MBS

9 Months Ended

Sep. 30, 2012

MBS

MBS

3.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 4 and 8)

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.  Non-Agency MBS may be rated by one or more Rating Agencies or may be unrated (i.e., not assigned a rating by any Rating Agency).  The rating indicates the opinion of the Rating Agency as to the creditworthiness of the investment, indicating the obligor’s ability to meet its full financial commitment on the obligation.  A rating of “D” is assigned when a security has defaulted on any of its contractual terms.

The following tables present certain information about the Company’s MBS at September 30, 2012 and December 31, 2011:

	September 30, 2012
								Discount
								Designated
					Accretable			as Credit							Gross		Gross			Net
	Current		Purchase		Purchase			Reserve			Amortized				Unrealized		Unrealized			Unrealized
(In Thousands)	Face		Premiums		Discounts			and OTTI (1)			Cost (2)		Fair Value		Gains		Losses			Gain/(Loss)
Agency MBS:
Fannie Mae	$	6,357,355	$	204,196	$	(70	)	$	—		$	6,561,481	$	6,792,421	$	231,889	$	(949	)	$	230,940
Freddie Mac	615,976		20,996		—			—			642,312		668,748		26,448		(12		)	26,436
Ginnie Mae	14,902		257		—			—			15,159		15,679		520		—			520
Total Agency MBS	6,988,233		225,449		(70		)	—			7,218,952		7,476,848		258,857		(961		)	257,896
Non-Agency MBS: (3)
Rated AAA	35,908		179		(938		)	—			35,149		36,259		1,110		—			1,110
Rated AA	46		1		—			—			47		39		—		(8		)	(8		)
Rated A	22,713		644		—			—			23,357		22,214		—		(1,143		)	(1,143		)
Rated BBB	32,049		29		(2,123		)	(378		)	29,577		31,391		1,981		(167		)	1,814
Rated BB	120,010		41		(8,802		)	(1,724		)	109,525		110,928		2,456		(1,053		)	1,403
Rated B	307,488		15		(27,539		)	(18,879		)	261,085		275,878		17,036		(2,243		)	14,793
Rated CCC	1,155,928		—		(86,864		)	(203,508		)	865,556		969,810		107,609		(3,355		)	104,254
Rated CC	647,499		—		(27,799		)	(128,181		)	491,519		533,770		42,923		(672		)	42,251
Rated C	1,104,962		—		(44,439		)	(225,212		)	835,311		916,709		83,075		(1,677		)	81,398
Unrated and D-rated (4)	3,030,468		—		(109,572		)	(881,769		)	2,039,127		2,299,977		263,737		(2,887		)	260,850
Total Non-Agency MBS	6,457,071		909		(308,076		)	(1,459,651		)	4,690,253		5,196,975		519,927		(13,205		)	506,722
Total MBS	$	13,445,304	$	226,358	$	(308,146	)	$	(1,459,651	)	$	11,909,205	$	12,673,823	$	778,784	$	(14,166	)	$	764,618

	December 31, 2011
								Discount
								Designated
					Accretable			as Credit							Gross		Gross			Net
	Current		Purchase		Purchase			Reserve			Amortized				Unrealized		Unrealized			Unrealized
(In Thousands)	Face		Premiums		Discounts			and OTTI (1)			Cost (2)		Fair Value		Gains		Losses			Gain/(Loss)
Agency MBS:
Fannie Mae	$	5,981,834	$	154,809	$	(135	)	$	—		$	6,136,508	$	6,329,925	$	194,997	$	(1,580	)	$	193,417
Freddie Mac	743,517		22,717		—			—			768,572		791,085		22,677		(164		)	22,513
Ginnie Mae	15,920		275		—			—			16,195		16,521		326		—			326
Total Agency MBS	6,741,271		177,801		(135		)	—			6,921,275		7,137,531		218,000		(1,744		)	216,256
Non-Agency MBS: (3)
Rated AAA	12,258		245		—			—			12,503		12,258		—		(245		)	(245		)
Rated AA	47		1		—			—			48		34		—		(14		)	(14		)
Rated A	28,950		765		(624		)	(5		)	29,086		24,911		341		(4,516		)	(4,175		)
Rated BBB	46,593		42		(3,020		)	(582		)	43,033		38,352		—		(4,681		)	(4,681		)
Rated BB	100,513		33		(10,749		)	(3,223		)	86,574		81,789		2,232		(7,017		)	(4,785		)
Rated B	355,930		17		(30,584		)	(25,004		)	300,359		277,438		2,729		(25,650		)	(22,921		)
Rated CCC	1,031,407		—		(68,174		)	(203,185		)	760,048		741,028		27,767		(46,787		)	(19,020		)
Rated CC	687,664		—		(33,478		)	(142,777		)	511,409		487,619		14,209		(37,999		)	(23,790		)
Rated C	2,128,919		—		(64,963		)	(487,397		)	1,576,559		1,503,737		44,988		(117,810		)	(72,822		)
Unrated and D-rated (4)	1,022,072		—		(38,887		)	(366,593		)	616,592		608,280		34,934		(43,246		)	(8,312		)
Total Non-Agency MBS	5,414,353		1,103		(250,479		)	(1,228,766		)	3,936,211		3,775,446		127,200		(287,965		)	(160,765		)
Total MBS	$	12,155,624	$	178,904	$	(250,614	)	$	(1,228,766	)	$	10,857,486	$	10,912,977	$	345,200	$	(289,709	)	$	55,491

(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, 2012 reflect Credit Reserve of $1.409 billion and OTTI of $50.3 million. Amounts disclosed at December 31, 2011 reflect Credit Reserve of $1.174 billion and OTTI of $54.5 million.

(2)  Includes principal payments receivable of $5.3 million and $2.3 million at September 30, 2012 and December 31, 2011, respectively, which are not included in the Current Face.

(3)  Non-Agency MBS, including Non-Agency MBS transferred to consolidated VIEs, are reported based on the lowest rating issued by a Rating Agency, if more than one rating is issued on the security, at the date presented.

(4)  Includes 214 Non-Agency MBS that were D-rated and had an aggregate amortized cost and fair value of $2.025 billion and $2.281 billion, respectively, at September 30, 2012 and 78 Non-Agency MBS that were D-rated and had an aggregate amortized cost and fair value of $602.0 million and $593.8 million, respectively, at December 31, 2011.

Unrealized Losses on MBS and Impairments

The following table presents information about the Company’s MBS that were in an unrealized loss position at September 30, 2012:

Unrealized Loss Position For:
	Less than 12 Months					12 Months or more					Total
	Fair		Unrealized		Number of	Fair		Unrealized		Number of	Fair		Unrealized
(In Thousands)	Value		Losses		Securities	Value		Losses		Securities	Value		Losses
Agency MBS:
Fannie Mae	$	117,361	$	214	23	$	45,376	$	735	10	$	162,737	$	949
Freddie Mac	—		—		—	2,757		12		1	2,757		12
Total Agency MBS	117,361		214		23	48,133		747		11	165,494		961
Non-Agency MBS:
Rated AA	—		—		—	39		8		1	39		8
Rated A	—		—		—	22,214		1,143		2	22,214		1,143
Rated BBB	—		—		—	1,282		167		2	1,282		167
Rated BB	—		—		—	30,000		1,053		5	30,000		1,053
Rated B	—		—		—	97,342		2,243		8	97,342		2,243
Rated CCC	6,955		18		1	72,474		3,337		8	79,429		3,355
Rated CC	—		—		—	48,847		672		5	48,847		672
Rated C	—		—		—	74,379		1,677		5	74,379		1,677
Unrated and other	—		—		—	136,871		2,887		14	136,871		2,887
Total Non-Agency MBS	6,955		18		1	483,448		13,187		50	490,403		13,205
Total MBS	$	124,316	$	232	24	$	531,581	$	13,934	61	$	655,897	$	14,166

At September 30, 2012, 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 have occurred to date.

Gross unrealized losses on the Company’s Agency MBS were $961,000 at September 30, 2012.  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 their maturity, the Company considers 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, 2012 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 $13.2 million at September 30, 2012.  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 credit-related OTTI losses through earnings during the three months ended September 30, 2012 and recognized approximately $1.2 million of credit-related OTTI losses on Non-Agency MBS during the nine months ended September 30, 2012.  The Company recognized credit-related OTTI losses through earnings of approximately $4.0 million and $6.4 million on Non-Agency MBS during the three and nine months ended September 30, 2011, respectively.

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.  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 the composition of OTTI charges recorded by the Company for the three and nine months ended September 30, 2012 and 2011:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
(In Thousands)	2012		2011			2012			2011
Total OTTI losses	$	—	$	(14,913	)	$	(879	)	$	(15,550	)
OTTI recognized in/(reclassified from) other comprehensive income	—		10,922			(321		)	9,167
OTTI recognized in earnings	$	—	$	(3,991	)	$	(1,200	)	$	(6,383	)

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 other comprehensive income.  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		Nine Months Ended
(In Thousands)	September 30, 2012		September 30, 2012
Credit loss component of OTTI at beginning of period	$	36,115	$	34,915
Additions for credit related OTTI not previously recognized	—		458
Subsequent additional credit related OTTI recorded	—		742
Credit loss component of OTTI at end of period	$	36,115	$	36,115

The significant inputs considered and assumptions made at time of impairment in determining the measurement of the component of OTTI recognized in earnings for the Company’s Non-Agency MBS for the three and nine months ended September 30, 2012 and 2011 are summarized as follows:

	Three Months Ended		Nine Months Ended
	September 30,		September 30,
	2012	2011	2012	2011
Credit enhancement (1) (2)
Weighted average (3)	—	2.70%	3.26%	3.02%
Range (4)	—	0.00-10.40%	0.00-16.50%	0.00-13.30%
Projected CPR (2) (5)
Weighted average (3)	—	11.00%	9.90%	10.90%
Range (4)	—	6.90-12.20%	9.10-13.30%	1.90-12.20%
Projected Loss Severity (2) (6)
Weighted average (3)	—	56.10%	55.50%	53.60%
Range (4)	—	46.10-70.00%	45.90-60.00%	41.90-70.00%
60+ days delinquent (2) (7)
Weighted average (3)	—	21.40%	24.40%	21.30%
Range (4)	—	9.10-36.70%	18.20-32.40%	7.30-36.70%

(1) Represents a level of protection for these securities, expressed as a percentage of total current underlying loan balance.

(2)  Information provided is based on loans for all groups that provide credit enhancement for MBS with credit enhancement. If an MBS no longer has credit enhancement, information provided is based on loans for the individual group owned by the Company.

(3) Calculated by weighting the relevant input/assumptions for each individual security by current outstanding face of the security.

(4) Represents the range of inputs/assumptions based on individual securities.

(5) CPR - conditional prepayment rate.

(6)  Projected loss severity represents the projected amount of loss realized on liquidated properties as a percentage of the principal balance.

(7) Includes, for each security, underlying loans 60 or more days delinquent, foreclosed loans and other real estate owned.

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, 2012 and 2011:

	Three Months Ended						Three Months Ended
	September 30, 2012						September 30, 2011
	Discount						Discount
	Designated as						Designated as
	Credit Reserve			Accretable			Credit Reserve			Accretable
(In Thousands)	and OTTI (1)			Discount (1) (2)			and OTTI (1)			Discount (1) (2)
Balance at beginning of period	$	(1,440,752	)	$	(265,137	)	$	(1,174,890	)	$	(222,930	)
Accretion of discount	—			8,816			—			10,785
Realized credit losses	49,314			—			10,735			—
Purchases	(122,266		)	4,554			(29,141		)	(16,198		)
Net impairment losses recognized in earnings	—			—			(3,991		)	—
Unlinking of Linked Transactions	—			(2,256		)	(10,419		)	(61		)
Transfers/release of credit reserve	54,053			(54,053		)	11,305			(11,305		)
Balance at end of period	$	(1,459,651	)	$	(308,076	)	$	(1,196,401	)	$	(239,709	)

	Nine Months Ended						Nine Months Ended
	September 30, 2012						September 30, 2011
	Discount						Discount
	Designated as						Designated as
	Credit Reserve			Accretable			Credit Reserve			Accretable
(In Thousands)	and OTTI (3)			Discount (2) (3)			and OTTI (3)			Discount (2) (3)
Balance at beginning of period	$	(1,228,766	)	$	(250,479	)	$	(746,678	)	$	(228,966	)
Accretion of discount	—			28,107			—			33,107
Realized credit losses	107,229			—			20,612			—
Purchases	(370,649		)	(3,883		)	(360,655		)	(19,035		)
Reclass discount for OTTI	866			(866		)	101			(101		)
Net impairment losses recognized in earnings	(1,200		)	—			(6,383		)	—
Unlinking of Linked Transactions	(38,662		)	(9,424		)	(116,489		)	(11,623		)
Transfers/release of credit reserve	71,531			(71,531		)	13,091			(13,091		)
Balance at end of period	$	(1,459,651	)	$	(308,076	)	$	(1,196,401	)	$	(239,709	)

(1)  In addition, the Company reallocated $54,000 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, 2012. The Company reallocated $1.1 million of purchase discount designated as accretable purchase discount to Credit Reserve on Non-Agency MBS underlying Linked Transactions during the three months ended September 30, 2011.

(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 $575,000 and $309,000 of purchase discount designated as accretable purchase discount to Credit Reserve on Non-Agency MBS underlying Linked Transactions during the nine months ended September 30, 2012 and 2011, respectively.

Impact of MBS on Accumulated Other Comprehensive Income/(Loss)

The following table presents the impact of the Company’s MBS on its accumulated other comprehensive income for the three and nine months ended September 30, 2012 and 2011:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(In Thousands)	2012			2011			2012			2011
Accumulated other comprehensive income from MBS:
Unrealized gain on MBS at beginning of period	$	296,007		$	292,376		$	55,491		$	393,822
Unrealized gain on Agency MBS, net	61,999			12,035			47,169			50,092
Unrealized gain/(loss) on Non-Agency MBS, net	409,742			(109,294		)	666,287			(250,845		)
Reclassification adjustment for MBS sales included in net income	(3,130		)	(4,525		)	(5,529		)	(4,869		)
Reclassification adjustment for OTTI included in net income	—			3,991			1,200			6,383
Change in accumulated other comprehensive income/(loss) from MBS	$	468,611		(97,793		)	709,127			(199,239		)
Balance at end of period	$	764,618		$	194,583		$	764,618		$	194,583

Sales of MBS

During the three and nine months ended September 30, 2012, the Company sold certain Agency MBS for $66.0 million and $137.1 million, realizing gross gains of $4.3 million and $7.2 million, respectively.  During the first nine months of 2011, the Company sold certain Agency MBS for $76.5 million, realizing gross gains of $4.2 million; all of these sales occurred during the third quarter of 2011.

MBS Interest Income

The following table presents the components of interest income on the Company’s Agency MBS for the three and nine months ended September 30, 2012 and 2011:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(In Thousands)	2012			2011			2012			2011
Coupon interest	$	61,978		$	70,654		$	187,963		$	212,703
Effective yield adjustment (1)	(14,780		)	(10,697		)	(37,915		)	(26,589		)
Agency MBS interest income	$	47,198		$	59,957		$	150,048		$	186,114

(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 nine months ended September 30, 2012 and 2011:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(In Thousands)	2012		2011		2012		2011
Coupon interest	$	69,139	$	60,038	$	196,144	$	153,563
Effective yield adjustment (1)	8,760		10,746		27,913		32,970
Non-Agency MBS interest income	$	77,899	$	70,784	$	224,057	$	186,533

(1)  The effective yield adjustment is the difference between the net interest 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.