest income. Amounts disclosed at September 30, 2015 reflect Credit Reserve of $793.7 million and OTTI of $21.7 million. Amounts disclosed at December 31, 2014 reflect Credit Reserve of $877.6 million and OTTI of $23.0 million.


(2)	Includes principal payments receivable of $1.1 million and $542,000 at September 30, 2015 and December 31, 2014, 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 September 30, 2015 RPL/NPL MBS had a $2.492 billion Principal/Current face, $2.490 billion amortized cost and $2.487 billion fair value. At December 31, 2014, RPL/NPL MBS had a $161.0 million Principal/Current face, $161.0 million amortized cost and $161.0 million fair value (excludes RPL/NPL MBS with $1.850 billion Principal/Current face, $1.847 billion amortized cost and $1.847 billion fair value that were presented as a component of Linked Transactions at December 31, 2014).


(5)	At September 30, 2015 and December 31, 2014, the Company expected to recover approximately 88% and 83%, respectively, of the then-current face amount of Non-Agency MBS.

(6)

Amounts disclosed at September 30, 2015 includes CRT securities with a fair value of $27.7 million for which the fair value option has been elected. Such securities have gross unrealized gains of approximately $515,000, gross unrealized losses of approximately $19,000 and net unrealized gains of approximately $496,000 at September 30, 2015. For the three and nine months ended September 30, 2015, such securities generated net unrealized losses of approximately $14,000 and net unrealized gains of approximately $496,000, respectively, that are included in Other Income, net in our consolidated statements of operations.

Unrealized Losses on MBS and CRT Securities

The following table presents information about the Company’s MBS and CRT securities that were in an unrealized loss position at September 30, 2015:

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
(Dollars in Thousands)	Fair Value		Unrealized Losses		Number of Securities	Fair Value		Unrealized Losses		Number of Securities	Fair Value		Unrealized Losses
Agency MBS:
Fannie Mae	$	508,889	$	2,921	63	$	852,198	$	11,841	109	$	1,361,087	$	14,762
Freddie Mac	259,638		2,369		35	332,303		5,689		64	591,941		8,058
Total Agency MBS	768,527		5,290		98	1,184,501		17,530		173	1,953,028		22,820
Non-Agency MBS:
Expected to Recover Par (1)	1,411,102		4,117		33	13,249		736		8	1,424,351		4,853
Expected to Recover Less than Par (1)	120,040		1,982		24	67,908		2,571		11	187,948		4,553
Total Non-Agency MBS	1,531,142		6,099		57	81,157		3,307		19	1,612,299		9,406
Total MBS	2,299,669		11,389		155	1,265,658		20,837		192	3,565,327		32,226
CRT securities (2)	89,253		1,285		19	4,538		463		1	93,791		1,748
Total MBS and CRT securities	$	2,388,922	$	12,674	174	$	1,270,196	$	21,300	193	$	3,659,118	$	33,974


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


(2)	Amounts disclosed at September 30, 2015 includes CRT securities with a fair value of $9.6 million for which the fair value option has been elected. Such securities have unrealized losses of $19,000 at September 30, 2015.

At September 30, 2015, the Company did not intend to sell any of its investments that were in an unrealized loss position, and it is “more likely than not” that the Company will not be required to sell these securities 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 to a third-party 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 $22.8 million at September 30, 2015. 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 September 30, 2015 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 $9.4 million at September 30, 2015. 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 a reflection of current market yields and/or market place bid-ask spreads. 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 securities, which considers recent bond performance and, where possible, expected future performance of the underlying collateral.

The Company recognized credit-related OTTI losses through earnings related to its Non-Agency MBS of $705,000 during the nine months ended September 30, 2015. The Company did not recognize any credit-related OTTI losses through earnings related to its MBS during the three months ended September 30, 2015 and three and nine months ended September 30, 2014.

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, LTVs, 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 and had no OTTI recorded this period, 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 LTVs 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 LTVs supports the Company’s assessment that such MBS are not other-than-temporarily impaired.

The following table presents the composition of OTTI charges recorded by the Company for the three and nine months ended September 30, 2015 and 2014:



	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands)	2015		2014		2015			2014
Total OTTI losses	$	—	$	—	$	(525	)	$	—
OTTI reclassified from OCI	—		—		(180		)	—
OTTI recognized in earnings	$	—	$	—	$	(705	)	$	—

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.



(In Thousands)	Three Months Ended September 30, 2015		Nine Months Ended September 30, 2015
Credit loss component of OTTI at beginning of period	$	36,820	$	36,115
Additions for credit related OTTI not previously recognized	—		461
Subsequent additional credit related OTTI recorded	—		244
Credit loss component of OTTI at end of period	$	36,820	$	36,820

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 nine months ended September 30, 2015 and 2014:



	Three Months Ended September 30, 2015						Three Months Ended September 30, 2014
(In Thousands)	Discount Designated as Credit Reserve and OTTI			Accretable Discount (1)			Discount Designated as Credit Reserve and OTTI (2)			Accretable Discount (1)(2)
Balance at beginning of period	$	(847,017	)	$	(362,946	)	$	(986,842	)	$	(436,111	)
Accretion of discount	—			22,805			—			25,504
Realized credit losses	21,527			—			20,733			—
Purchases	(455		)	113			(4,200		)	272
Sales	3,676			11,193			21,024			4,169
Transfers/release of credit reserve	6,872			(6,872		)	20,185			(20,185		)
Balance at end of period	$	(815,397	)	$	(335,707	)	$	(929,100	)	$	(426,351	)



	Nine Months Ended September 30, 2015						Nine Months Ended September 30, 2014
(In Thousands)	Discount Designated as Credit Reserve and OTTI			Accretable Discount (1)			Discount Designated as Credit Reserve and OTTI (3)			Accretable Discount (1)(3)
Balance at beginning of period	$	(900,557	)	$	(399,564	)	$	(1,043,037	)	$	(460,039	)
Cumulative effect adjustment on adoption of revised accounting standard for repurchase agreement financing	(15,543		)	1,832			—			—
Accretion of discount	—			71,700			—			78,701
Realized credit losses	62,377			—			69,129			—
Purchases	(1,200		)	(4,012		)	(70,535		)	25,314
Sales	5,573			28,995			34,780			10,236
Net impairment losses recognized in earnings	(705		)	—			—			—
Transfers/release of credit reserve	34,658			(34,658		)	80,563			(80,563		)
Balance at end of period	$	(815,397	)	$	(335,707	)	$	(929,100	)	$	(426,351	)


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


(2)	The Company reallocated $333,000 of purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions during the three months ended September 30, 2014.


(3)	The Company reallocated $218,000 of purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions during the nine months ended September 30, 2014.

Impact of AFS Securities on AOCI

The following table presents the impact of the Company’s AFS securities on its AOCI for the three and nine months ended September 30, 2015 and 2014:



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2015			2014			2015			2014
AOCI from AFS securities:
Unrealized gain on AFS securities at beginning of period	$	759,151		$	905,704		$	813,515		$	752,912
Unrealized (loss)/gain on Agency MBS, net	(2,028		)	(14,937		)	(14,393		)	46,000
Unrealized (loss)/gain on Non-Agency MBS, net	(42,011		)	(28,473		)	(72,791		)	70,973
Cumulative effect adjustment on adoption of revised accounting standard for repurchase agreement financing	—			—			4,537			—
Reclassification adjustment for MBS sales included in net income	(11,363		)	(13,589		)	(26,414		)	(21,180		)
Reclassification adjustment for OTTI included in net income	—			—			(705		)	—
Change in AOCI from AFS securities	(55,402		)	(56,999		)	(109,766		)	95,793
Balance at end of period	$	703,749		$	848,705		$	703,749		$	848,705

Sales of MBS

During the three and nine months ended September 30, 2015, the Company sold certain Non-Agency MBS for $23.5 million and $50.7 million, realizing gross gains of $11.2 million and $25.2 million, respectively. During the three and nine months ended September 30, 2014, the Company sold certain Non-Agency MBS for $61.6 million and $103.6 million, realizing gross gains of $13.9 million and $25.3 million, respectively. The Company has no continuing involvement with any of the sold MBS.

Interest Income on MBS and CRT Securities

The following table presents the components of interest income on the Company’s MBS and CRT securities for the three and nine months ended September 30, 2015 and 2014:



	Three Months Ended September 30,						Nine Months Ended September 30,
(In Thousands)	2015			2014			2015			2014
Agency MBS
Coupon interest	$	35,154		$	46,529		$	113,543		$	145,864
Effective yield adjustment (1)	(11,536		)	(13,463		)	(32,513		)	(35,860		)
Interest income	$	23,618		$	33,066		$	81,030		$	110,004

Legacy Non-Agency MBS
Coupon interest	$	44,824		$	52,270		$	141,152		$	161,318
Effective yield adjustment (2)	21,955			25,477			69,816			78,561
Interest income	$	66,779		$	77,747		$	210,968		$	239,879

RPL/NPL MBS
Coupon interest	$	22,898		$	97		$	63,602		$	800
Effective yield adjustment (2)	753			—			1,662			—
Interest income	$	23,651		$	97		$	65,264		$	800

CRT securities
Coupon interest	$	1,432		$	30		$	4,000		$	30
Effective yield adjustment (2)	161			—			477			—
Interest income	$	1,593		$	30		$	4,477		$	30

(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.

(2) The effective yield adjustment is the difference between the net income calculated using the net yield, which is based on management’s estimates of the amount and timing of future cash flows, less the current coupon yield.