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Fair Value of Financial Instruments (Tables)

9 Months Ended

Sep. 30, 2019

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 Topic 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an 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 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.


•	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 following table presents the Company’s financial instruments that are measured at fair value on a recurring basis by their valuation hierarchy levels as of the dates indicated:



	September 30, 2019								December 31, 2018
	Fair Value		Level 1		Level 2		Level 3		Fair Value		Level 1		Level 2		Level 3
Assets carried at fair value:
MBS	$	5,302,926	$	—	$	5,301,118	$	1,808	$	3,749,464	$	—	$	3,747,190	$	2,274
Derivative assets:
Interest rate swaps	—		—		—		—		324		—		324		—
Interest rate swaptions	1,851		—		1,851		—		—		—		—		—
Futures	928		928		—		—		—		—		—		—
TBA securities-net long positions	2,066		—		2,066		—		6,239		—		6,239		—
Total assets carried at fair value	$	5,307,771	$	928	$	5,305,035	$	1,808	$	3,756,027	$	—	$	3,753,753	$	2,274

Liabilities carried at fair value:
TBA-net short positions	439		—		439		—		—		—		—		—
Futures	—		—		—		—		1,218		1,218		—		—
Total liabilities carried at fair value	$	439	$	—	$	439	$	—	$	1,218	$	1,218	$	—	$	—

The fair value of interest rate swaps is measured using the income approach with the primary input being the forward interest rate swap curve, which is considered an observable input, and thus their fair values are considered Level 2 measurements. As of September 30, 2019, all of the Company’s interest rate swap agreements are centrally cleared through the CME. Please refer to Note 1 for information regarding the exchange of variation margin being legally considered as settlement of the derivative as opposed to a pledge of collateral. The amount shown as of December 31, 2018 for interest rate swaps is the unsettled fair value of the instruments subject to bilateral agreements and not centrally cleared through the CME as of that date. The fair value

of interest rate swaptions is based on the fair value of the underlying interest rate swap and time remaining until its expiration. U.S. Treasury futures (held as of December 31, 2018) and Eurodollar futures (held as of September 30, 2019) are valued based on closing exchange prices on these contracts and are classified accordingly as Level 1 measurements. The fair value of TBA securities is estimated using methods similar those used to fair value the Company’s Level 2 MBS.

The fair value measurements for a majority of the Company's MBS are considered Level 2 because these securities are substantially similar to securities that either are actively traded or have been recently traded in their respective markets. The Company determines the fair value of its Level 2 securities based on prices received from the Company's primary pricing service as well as other pricing services and brokers. The Company evaluates the third-party prices it receives to assess their reasonableness. Although the Company does not adjust third-party prices, they may be excluded from use in the determination of a security's fair value if they are significantly different from other observable market data. In valuing a security, the primary pricing service uses either a market approach, which uses observable prices and other relevant information that is generated by market transactions of identical or similar securities, or an income approach, which uses valuation techniques to convert future amounts to a single, discounted present value amount. The Company also reviews the assumptions and inputs utilized in the valuation techniques of its primary pricing service. Examples of these observable inputs and assumptions include market interest rates, credit spreads, and projected prepayment speeds, among other things.

The Company owns certain non-Agency MBS for which there are not sufficiently recent trades of substantially similar securities, and their fair value measurements are thus considered Level 3. The Company determines the fair value of its Level 3 securities by discounting the estimated future cash flows derived from cash flow models using significant inputs which are determined by the Company when market observable inputs are not available. 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 changes in any of these inputs in isolation may result in a significantly different fair value measurement. Level 3 assets are generally most sensitive to the default rate and severity assumptions.

The activity of the Company’s non-Agency MBS measured at fair value on a recurring basis using Level 3 inputs is presented in the following table for the periods indicated:



	Nine Months Ended
	September 30,
	2019			2018
Balance as of beginning of period	$	2,274		$	7,243
Unrealized gain included in OCI	225			(862		)
Principal payments	(1,853		)	(1,031		)
Accretion	1,162			886
Balance as of end of period	$	1,808		$	6,236

The Company reviews the classification of its financial instruments within the fair value hierarchy on a quarterly basis, and management may conclude that its financial instruments should be reclassified to a different level in the future if a change in type of inputs occurs.

The following table presents a summary of the carrying value and estimated fair values of the Company’s financial instruments as of the dates indicated:



	September 30, 2019				December 31, 2018
	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets:
Mortgage-backed securities	$	5,302,926	$	5,302,926	$	3,749,464	$	3,749,464
Mortgage loans held for investment, net ⁽¹⁾	9,836		6,779		11,527		8,566
Derivative assets	4,845		4,845		6,563		6,563
Liabilities:
Repurchase agreements ⁽²⁾	$	4,872,869	$	4,872,869	$	3,267,984	$	3,267,984
Non-recourse collateralized financing ⁽¹⁾	2,950		2,984		3,458		3,475
Derivative liabilities	439		439		1,218		1,218


(1)	The Company determines the fair value of its mortgage loans held for investment, net and its non-recourse collateralized financing using internally developed cash flow models with inputs similar to those used to estimate the fair value of the Company’s Level 3 non-Agency MBS.

(2)

The carrying value of repurchase agreements generally approximates fair value due to their short-term maturities.

Schedule of Fair Value, Assets and Liabilities Measured on Recurring Basis

The following table presents the Company’s financial instruments that are measured at fair value on a recurring basis by their valuation hierarchy levels as of the dates indicated:



	September 30, 2019								December 31, 2018
	Fair Value		Level 1		Level 2		Level 3		Fair Value		Level 1		Level 2		Level 3
Assets carried at fair value:
MBS	$	5,302,926	$	—	$	5,301,118	$	1,808	$	3,749,464	$	—	$	3,747,190	$	2,274
Derivative assets:
Interest rate swaps	—		—		—		—		324		—		324		—
Interest rate swaptions	1,851		—		1,851		—		—		—		—		—
Futures	928		928		—		—		—		—		—		—
TBA securities-net long positions	2,066		—		2,066		—		6,239		—		6,239		—
Total assets carried at fair value	$	5,307,771	$	928	$	5,305,035	$	1,808	$	3,756,027	$	—	$	3,753,753	$	2,274

Liabilities carried at fair value:
TBA-net short positions	439		—		439		—		—		—		—		—
Futures	—		—		—		—		1,218		1,218		—		—
Total liabilities carried at fair value	$	439	$	—	$	439	$	—	$	1,218	$	1,218	$	—	$	—

Fair Value, Assets Measured on Recurring Basis, Unobservable Input Reconciliation

The activity of the Company’s non-Agency MBS measured at fair value on a recurring basis using Level 3 inputs is presented in the following table for the periods indicated:



	Nine Months Ended
	September 30,
	2019			2018
Balance as of beginning of period	$	2,274		$	7,243
Unrealized gain included in OCI	225			(862		)
Principal payments	(1,853		)	(1,031		)
Accretion	1,162			886
Balance as of end of period	$	1,808		$	6,236

Fair Value, by Balance Sheet Grouping

The following table presents a summary of the carrying value and estimated fair values of the Company’s financial instruments as of the dates indicated:



	September 30, 2019				December 31, 2018
	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets:
Mortgage-backed securities	$	5,302,926	$	5,302,926	$	3,749,464	$	3,749,464
Mortgage loans held for investment, net ⁽¹⁾	9,836		6,779		11,527		8,566
Derivative assets	4,845		4,845		6,563		6,563
Liabilities:
Repurchase agreements ⁽²⁾	$	4,872,869	$	4,872,869	$	3,267,984	$	3,267,984
Non-recourse collateralized financing ⁽¹⁾	2,950		2,984		3,458		3,475
Derivative liabilities	439		439		1,218		1,218


(1)	The Company determines the fair value of its mortgage loans held for investment, net and its non-recourse collateralized financing using internally developed cash flow models with inputs similar to those used to estimate the fair value of the Company’s Level 3 non-Agency MBS.

(2)

The carrying value of repurchase agreements generally approximates fair value due to their short-term maturities.

- 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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