Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 2012

Fair Value Disclosures [Abstract]

Fair Value of Financial Instruments

FAIR VALUE OF FINANCIAL INSTRUMENTS

ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 clarifies that fair value should be based on the assumptions market participants would use when pricing as asset or liability and also requires an entity to consider all aspects of nonperformance risk, including the entity's own credit standing, when measuring fair value of a liability. ASC Topic 820 established a valuation hierarchy of three levels as follows:

• Level 1 – Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities as of the measurement date.

• Level 2 – Inputs include quoted prices in active markets for similar assets or liabilities; quoted prices in inactive markets for identical or similar assets or liabilities; or inputs are either directly observable or indirectly observable through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.  The Company’s fair valued assets and liabilities that are generally included in this category are Agency MBS, certain non-Agency MBS, and derivatives.

• Level 3 – Unobservable inputs are supported by little or no market activity. The unobservable inputs represent management’s best estimate of how market participants would price the asset or liability at the measurement date.  Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.  The Company’s fair valued assets and liabilities that are generally included in this category are certain non-Agency MBS.

The following table presents the fair value of the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2012, segregated by the hierarchy level of the fair value estimate:

			Fair Value Measurements
	Fair Value		Level 1		Level 2		Level 3
Assets:
Agency MBS	$	3,650,672	$	—	$	3,650,672	$	—
Non-Agency MBS:
CMBS (including CMBS IO)	572,690		—		472,374		100,316
RMBS	14,241		—		5,640		8,601
Other investments	25		—		—		25
Total assets carried at fair value	$	4,237,628	$	—	$	4,128,686	$	108,942
Liabilities:
Derivative liabilities	$	46,496	$	—	$	46,496	$	—
Total liabilities carried at fair value	$	46,496	$	—	$	46,496	$	—

The Company’s Agency MBS, as well a portion of its non-Agency CMBS, are substantially similar to securities that either are currently actively traded or have been recently traded in their respective market.  Their fair values are derived from an average of multiple dealer quotes and thus are considered Level 2 fair value measurements.

The Company’s remaining non-Agency CMBS and non-Agency RMBS are comprised of securities for which there are not substantially similar securities that trade frequently.  As such, the Company determines the fair value of those securities by discounting the estimated future cash flows derived from cash flow models using assumptions that are confirmed to the extent possible by third party dealers or other pricing indicators.  Significant inputs into those pricing models are Level 3 in nature due to the lack of readily available market quotes.  Information utilized in those pricing models include the security’s credit rating, coupon rate, estimated prepayment speeds, expected weighted average life, collateral composition, estimated future interest rates, expected credit losses, and credit enhancement as well as certain other relevant information.  Significant increases (decreases) in any of these inputs in isolation would result in a significantly lower (higher) fair value measurement. A change in the assumption used for the probability of default may be accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

The table below presents information about the significant unobservable inputs used in the fair value measurement for the Company's Level 3 non-Agency RMBS and CMBS during the three and nine months ended September 30, 2012:

	Quantitative Information about Level 3 Fair Value Measurements(1)
	Prepayment Speed		Default Rate		Severity		Discount Rate
Non-Agency CMBS	20 CPY		2.5	%	35.0	%	4.4	%
Non-Agency RMBS	5	CPR	0.5	%	9.0	%	5.1	%

(1) Data presented are weighted averages.

The following tables present the activity of the instruments fair valued at Level 3 for the three and nine months ended September 30, 2012:

	For the Three Months Ended September 30, 2012
	Level 3 Fair Values
	Non-Agency CMBS			Non-Agency RMBS			Other		Total assets
Balance as of June 30, 2012	$	104,515		$	12,657		$	25	$	117,197
Total unrealized losses:
Included in other comprehensive income	90			41			—		131
Principal payments	(4,194		)	(4,108		)	—		(8,302		)
Amortization	(95		)	11			—		(84		)
Balance as of September 30, 2012	$	100,316		$	8,601		$	25	$	108,942

	For the Nine Months Ended September 30, 2012
	Level 3 Fair Values
	Non-Agency CMBS			Non-Agency RMBS			Other		Total assets
Balance as of December 31, 2011	$	123,703		$	10,296		$	25	$	134,024
Purchases	—			7,500			—		7,500
Transfers out to Level 2	(4,670		)	—			—		(4,670		)
Total unrealized losses:
Included in other comprehensive income	(1,934		)	117			—		(1,817		)
Principal payments	(16,409		)	(9,349		)	—		(25,758		)
Amortization	(374		)	37			—		(337		)
Balance as of September 30, 2012	$	100,316		$	8,601		$	25	$	108,942

The Company evaluates the availability and quality of valuation inputs for its Level 3 securities on a monthly basis. When it determines that there are sufficient observable market inputs for the same or similar securities, the securities are transferred to Level 2 at the end of the reporting period in which that determination is made. As shown in the tables above for the nine months ended September 30, 2012, the Company transferred two of its non-Agency CMBS from Level 3 to Level 2 during the second quarter of 2012. The liquidity for securities similar to these non-Agency CMBS improved such that the Company was able to obtain market discount rates and prepayment speeds which it used in establishing the fair value of these two non-Agency CMBS.

The following table presents the recorded basis and estimated fair values of the Company’s financial instruments as of September 30, 2012 and December 31, 2011:

	September 30, 2012				December 31, 2011
	Recorded Basis		Fair Value		Recorded Basis		Fair Value
Assets:
Agency MBS	$	3,650,672	$	3,650,672	$	1,965,159	$	1,965,159
Non-Agency CMBS	572,690		572,690		405,826		405,826
Non-Agency RMBS	14,241		14,241		15,270		15,270
Securitized mortgage loans, net	77,748		66,879		113,703		101,116
Other investments	896		842		1,018		892
Liabilities:
Repurchase agreements	$	3,670,972	$	3,670,972	$	2,093,793	$	2,093,793
Non-recourse collateralized financing	31,295		31,013		70,895		69,752
Derivative liabilities	46,496		46,496		27,997		27,997

There were no assets or liabilities which were measured at fair value on a non-recurring basis as of September 30, 2012 or December 31, 2011.