Valuation

3 Months Ended

Mar. 31, 2012

Valuation [Abstract]

Valuation

3. Valuation

The following is a description of the valuation methodologies used for the Company's financial instruments.

Level 1 valuation methodologies include the observation of quoted prices (unadjusted) for identical assets or liabilities in active markets, often received from widely recognized data providers.

Level 2 valuation methodologies include the observation of (i) quoted prices for similar assets or liabilities in active markets, (ii) inputs other than quoted prices that are observable for the asset or liability (for example, interest rates and yield curves) in active markets and (iii) quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3 valuation methodologies include (i) the use of proprietary models that require the use of a significant amount of judgment and the application of various assumptions including, but not limited to, prepayment and default rate assumptions and (ii) the solicitation of valuations from third parties (typically, broker-dealers). Third-party valuation providers often utilize proprietary models that are highly subjective and also require the use of a significant amount of judgment and the application of various assumptions including, but not limited to, prepayment and default rate assumptions. The Manager utilizes such information to assign a good faith valuation (the estimated price that would be received to sell an asset or paid to transfer a liability in an orderly transaction at the valuation date) to such financial instruments. The Manager has been able to obtain third-party valuations on the vast majority of the Company's financial instruments and expects to continue to solicit third-party valuations on substantially all of the Company's financial instruments in the future to the extent practical.

The Manager uses its judgment based on its own models, the assessments of its portfolio managers and third-party valuations it obtains, to determine and assign fair values to the Company's Level 3 financial instruments. Because of the inherent uncertainty of valuation, estimated values may differ significantly from the values that would have been used had a ready market for the financial instruments existed and the differences could be material to the consolidated financial statements.

The table below reflects the value of the Company's Level 1, Level 2 and Level 3 financial instruments at March 31, 2012:

(In thousands)
Description	Level 1			Level 2			Level 3			Total
Assets:
Cash and cash equivalents	$	51,546		$	—		$	—		$	51,546
Investments at fair value-
Agency residential mortgage-backed securities	$	—		$	794,667		$	6,016		$	800,683
Private label residential mortgage-backed securities		—			—			408,230			408,230
Private label commercial mortgage-backed securities		—			—			12,171			12,171
Commercial mortgage loans		—			—			4,500			4,500
Total investments at fair value		—			794,667			430,917			1,225,584
Financial derivatives-assets at fair value-
Credit default swaps on asset-backed securities		—			—			48,746			48,746
Credit default swaps on asset-backed indices		—			45,223			—			45,223
Interest rate swaps		—			87			—			87
Total financial derivatives-assets at fair value		—			45,310			48,746			94,056
Repurchase agreements		—			13,650			—			13,650
Total investments, financial derivatives-assets at fair value and repurchase agreements	$	—		$	853,627		$	479,663		$	1,333,290
Liabilities:
Investments sold short at fair value-
U.S. Treasury and Agency residential mortgage-backed securities	$	—		$	(579,852	)	$	—		$	(579,852	)
Financial derivatives-liabilities at fair value-
Credit default swaps on corporate indices		—			(364	)		—			(364	)
Credit default swaps on asset backed indices		—			(20,536	)		—			(20,536	)
Total return swaps		—			(249	)		—			(249	)
Interest rate swaps		—			(6,097	)		—			(6,097	)
Unrealized depreciation on futures contracts		(52	)		—			—			(52	)
Total financial derivatives-liabilities at fair value		(52	)		(27,246	)		—			(27,298	)
Securitized debt		—			—			(1,485	)		(1,485	)
Total investments sold short, financial derivatives-liabilities at fair value and securitized debt	$	(52	)	$	(607,098	)	$	(1,485	)	$	(608,635	)

Investments under the Agency residential mortgage-backed securities Level 3 category are investments in Agency interest only RMBS securities. There were no transfers of financial instruments between Level 1, Level 2 or Level 3 during the three month period ended March 31, 2012.

The following table identifies the significant unobservable inputs that affect the valuation of the Company's Level 3 assets and liabilities as of March 31, 2012:

	Fair Value as of March 31, 2012		Valuation Technique	Unobservable Input	Range						Weighted Average
Description					Min			Max
	(In thousands)
Private label residential mortgage-backed securities (1)	$	406,745	Discounted Cash Flows	Yield		4.7	%		22.7	%		9.5	%
				Projected Collateral Prepayments		0.6	%		38.8	%		16.4	%
				Projected Collateral Losses		4.2	%		88.4	%		36.7	%
				Projected Collateral Recoveries		0.0	%		42.6	%		20.7	%
				Projected Collateral Scheduled Amortization		3.0	%		89.4	%		26.2	%
												100.0	%
Credit default swaps on asset-backed securities		48,746	Net Discounted Cash Flows
				Projected Collateral Prepayments		5.3	%		36.2	%		13.1	%
				Projected Collateral Losses		25.2	%		62.1	%		49.1	%
				Projected Collateral Recoveries		11.7	%		34.0	%		20.3	%
				Projected Collateral Scheduled Amortization		7.7	%		37.0	%		17.5	%
												100.0	%
Private label commercial mortgage-backed securities and Commercial mortgage loans		16,671	Discounted Cash Flows	Yield		7.9	%		10.9	%		9.7	%
				Projected Collateral Losses		0.0	%		30.5	%		4.6	%
				Projected Collateral Recoveries		0.0	%		46.4	%		14.9	%
				Projected Collateral Scheduled Amortization		47.8	%		100.0	%		80.5	%
												100.0	%
Agency interest only residential mortgage-backed securities		6,016	Option Adjusted Spread ("OAS")	LIBOR OAS(2)		741			2,754			1,107
				Projected Collateral Prepayments		74.3	%		93.0	%		81.8	%
				Projected Collateral Scheduled Amortization		7.0	%		25.7	%		18.2	%
												100.0	%

⁽¹⁾ Includes securitized debt with a fair value of $1.5 million as of March 31, 2012.

⁽²⁾  Shown in basis points.

Collateral prepayments, losses, recoveries and scheduled amortization are projected over the remaining life of the collateral and expressed as a percentage of the collateral's current principal balance.

The Company uses a LIBOR Option Adjusted Spread ("OAS") valuation methodology to value its Agency interest only RMBS assets. In the LIBOR OAS methodology, cash flows are projected using Ellington's models over multiple interest rate scenarios, and these projected cash flows are then discounted using the LIBOR rates implied by each interest rate scenario. The LIBOR OAS of an asset is then computed as the unique constant yield spread that, when added to all LIBOR rates in each interest rate scenario generated by the model, will equate (a) the expected present value of the projected asset cash flows over all model scenarios to (b) the actual current market price of the asset. LIBOR OAS is therefore model-dependent. Generally speaking, LIBOR OAS measures the additional yield spread over LIBOR that an asset provides at its current market price after taking into account any interest rate options embedded in the asset.

Material changes in any of the inputs above in isolation could result in a significant change to reported fair value measurements. Additionally, fair value measurements are impacted by the interrelationships of these inputs. For example, a higher expectation of collateral prepayments will generally result in a lower expectation of collateral losses. Conversely, higher losses will generally result in lower prepayments. Because the Company's credit default swaps on asset-backed security holdings represent credit default swap contracts whereby the Company has purchased credit protection, such default swaps on asset-backed securities generally have the directionally opposite sensitivity to prepayments, losses and recoveries as compared to the Company's long securities holdings. Prepayments do not represent a significant input for the Company's commercial mortgage-backed securities and commercial mortgage loans. Losses and recoveries do not represent a significant input for the Company's Agency RMBS interest only securities, given the guarantee of the issuing government agency or government-sponsored enterprise.

The Company's reverse repurchase agreements are carried at cost, which approximates fair value. These liabilities are classified as Level 2 liabilities based on the adequacy of the collateral and their short term nature.

The table below reflects the value of the Company's Level 1, Level 2 and Level 3 financial instruments at December 31, 2011:

(In thousands)
Description	Level 1		Level 2			Level 3		Total
Assets:
Cash and cash equivalents	$	62,737	$	—		$	—	$	62,737
Investments at fair value-
U.S. Treasury and Agency residential mortgage-backed securities	$	—	$	769,120		$	5,337	$	774,457
Private label residential mortgage-backed securities		—		—			417,533		417,533
Private label commercial mortgage-backed securities		—		—			16,093		16,093
Commercial mortgage loans		—		—			4,400		4,400
Total investments at value		—		769,120			443,363		1,212,483
Financial derivatives-assets at fair value-
Credit default swaps on corporate indices		—		963			—		963
Credit default swaps on asset-backed securities		—		—			61,498		61,498
Credit default swaps on asset-backed indices		—		40,303			—		40,303
Interest rate swaps		—		95			—		95
Unrealized appreciation on futures contracts		12		—			—		12
Total financial derivatives-assets at fair value		12		41,361			61,498		102,871
Repurchase agreements		—		15,750			—		15,750
Total investments, financial derivatives-assets at fair value and repurchase agreements	$	12	$	826,231		$	504,861	$	1,331,104
Liabilities:
Investments sold short at fair value-
U.S. Treasury and Agency residential mortgage-backed securities	$	—	$	(462,394	)	$	—	$	(462,394	)
Financial derivatives-liabilities at fair value-
Credit default swaps on asset-backed indices		—		(9,548	)		—		(9,548	)
Total return swaps		—		(274	)		—		(274	)
Interest rate swaps		—		(17,218	)		—		(17,218	)
Total financial derivatives-liabilities at fair value		—		(27,040	)		—		(27,040	)
Total investments sold short and financial derivatives-liabilities at fair value	$	—	$	(489,434	)	$	—	$	(489,434	)

Investments under the U.S. Treasury and Agency residential mortgage-backed securities Level 3 category are investments in Agency interest only RMBS securities. There were no transfers of financial instruments between Level 1, Level 2 or Level 3 during the year ended December 31, 2011.

The tables below include a roll-forward of the Company's financial instruments for the three month periods ended March 31, 2012 and 2011, respectively (including the change in fair value), for financial instruments classified by the Company within Level 3 of the valuation hierarchy.

Level 3—Fair Value Measurement Using Significant Unobservable Inputs:

Three Month Period Ended March 31, 2012

(In thousands)	Beginning Balance as of December 31, 2011		Accreted Discounts / Amortized Premiums			Realized Gain/ (Loss)			Change in Net Unrealized Gain/(Loss)		Purchases		Sales			Transfers In and/or Out of Level 3		Ending Balance as of March 31, 2012
Assets:
Investments at fair value-
Agency residential mortgage-backed securities	$	5,337	$	(624	)	$	—		$	431	$	872	$	—		$	—	$	6,016
Private label residential mortgage-backed securities		417,533		4,374			6,201			17,660		98,678		(136,216	)		—		408,230
Private label commercial mortgage-backed securities		16,093		117			344			1,688		1,308		(7,379	)		—		12,171
Commercial mortgage loans		4,400		28			—			72		—		—			—		4,500
Total investments at fair value		443,363		3,895			6,545			19,851		100,858		(143,595	)		—		430,917
Financial derivatives- assets at fair value
Credit default swaps on asset-backed securities		61,498		—			(4,744	)		6,799		123		(14,930	)		—		48,746
Total financial derivatives- assets at fair value		61,498		—			(4,744	)		6,799		123		(14,930	)		—		48,746
Total investments and financial derivatives-assets at fair value	$	504,861	$	3,895		$	1,801		$	26,650	$	100,981	$	(158,525	)	$	—	$	479,663
Liabilities:
Securitized debt	$	—	$	(13	)	$	—		$	10	$	—	$	(1,482	)	$	—	$	(1,485	)
Total securitized debt	$	—	$	(13	)	$	—		$	10	$	—	$	(1,482	)	$	—	$	(1,485	)

All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at March 31, 2012, as well as Level 3 financial instruments disposed of by the Company during the three month period ended March 31, 2012. For Level 3 financial instruments held by the Company at March 31, 2012, change in net unrealized gain (loss) of $12.7 million, $(4.5) million and $0.01 million, for the three month period ended March 31, 2012 relate to investments, financial derivative-assets and securitized debt, respectively.

Level 3—Fair Value Measurement Using Significant Unobservable Inputs:

Three Month Period Ended March 31, 2011

(In thousands)	Beginning Balance as of December 31, 2010		Accreted Discounts / Amortized Premiums			Realized Gain/(Loss)		Change in Net Unrealized Gain/(Loss)			Purchases		Sales			Transfers In and/or Out of Level 3		Ending Balance as of March 31, 2011
Assets:
Investments at fair value-
Agency residential mortgage-backed securities	$	—	$	(93	)	$	—	$	8		$	4,383	$	—		$	—	$	4,298
Private label residential mortgage-backed securities		338,839		3,649			11,177		(6,637	)		96,427		(88,773	)		—		354,682
Private label commercial mortgage-backed securities		1,850		83			772		(248	)		15,345		(4,719	)		—		13,083
Commercial mortgage loans		—		15			—		(15	)		4,675		—			—		4,675
Total investments at value		340,689		3,654			11,949		(6,892	)		120,830		(93,492	)		—		376,738
Financial derivatives- assets at fair value
Credit default swaps on asset-backed securities		102,850		—			2,681		(3,251	)		376		(12,274	)		—		90,382
Total financial derivatives- assets at fair value		102,850		—			2,681		(3,251	)		376		(12,274	)		—		90,382
Total investments and financial derivatives-assets at fair value	$	443,539	$	3,654		$	14,630	$	(10,143	)	$	121,206	$	(105,766	)	$	—	$	467,120

All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at March 31, 2011, as well as Level 3 financial instruments disposed of by the Company during the three month period ended March 31, 2011. For Level 3 financial instruments held by the Company at March 31, 2011, change in net unrealized gain (loss) of $(1.5) million and $(3.4) million for the three month period ended March 31, 2011 relate to investments and financial derivative-assets, respectively.