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 solicitation of valuations from third parties (typically, pricing services and broker-dealers), (ii) 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 assumptions and default rate assumptions, and (iii) the assessment of observable or reported recent trading activity. The Company utilizes such information to assign a good faith fair value (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 each such financial instrument.

The Company seeks to obtain at least one third-party indicative valuation for each instrument, and often obtains multiple indicative valuations when available. 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 assumptions and default rate assumptions. The Company has been able to obtain third-party valuations on the vast majority of the Company's assets and expects to continue to solicit third-party valuations on substantially all of its assets in the future to the extent practical. The Company generally values each financial instrument at the average of third-party valuations received and not rejected as described below. Third-party valuations are not binding on the Company and while the Company generally does not adjust valuations it receives, the Company may challenge or reject a valuation when, based on validation criteria, the Company determines that such valuation is unreasonable or erroneous. Furthermore, the Company may determine, based on validation criteria, that for a given instrument the average of the third-party valuations received does not result in what the Company believes to be fair value, and in such circumstances the Company may override this average with its own good faith valuation. The validation criteria include the use of the Company's own models, recent trading activity in the same or similar instruments, and valuations received from third parties. The Company's valuation process, including the application of validation criteria, is overseen by the Manager's valuation committee. Because of the inherent uncertainty of valuation, these 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, 2014:



Description	Level 1			Level 2			Level 3			Total
Assets:	(In thousands)
Cash and cash equivalents	$	170,362		$	—		$	—		$	170,362
Investments, at fair value-
Agency residential mortgage-backed securities	$	—		$	1,076,782		$	41,375		$	1,118,157
Private label residential mortgage-backed securities	—			—			490,083			490,083
Private label commercial mortgage-backed securities	—			—			32,645			32,645
Commercial mortgage loans	—			—			44,005			44,005
Residential mortgage loans	—			—			23,566			23,566
Other asset-backed securities	—			—			47,458			47,458
Real estate owned	—			—			97			97
Total investments, at fair value	—			1,076,782			679,229			1,756,011
Financial derivatives–assets, at fair value-
Credit default swaps on asset-backed securities	—			—			15,174			15,174
Credit default swaps on corporate bond indices	—			19,176			—			19,176
Credit default swaps on asset-backed indices	—			5,097			—			5,097
Interest rate swaps	—			17,473			—			17,473
Total return swaps	—			15			—			15
Options	—			393			—			393
Futures	65			—			—			65
Forwards	—			167			—			167
Total financial derivatives–assets, at fair value	65			42,321			15,174			57,560
Repurchase agreements	—			29,875			—			29,875
Total investments and financial derivatives–assets, at fair value and repurchase agreements	$	65		$	1,148,978		$	694,403		$	1,843,446
Liabilities:
Investments sold short, at fair value-
Agency residential mortgage-backed securities	$	—		$	(787,667	)	$	—		$	(787,667	)
Government debt	—			(24,195		)	—			(24,195		)
Common stock	(6,903		)	—			—			(6,903		)
Total investments sold short, at fair value	(6,903		)	(811,862		)	—			(818,765		)
Financial derivatives–liabilities, at fair value-
Credit default swaps on corporate bond indices	—			(15,984		)	—			(15,984		)
Credit default swaps on asset-backed indices	—			(7,095		)	—			(7,095		)
Credit default swaps on asset-backed securities	—			—			(350		)	(350		)
Interest rate swaps	—			(5,532		)	—			(5,532		)
Total return swaps	—			(31		)	—			(31		)
Options	—			(328		)	—			(328		)
Futures	(142		)	—			—			(142		)
Forwards	—			(42		)	—			(42		)
Total financial derivatives–liabilities, at fair value	(142		)	(29,012		)	(350		)	(29,504		)
Securitized debt	—			—			(983		)	(983		)
Total investments sold short, financial derivatives–liabilities, and securitized debt, at fair value	$	(7,045	)	$	(840,874	)	$	(1,333	)	$	(849,252	)

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, 2014.

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 following table identifies the significant unobservable inputs that affect the valuation of the Company's Level 3 assets and liabilities as of March 31, 2014:



	Fair Value		Valuation Technique	Unobservable Input	Range						Weighted Average
Description	Fair Value		Valuation Technique	Unobservable Input	Min			Max			Weighted Average
	(In thousands)
Private label residential mortgage-backed securities and Other asset-backed securities⁽¹⁾	$	475,211	Market Quotes	Non Binding Indicative Price	$	1.79		$	110.11		$	77.94
Private label residential mortgage-backed securities	61,348		Discounted Cash Flows	Yield	3.5		%	23.9		%	7.9		%
				Projected Collateral Prepayments	7.4		%	86.8		%	34.4		%
				Projected Collateral Losses	1.4		%	44.2		%	14.5		%
				Projected Collateral Recoveries	0.0		%	24.8		%	7.6		%
				Projected Collateral Scheduled Amortization	0.0		%	84.8		%	43.5		%
											100.0		%
Private label commercial mortgage-backed securities	4,405		Discounted Cash Flows	Yield	9.7		%	24.9		%	14.7		%
				Projected Collateral Losses	0.2		%	2.4		%	1.2		%
				Projected Collateral Recoveries	1.9		%	12.0		%	6.6		%
				Projected Collateral Scheduled Amortization	85.6		%	97.8		%	92.2		%
											100.0		%
Private label commercial mortgage-backed securities and commercial mortgage loans	33,214		Market Quotes	Non Binding Indicative Price	$	14.25		$	99.50		$	68.31
Performing commercial mortgage loans	19,000		Discounted Cash Flows	Yield	12.7		%	15.0		%	13.9		%
Non-performing commercial mortgage loans	20,030		Discounted Cash Flows	Yield	10.4		%	19.7		%	17.7		%
				Months to Resolution	7			17			10
Non-performing residential mortgage loan pools	23,663		Discounted Cash Flows	Yield	6.8		%	7.1		%	7.1		%
				Months to Resolution	4.8			16.1			9.2
Agency interest only residential mortgage-backed securities	40,018		Market Quotes	Non Binding Indicative Price	$	6.13		$	22.65		$	14.19
Agency interest only residential mortgage-backed securities	1,357		Option Adjusted Spread ("OAS")	LIBOR OAS⁽²⁾	754			1,032			917
				Projected Collateral Prepayments	60.1		%	75.9		%	66.6		%
				Projected Collateral Scheduled Amortization	24.1		%	39.9		%	33.4		%
											100.0		%
Credit default swaps on asset-backed securities	14,824		Net Discounted Cash Flows	Projected Collateral Prepayments	19.2		%	56.8		%	29.6		%
				Projected Collateral Losses	16.1		%	49.4		%	34.2		%
				Projected Collateral Recoveries	8.3		%	15.4		%	13.3		%
				Projected Collateral Scheduled Amortization	15.4		%	41.7		%	22.9		%
											100.0		%


(1)	Includes securitized debt with a fair value of $1.0 million as of March 31, 2014.


(2)	Shown in basis points.

Third-party non-binding indicative prices are validated by comparing such prices to internally generated prices based on the Company's models and to recent trading activity in the same or similar instruments.

For those instruments valued using discounted and net discounted cash flows, 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. Averages are weighted based on the fair value of the related instrument. In the case of credit default swaps on asset-backed securities, averages are weighted based on each instrument's bond equivalent value. Bond equivalent value represents the investment amount of a corresponding position in the reference obligation, calculated as the difference between the outstanding principal balance of the underlying reference obligation and the fair value, inclusive of accrued interest, of the derivative contract. For those assets valued using the LIBOR Option Adjusted Spread ("OAS") valuation methodology, cash flows are projected using the Company'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. The Company considers the expected timeline to resolution in the determination of fair value for its non-performing commercial and residential loans.

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 be accompanied by a lower expectation of collateral losses. Conversely, higher losses will generally be accompanied by 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 table below reflects the value of the Company's Level 1, Level 2, and Level 3 financial instruments at December 31, 2013:



(In thousands)
Description	Level 1			Level 2			Level 3			Total
Assets:
Cash and cash equivalents	$	183,489		$	—		$	—		$	183,489
Investments, at fair value-
Agency residential mortgage-backed securities	$	—		$	989,842		$	40,504		$	1,030,346
Private label residential mortgage-backed securities	—			—			580,772			580,772
Private label commercial mortgage-backed securities	—			—			32,994			32,994
Commercial mortgage loans	—			—			23,887			23,887
Residential mortgage loans	—			—			24,062			24,062
Other asset-backed securities	—			—			38,069			38,069
Total investments, at fair value	—			989,842			740,288			1,730,130
Financial derivatives–assets, at fair value-
Credit default swaps on asset-backed securities	—			—			16,646			16,646
Credit default swaps on corporate bond indices	—			14,273			—			14,273
Credit default swaps on asset-backed indices	—			4,937			—			4,937
Interest rate swaps	—			23,553			—			23,553
Total return swaps	—			4			—			4
Options	—			251			—			251
Total financial derivatives–assets, at fair value	—			43,018			16,646			59,664
Repurchase agreements	—			27,962			—			27,962
Total investments and financial derivatives–assets, at fair value and repurchase agreements	$	—		$	1,060,822		$	756,934		$	1,817,756
Liabilities:
Investments sold short, at fair value-
Agency residential mortgage-backed securities	$	—		$	(811,957	)	$	—		$	(811,957	)
Government debt	—			(27,288		)	—			(27,288		)
Common stock	(6,369		)	—			—			(6,369		)
Total investments sold short, at fair value	(6,369		)	(839,245		)	—			(845,614		)
Financial derivatives–liabilities, at fair value-
Credit default swaps on corporate bond indices	—			(24,949		)	—			(24,949		)
Credit default swaps on asset-backed indices	—			(11,866		)	—			(11,866		)
Credit default swaps on asset-backed securities	—			—			(350		)	(350		)
Interest rate swaps	—			(5,064		)	—			(5,064		)
Total return swaps	—			(67		)	—			(67		)
Options	—			(84		)	—			(84		)
Futures	(2,373		)	—			—			(2,373		)
Forwards	—			(38		)	—			(38		)
Total financial derivatives–liabilities, at fair value	(2,373		)	(42,068		)	(350		)	(44,791		)
Securitized debt	—			—			(983		)	(983		)
Total investments sold short, financial derivatives–liabilities, and securitized debt, at fair value	$	(8,742	)	$	(881,313	)	$	(1,333	)	$	(891,388	)

The following table identifies the significant unobservable inputs that affect the valuation of the Company's Level 3 assets and liabilities as of December 31, 2013:



	Fair Value		Valuation Technique	Unobservable Input	Range						Weighted Average
Description	Fair Value		Valuation Technique	Unobservable Input	Min			Max			Weighted Average
	(In thousands)
Private label residential mortgage-backed securities and Other asset-backed securities⁽¹⁾	$	550,701	Market Quotes	Non Binding Indicative Price	$	1.80		$	110.35		$	78.09
Private label residential mortgage-backed securities	67,158		Discounted Cash Flows	Yield	3.8		%	20.5		%	8.0		%
				Projected Collateral Prepayments	6.9		%	64.5		%	29.7		%
				Projected Collateral Losses	4.3		%	35.2		%	17.4		%
				Projected Collateral Recoveries	0.3		%	17.1		%	9.1		%
				Projected Collateral Scheduled Amortization	14.1		%	87.3		%	43.8		%
											100.0		%
Private label commercial mortgage-backed securities	3,480		Discounted Cash Flows	Yield	9.2		%	18.2		%	13.5		%
				Projected Collateral Losses	0.2		%	0.2		%	0.2		%
				Projected Collateral Recoveries	15.4		%	15.4		%	15.4		%
				Projected Collateral Scheduled Amortization	84.4		%	84.4		%	84.4		%
											100.0		%
Private label commercial mortgage-backed securities and commercial mortgage loans	34,489		Market Quotes	Non Binding Indicative Price	$	14.25		$	102.89		$	74.24
Performing commercial mortgage loans	8,788		Discounted Cash Flows	Yield	12.7		%	12.8		%	12.7		%
Non-performing commercial mortgage loans	10,123		Discounted Cash Flows	Yield	15.0		%	15.0		%	15.0		%
				Months to Resolution	5			7			6
Non-performing residential mortgage loan pools	24,062		Discounted Cash Flows	Yield	7.4		%	7.4		%	7.4		%
				Months to Resolution	16.3			16.3			16.3
Agency interest only residential mortgage-backed securities	38,783		Market Quotes	Non Binding Indicative Price	$	6.26		$	33.77		$	14.53
Agency interest only residential mortgage-backed securities	1,721		Option Adjusted Spread ("OAS")	LIBOR OAS⁽²⁾	349			645			422
				Projected Collateral Prepayments	49.0		%	58.1		%	51.2		%
				Projected Collateral Scheduled Amortization	41.9		%	51.0		%	48.8		%
											100.0		%
Credit default swaps on asset-backed securities	16,296		Net Discounted Cash Flows	Projected Collateral Prepayments	19.3		%	59.0		%	29.9		%
				Projected Collateral Losses	15.5		%	47.8		%	34.8		%
				Projected Collateral Recoveries	8.2		%	15.2		%	13.1		%
				Projected Collateral Scheduled Amortization	15.7		%	41.2		%	22.2		%
											100.0		%


(1)	Includes securitized debt with a fair value of $1.0 million as of December 31, 2013.


(2)	Shown in basis points.

The tables below include a roll-forward of the Company's financial instruments for the three month periods ended March 31, 2014 and 2013 (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, 2014



(In thousands)	Beginning Balance as of December 31, 2013			Accreted Discounts / (Amortized Premiums)			Net Realized Gain/ (Loss)			Change in Net Unrealized Gain/(Loss)			Purchases/ Payments		Sales/ Issuances			Transfers In and/or Out of Level 3		Ending Balance as of March 31, 2014
Assets:
Investments, at fair value-
Agency residential mortgage-backed securities	$	40,504		$	(2,289	)	$	35		$	751		$	2,554	$	(180	)	$	—	$	41,375
Private label residential mortgage-backed securities	580,772			5,385			23,460			(12,852		)	89,585		(196,267		)	—		490,083
Private label commercial mortgage-backed securities	32,994			205			872			1,515			37,769		(40,710		)	—		32,645
Commercial mortgage loans	23,887			563			2			(460		)	20,023		(10		)	—		44,005
Residential mortgage loans	24,062			—			18			(260		)	—		(254		)	—		23,566
Other asset-backed securities	38,069			159			(97		)	548			13,887		(5,108		)	—		47,458
Real estate owned	—			—			—			(4		)	101		—			—		97
Total investments, at fair value	740,288			4,023			24,290			(10,762		)	163,919		(242,529		)	—		679,229
Financial derivatives–assets, at fair value-
Credit default swaps on asset-backed securities	16,646			—			1,190			(1,210		)	39		(1,491		)	—		15,174
Total financial derivatives– assets, at fair value	16,646			—			1,190			(1,210		)	39		(1,491		)	—		15,174
Total investments and financial derivatives–assets, at fair value	$	756,934		$	4,023		$	25,480		$	(11,972	)	$	163,958	$	(244,020	)	$	—	$	694,403
Liabilities:
Financial derivatives–liabilities, at fair value-
Credit default swaps on asset-backed securities	$	(350	)	$	—		$	(19	)	$	—		$	—	$	19		$	—	$	(350	)
Total financial derivatives– liabilities, at fair value	(350		)	—			(19		)	—			—		19			—		(350		)
Securitized debt:
Securitized debt	(983		)	(7		)	—			(17		)	24		—			—		(983		)
Total securitized debt	(983		)	(7		)	—			(17		)	24		—			—		(983		)
Total financial derivatives– liabilities and securitized debt, at fair value	$	(1,333	)	$	(7	)	$	(19	)	$	(17	)	$	24	$	19		$	—	$	(1,333	)

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, 2014, as well as Level 3 financial instruments disposed of by the Company during the three month period ended March 31, 2014. For Level 3 financial instruments held by the Company at March 31, 2014, change in net unrealized gain (loss) of $2.3 million, $(1.2) million, and $(17.0) thousand, for the three month periods ended March 31, 2014 relate to investments, financial derivatives–assets, and securitized debt, respectively.

Level 3—Fair Value Measurement Using Significant Unobservable Inputs:

Three Month Period Ended March 31, 2013



(In thousands)	Ending Balance as of December 31, 2012			Accreted Discounts / (Amortized Premiums)			Net Realized Gain/ (Loss)			Change in Net Unrealized Gain/(Loss)			Purchases/ Payments		Sales/ Issuances			Transfers In and/or Out of Level 3		Ending Balance as of March, 31, 2013
Assets:
Investments, at fair value-
Agency residential mortgage-backed securities	$	6,644		$	(870	)	$	—		$	238		$	10,216	$	—		$	—	$	16,228
Private label residential mortgage-backed securities	528,366			6,640			15,602			24,020			72,832		(89,640		)	—		557,820
Private label commercial mortgage-backed securities	19,327			57			(1,449		)	3,244			12,344		(27,745		)	—		5,778
Commercial mortgage loans	9,546			8			—			159			—		—			—		9,713
Other asset-backed securities	—			(49		)	—			(107		)	11,794		—			—		11,638
Total investments, at fair value	563,883			5,786			14,153			27,554			107,186		(117,385		)	—		601,177
Financial derivatives–assets, at fair value-
Credit default swaps on asset-backed securities	36,031			—			3,251			(5,599		)	49		(7,334		)	—		26,398
Total financial derivatives– assets, at fair value	36,031			—			3,251			(5,599		)	49		(7,334		)	—		26,398
Total investments and financial derivatives–assets, at fair value	$	599,914		$	5,786		$	17,404		$	21,955		$	107,235	$	(124,719	)	$	—	$	627,575
Liabilities:
Financial derivatives– liabilities, at fair value-
Credit default swaps on asset-backed securities	$	(1	)	$	—		$	(28	)	$	(1	)	$	—	$	28		$	—	$	(2	)
Total financial derivatives– liabilities, at fair value	(1		)	—			(28		)	(1		)	—		28			—		(2		)
Securitized debt:
Securitized debt	(1,335		)	(9		)	—			69			70		—			—		(1,205		)
Total securitized debt	(1,335		)	(9		)	—			69			70		—			—		(1,205		)
Total financial derivatives– liabilities and securitized debt, at fair value	$	(1,336	)	$	(9	)	$	(28	)	$	68		$	70	$	28		$	—	$	(1,207	)

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, 2013, as well as Level 3 financial instruments disposed of by the Company during the three month period ended March 31, 2013. For Level 3 financial instruments held by the Company at March 31, 2013, change in net unrealized gain (loss) of $28.3 million, $(7.2) million, $(1.0) thousand, and $0.07 million for the three month period ended March 31, 2013 relate to investments, financial derivatives–assets, financial derivatives–liabilities, and securitized debt, respectively.