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Fair Value Measurements

12 Months Ended

Dec. 31, 2021

Definition and Hierarchy

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. Inputs refer broadly to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable or unobservable:

• Observable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from sources independent of the reporting entity.

• Unobservable inputs are inputs that reflect the reporting entity’s own assumptions.

A fair value hierarchy for inputs is implemented in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs are used when available. The availability of valuation techniques and the ability to attain observable inputs can vary from investment to investment and are affected by a wide variety of factors, including the type of investment, whether the investment is newly issued and not yet established in the marketplace, the liquidity of markets, and other characteristics particular to the transaction.

The fair value hierarchy is categorized into three broad levels based on the inputs as follows:

Level 1 - Valuations based on unadjusted, quoted prices in active markets for identical assets and liabilities.

Level 2 - Valuations based on quoted prices in an inactive market, or whose values are based on models - but the inputs to those models are observable either directly or indirectly for substantially the full term of the assets and liabilities. Level 2 inputs include the following:

a) Quoted prices for similar assets and liabilities in active markets (e.g. restricted stock);

b) Quoted prices for identical or similar assets and liabilities in non‑active markets (e.g. corporate and municipal bonds);

c) Pricing models whose inputs are observable for substantially the full term of the assets and liabilities (e.g. over‑the‑counter derivatives); and

d) Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability, (e.g. residential and commercial mortgage‑related assets, including whole loans securities and derivatives).

Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement. Valuation of these assets is typically based on the Company’s Manager’s own assumptions or expectations based on the best information available. The degree of judgment exercised by the Company’s Manager in determining fair value is greatest for investments categorized in Level 3.

The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the actual level is determined based on the level of inputs that is most significant to the fair value measurement in its entirety.

To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a ready market for the investments existed. Accordingly, the degree of judgment exercised by the Company’s Manager in determining fair value is greatest for investments categorized in Level 3. Transfers, if any, between levels are determined by the Company on the first day of the reporting period.

Valuation Techniques and Inputs

Following are descriptions of the valuation methodologies used to measure the Company’s assets and liabilities measured at fair value:

Investment Securities - U.S. Government and Agency Securities (“U.S. Treasury Bills”) are valued based on unadjusted, quoted prices for identical assets or liabilities in an active market. These securities are generally categorized as Level 1 securities.

Futures Contracts - Futures contracts that are traded on an exchange are valued at their last reported sales price as of the valuation date. Listed futures contracts are categorized in Level 1 of the fair value hierarchy.

Non‑Agency Residential Mortgage‑Backed Securities (“Non‑Agency”) - Non‑Agencies consist of investments in collateralized mortgage obligations. The Company utilizes PriceServe, Bank of America’s independent fixed income pricing service, as the primary valuation source for the investments. PriceServe obtains its price quotes from actual sales or quotes for sale of the same or similar securities and/or provides model‑based valuations that consider inputs derived from recent market activity including default rates, conditional prepayment rates, loss severity, expected yield to maturity, baseline DM/Yield, recovery assumptions, tranche type, collateral coupon, age and loan size and other inputs specific to each security. These quotes are most reflective of the price that would be achieved if the security was sold to an independent third party on the date of the consolidated financial statements. Non‑Agencies are categorized in Level 2 of the fair value hierarchy.

Commercial Mortgage Loans - Commercial mortgage loans are recognized at fair value. The fair value of commercial mortgage loans at fair value is predominately based on trading activity observed in the marketplace, provided by a third‑party pricing service. The pricing service obtains comparative pricing from banks, brokers, hedge funds, REITs and from its own brokerage business. The pricing service also maintains a spread matrix created from trading levels observed in the secondary market and from indications of holding values in client investments. The spreads are meant to depict the required spread demanded by investors in the current environment. The performing commercial mortgage loans are generally categorized as Level 2 securities in the fair value hierarchy, while non-performing loans are categorized as Level 3 given their limited marketability and availability of observable valuation inputs.

Residential Mortgage Loans - The Company recognizes residential mortgage loans at fair value. The fair value of the residential mortgage loans is predominantly based on trading activity observed in the marketplace, provided by a third‑party pricing service. The third‑party pricing service obtains comparative pricing from banks, brokers, hedge funds, REITs and from its own brokerage business. The third‑party pricing service also maintains a spread matrix created from trading levels observed in the secondary market and from indications of holding values in client investments. The spreads are meant to depict the required spread demanded by investors in the current environment. The matrix is segregated by loan structure type (hybrid arm, fixed rate, home equity line of credit, second lien, pay option arm, etc.), delinquency status, and loan to value strata. Significant matrix inputs are analyzed at the loan level. The performing residential mortgage loans are categorized as Level 2 in the fair value hierarchy, while non‑performing loans are categorized as Level 3 given their limited marketability and availability of observable valuation inputs. Both Level 2 and Level 3 loans matrix inputs include collateral behavioral models including prepayment rates, default rates, loss severity, and discount rates.

Valuation Processes

The Company’s Manager establishes valuation processes and procedures to ensure that the valuation techniques are fair and consistent, and valuation inputs are verifiable. The valuation committee of the Company’s Manager (the “Committee”) oversees the valuation process of the Company’s investments. The Committee is comprised of various personnel of the Company’s Manager, including those that are separate from the Company’s portfolio management and trading functions. The Committee is responsible for developing the Company’s written valuation processes and procedures, conducting periodic reviews of the valuation policies, and evaluating the overall fairness and consistent application of the valuation policies. The Committee meets on a monthly basis, or more frequently as needed, to review the valuations of the Company’s investments. If a security does not have a pricing source which is available or reliable, the Company’s Manager considers all appropriate factors relevant to determine the fair value of the security. Valuations determined by the Company’s Manager are required to be supported by market data, third‑party pricing sources, and industry accepted pricing models.

The following table sets forth information about the Company’s financial assets measured at fair value as of December 31, 2021:


	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets, at fair value
Residential mortgage loans	$	—	$	1,056,875	$	5,037	$	1,061,912
Residential mortgage loans in securitization trusts	—		665,802		1,563		667,365
Commercial mortgage loans	—		18,145		519		18,664
Investments in securities
Non-Agency RMBS (1)	—		113,579		—		113,579
Agency whole pool loan securities	—		372,055		—		372,055
AOMT CMBS (1)	—		10,756		—		10,756
U.S. Treasury Bills	249,999		—		—		249,999
Unrealized appreciation on TBAs (2)	2,428		—		—		2,428
Total assets	$	252,427	$	2,237,212	$	7,119	$	2,496,758

Liabilities, at fair value
Unrealized depreciation on futures contracts	$	728	$	—	$	—	$	728
Total liabilities	$	728	$	—	$	—	$	728

(1) Non‑Agency RMBS held as of December 31, 2021 included both retained tranches of AOMT securitizations in which the Company participated, additional AOMT securities purchased in secondary market transactions, and other RMBS purchased in secondary market transactions. All AOMT CMBS held as of December 31, 2021 was comprised of retained tranches of AOMT securitizations.

(2) “Unrealized appreciation on TBAs” is included in “other assets” on the consolidated balance sheet.

All unrealized gains and losses arising from valuation changes in residential and commercial mortgage loans, TBAs, and futures contracts are recognized in net income for the periods presented.

Transfers from Level 2 to Level 3 were comprised of residential loans more than 90 days overdue (including those in foreclosure) and commercial mortgage loans in special servicing or otherwise considered “non‑performing” by the Company’s third‑party valuation providers. Transfers between Levels are deemed to take place on the first day of the reporting period in which the transfer has taken place. Transfers between Level 2 and Level 3 were immaterial for the year ended December 31, 2021.

We use third‑party valuation firms who utilize proprietary methodologies to value our residential and commercial loans. These firms generally use both market comparable information and discounted cash flow modeling techniques to determine the fair value of our Level 3 assets. Use of these techniques requires determination of relevant input and assumptions, some of which represent significant unobservable inputs such as anticipated credit losses, prepayment rates, default rates, or other valuation assumptions. Accordingly, a significant increase or decrease in any of these inputs in isolation may result in a significantly lower or higher fair value measurement. The following table sets forth information regarding the Company’s significant Level 3 inputs as of December 31, 2021:


				Input Values
Asset	Fair Value		Unobservable Input	Range	Average
Residential mortgage loans, at fair value	$	5,037	Prepayment rate (annual CPR)	—% - 20.85%	6.89%
			Default rate	—% - 37.32%	13.05%
			Loss severity	(20.31)% - 36.35%	0.89%
			Expected remaining life	0.04 - 2.75 years	1.72 years

Residential mortgage loans in securitization trust, at fair value	$	1,563	Prepayment rate (annual CPR)	—% - 20.85%	6.89%
			Default rate	—% - 37.32%	13.05%
			Loss severity	(20.31)% - 36.35%	0.89%
			Expected remaining life	0.04 - 2.75 years	1.72 years

Commercial mortgage loans, at fair value	$	519	Loss severity	(25.00)%	(25.00)%
			Sale or Liquidation timeline	39 - 50 months	39 - 50 months

The following table sets forth information about the Company’s financial assets and liabilities measured at fair value as of December 31, 2020 (1):


	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets, at fair value
Residential mortgage loans	$	—	$	128,897	$	13,133	$	142,030
Commercial mortgage loans	—		6,859		607		7,466
Investments in securities
Non-Agency RMBS (1)	—		149,936		—		149,936
AOMT CMBS (1)	—		8,796		—		8,796
U.S. Treasury Bills	149,995		—		—		149,995
Total assets at fair value	$	149,995	$	294,488	$	13,740	$	458,223

Liabilities, at fair value
Unrealized depreciation on futures contracts	$	198	$	—	$	—	$	198
Total liabilities at fair value	$	198	$	—	$	—	$	198

(1) Non‑Agency RMBS held as of December 31, 2020 included both retained tranches of AOMT securitizations in which the Company participated, additional AOMT securities purchased in secondary market transactions, and other RMBS purchased in secondary market transactions. All AOMT CMBS held as of December 31, 2020 was comprised of retained tranches of AOMT securitizations.

All unrealized gains and losses arising from valuation changes in residential and commercial mortgage loans and futures contracts are recognized in net income for the periods presented.


				Input Values
Asset	Fair Value		Unobservable Input	Range	Average
Residential mortgage loans, at fair value	$	13,133	Prepayment rate (annual CPR)	—% - 15.77%	5.95%
			Default rate	5.58% - 24.79%	16.80%
			Loss severity	(13.21)% - 29.31%	3.29%
			Expected remaining life	0.70 - 2.42 years	1.87 years
Commercial mortgage loans, at fair value	$	607	Loss severity	(16.75%)	(16.75%)
			Sale or Liquidation timeline	15 - 23 months	15 - 23 months

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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