UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X]              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: March 31, 2017
OR
[  ]              TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO _________________
COMMISSION FILE NUMBER: 1-33796
CHIMERA INVESTMENT CORPORATION
(Exact name of Registrant as specified in its Charter) 
MARYLAND
 
26-0630461
(State or other jurisdiction of incorporation or organization)
 
 (IRS Employer Identification No.)
                                                                                                                                             
520 Madison Avenue
32nd Floor
NEW YORK, NEW YORK
(Address of principal executive offices)
10022
(Zip Code)
(212) 626-2300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:
Yes þ No ☐
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer,” and “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No þ
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:
Class
Outstanding at April 30, 2017
Common Stock, $0.01 par value
187,779,489




CHIMERA INVESTMENT CORPORATION

FORM 10-Q
TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
Consolidated Statements of Financial Condition as of March 31, 2017 (Unaudited) and December 31, 2016 (Derived from the audited consolidated financial statements as of December 31, 2016)
 
 
Consolidated Statements of Operations (Unaudited) for the three months ended March 31, 2017 and 2016
 
 
Consolidated Statements of Comprehensive Income (Unaudited) for the three months ended March 31, 2017 and 2016
 
 
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the three months ended March 31, 2017 and 2016
 
 
Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2017 and 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



1



Part I
Item 1. Consolidated Financial Statements
CHIMERA INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except share and per share data)
(Unaudited)
 
March 31, 2017
December 31, 2016
Assets:
 
 
Cash and cash equivalents
$
82,556

$
177,714

Non-Agency RMBS, at fair value
3,228,391

3,330,063

Agency MBS, at fair value
4,101,851

4,167,754

Securitized loans held for investment, at fair value
12,713,273

8,753,653

Accrued interest receivable
99,669

79,697

Other assets
190,021

166,350

Derivatives, at fair value, net
10,889

9,677

Total assets (1)
$
20,426,650

$
16,684,908

Liabilities:
 

 

Repurchase agreements ($7.3 billion and $7.0 billion, MBS pledged as collateral, respectively)
$
5,851,204

$
5,600,903

Securitized debt, collateralized by Non-Agency RMBS ($1.8 billion pledged as collateral)
303,389

334,124

Securitized debt at fair value, collateralized by loans held for investment ($12.7 billion and $8.8 billion pledged as collateral, respectively)
10,111,293

6,941,097

Payable for investments purchased
473,269

520,532

Accrued interest payable
67,596

48,670

Dividends payable
97,008

97,005

Accounts payable and other liabilities
9,176

16,694

Derivatives, at fair value
1,627

2,350

Total liabilities (1)
$
16,914,562

$
13,561,375






Commitments and Contingencies (See Note 15)









Stockholders' Equity:
 

 

Preferred Stock, par value of $0.01 per share, 100,000,000 shares authorized:




8.00% Series A cumulative redeemable: 5,800,000 shares issued and outstanding, respectively ($145,000 liquidation preference)
$
58

$
58

8.00% Series B cumulative redeemable: 13,000,000 and 0 shares issued and outstanding, respectively ($325,000 liquidation preference)
130


Common stock: par value $0.01 per share; 300,000,000 shares authorized, 187,779,489 and 187,739,634 shares issued and outstanding, respectively
1,878

1,877

Additional paid-in-capital
3,824,197

3,508,779

Accumulated other comprehensive income
727,711

718,106

Cumulative earnings
2,605,991

2,443,184

Cumulative distributions to stockholders
(3,647,877
)
(3,548,471
)
Total stockholders' equity
$
3,512,088

$
3,123,533

Total liabilities and stockholders' equity
$
20,426,650

$
16,684,908

(1) The Company's consolidated statements of financial condition include assets of consolidated variable interest entities (“VIEs”) that can only be used to settle obligations and liabilities of the VIE for which creditors do not have recourse to the primary beneficiary (Chimera Investment Corporation). As of March 31, 2017 and December 31, 2016, total assets of consolidated VIEs were $14,693,307 and $10,761,954, respectively, and total liabilities of consolidated VIEs were $10,451,235 and $7,300,163, respectively. See Note 8 for further discussion.

See accompanying notes to consolidated financial statements.


2



CHIMERA INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except share and per share data)
(Unaudited)
 
For the Quarters Ended

March 31, 2017
March 31, 2016
Net Interest Income:


Interest income (1)
$
251,344

$
201,194

Interest expense (2)
110,231

62,981

Net interest income
141,113

138,213

Other-than-temporary impairments:
 

 

Total other-than-temporary impairment losses
(2,713
)
(4,423
)
Portion of loss recognized in other comprehensive income
(15,988
)
(6,255
)
Net other-than-temporary credit impairment losses
(18,701
)
(10,678
)
Other investment gains (losses):
 

 

Net unrealized gains (losses) on derivatives
4,896

(101,110
)
Realized gains (losses) on terminations of interest rate swaps

(458
)
Net realized gains (losses) on derivatives
(9,358
)
(34,969
)
Net gains (losses) on derivatives
(4,462
)
(136,537
)
Net unrealized gains (losses) on financial instruments at fair value
72,243

16,871

Net realized gains (losses) on sales of investments
5,167

(2,674
)
Gains (losses) on Extinguishment of Debt

(1,766
)
Total other gains (losses)
72,948

(124,106
)
 
 
 
Other income:
 

 

Other income

95,000

Total other income

95,000

 
 
 
Other expenses:
 

 

Compensation and benefits
7,556

5,222

General and administrative expenses
4,040

4,503

Servicing Fees of consolidated VIEs
9,588

5,577

Deal Expenses
11,353


Total other expenses
32,537

15,302

Income (loss) before income taxes
162,823

83,127

Income taxes
16

29

Net income (loss)
$
162,807

$
83,098






Dividend on preferred stock
5,283







Net income (loss) available to common shareholders
$
157,524

$
83,098






Net income (loss) per share available to common shareholders:


 

Basic
$
0.84

$
0.44

Diluted
$
0.84

$
0.44






Weighted average number of common shares outstanding:
 

 

Basic
187,761,748

187,723,472

Diluted
188,195,061

187,840,182






Dividends declared per share of common stock
$
0.50

$
0.98








(1) Includes interest income of consolidated VIEs of $192,989 and $131,980 for the quarters ended March 31, 2017 and 2016 respectively. See Note 8 to consolidated financial statements for further discussion.
(2) Includes interest expense of consolidated VIEs of $82,684 and $39,250 for the quarters ended March 31, 2017 and 2016 respectively. See Note 8 to consolidated financial statements for further discussion.

See accompanying notes to consolidated financial statements.


3




CHIMERA INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(dollars in thousands, except share and per share data)
(Unaudited)




For the Quarters Ended

March 31, 2017
March 31, 2016
Comprehensive income (loss):
 

Net income (loss)
$
162,807

$
83,098

Other comprehensive income:
 

Unrealized gains (losses) on available-for-sale securities, net
(3,910
)
59,408

Reclassification adjustment for net losses included in net income for other-than-temporary credit impairment losses
18,701

10,678

Reclassification adjustment for net realized losses (gains) included in net income
(5,186
)
(1,612
)
Other comprehensive income (loss)
9,605

68,474

Comprehensive income (loss) before preferred stock dividends
$
172,412

$
151,572

Dividends on preferred stock
$
5,283

$

Comprehensive income (loss) available to common stock shareholders
$
167,129

$
151,572




4



CHIMERA INVESTMENT CORPORATION      
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(dollars in thousands, except per share data)
(Unaudited)
 
Series A Preferred Stock Par Value
Series B Preferred Stock Par Value
Common
Stock Par
Value
Additional Paid-in Capital
Accumulated Other Comprehensive Income
Cumulative Earnings
Cumulative Distributions to Stockholders
Total
Balance, December 31, 2015
$

$

$
1,877

$
3,366,568

$
773,791

$
1,891,239

$
(3,087,287
)
$
2,946,188

Net income (loss)





83,098


83,098

Other comprehensive income (loss)




68,474



68,474

Stock based compensation


0

102




102

Repurchase of common stock








Common dividends declared






(184,227
)
(184,227
)
Balance, March 31, 2016
$

$

$
1,877

$
3,366,670

$
842,265

$
1,974,337

$
(3,271,514
)
$
2,913,635

 
 
 
 
 
 
 
 
 
Balance, December 31, 2016
$
58

$

$
1,877

$
3,508,779

$
718,106

$
2,443,184

$
(3,548,471
)
$
3,123,533

Net income (loss)





162,807


162,807

Other comprehensive income (loss)




9,605



9,605

Stock based compensation


1

1,119




1,120

Common dividends declared






(94,123
)
(94,123
)
Preferred dividends declared






(5,283
)
(5,283
)
Issuance of preferred stock

130


314,299




314,429

Balance, March 31, 2017
$
58

$
130

$
1,878

$
3,824,197

$
727,711

$
2,605,991

$
(3,647,877
)
$
3,512,088



See accompanying notes to consolidated financial statements.


5



CHIMERA INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(Unaudited)
 
For the Quarter Ended
 
March 31, 2017
March 31, 2016
Cash Flows From Operating Activities:
Net income
$
162,807

$
83,098

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
(Accretion) amortization of investment discounts/premiums, net
(13,712
)
6,469

Accretion (amortization) of deferred financing costs and securitized debt discounts/premiums, net
5,109

2,581

Amortization of swaption premium
3,303

1,656

Net unrealized losses (gains) on derivatives
(4,896
)
101,110

Margin (paid) received on derivatives
4,974

(98,958
)
Net unrealized losses (gains) on financial instruments at fair value
(72,243
)
(16,871
)
Net realized losses (gains) on sales of investments
(5,167
)
2,674

Net other-than-temporary credit impairment losses
18,701

10,678

(Gain) loss on extinguishment of debt

1,766

Equity-based compensation expense
1,119

102

Changes in operating assets:


 

Decrease (increase) in accrued interest receivable, net
(19,972
)
1,194

Decrease (increase) in other assets
(30,275
)
9,440

Changes in operating liabilities:


 

Increase (decrease) in accounts payable and other liabilities
(7,517
)
(5,810
)
Increase (decrease) in accrued interest payable, net
18,929

8,441

Net cash provided by (used in) operating activities
$
61,160

$
107,570

Cash Flows From Investing Activities:
Agency MBS portfolio:
 

 

Purchases
$
(113,599
)
$
(441,308
)
Sales

270,196

Principal payments
115,237

123,590

Non-Agency RMBS portfolio:
 

 

Purchases
(5,663
)
(41,947
)
Sales

283

Principal payments
127,929

124,013

Securitized loans held for investment:
 

 

Purchases
(4,165,322
)

Principal payments
324,851

145,871

Net cash provided by (used in) investing activities
$
(3,716,567
)
$
180,698

Cash Flows From Financing Activities:
Proceeds from repurchase agreements
$
6,551,098

$
7,897,654

Payments on repurchase agreements
(6,300,798
)
(7,791,362
)
Net proceeds from preferred stock offerings
314,429


Proceeds from securitized debt borrowings, collateralized by loans held for investment
3,457,535

98,263

Payments on securitized debt borrowings, collateralized by loans held for investment
(331,290
)
(197,595
)
Payments on securitized debt borrowings, collateralized by Non-Agency RMBS
(31,320
)
(34,880
)
Common dividends paid
(94,056
)
(183,957
)
Preferred dividends paid
(5,349
)

Net cash provided by (used in) financing activities
$
3,560,249

$
(211,877
)
Net increase (decrease) in cash and cash equivalents
(95,158
)
76,391

Cash and cash equivalents at beginning of period
177,714

114,062

Cash and cash equivalents at end of period
$
82,556

$
190,453

 
 
 
Supplemental disclosure of cash flow information:
Interest received
$
217,660

$
208,857

Interest paid
$
86,193

$
51,959

Non-cash investing activities:
 

 

Payable for investments purchased
$
473,269

$
582,875

Net change in unrealized gain (loss) on available-for sale securities
$
9,605

$
68,474






Non-cash financing activities:
 

 

    Common dividends declared, not yet paid
$
94,625

$
90,367

See accompanying notes to consolidated financial statements.

6



CHIMERA INVESTMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. Organization

Chimera Investment Corporation (the “Company”) was organized in Maryland on June 1, 2007. The Company commenced operations on November 21, 2007 when it completed its initial public offering. The Company elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended, and regulations promulgated thereunder (the “Code”).

The Company conducts its operations through various subsidiaries including subsidiaries it treats as taxable REIT subsidiaries (“TRS”). In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate related business. The Company currently has eight wholly owned direct subsidiaries: Chimera RMBS Whole Pool LLC, and Chimera RMBS LLC formed in June 2009; CIM Trading Company LLC (“CIM Trading”), formed in July 2010; Chimera Funding TRS LLC (“CIM Funding TRS”), a TRS formed in October 2013, Chimera CMBS Whole Pool LLC and Chimera RMBS Securities LLC formed in March 2015; Chimera Insurance Company, LLC formed in July 2015 and Chimera RR Holdings LLC formed in April 2016.

2. Summary of the Significant Accounting Policies

(a) Basis of Presentation and Consolidation

The accompanying consolidated financial statements and related notes of the Company have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). In the opinion of management, all adjustments considered necessary for a fair presentation of the Company's financial position, results of operations and cash flows have been included. Certain prior period amounts have been reclassified to conform to the current period's presentation.

The consolidated financial statements include, the Company’s accounts, the accounts of its wholly-owned subsidiaries, and variable interest entities (“VIEs”) in which the Company is the primary beneficiary. All intercompany balances and transactions have been eliminated in consolidation.

The Company uses securitization trusts considered to be VIEs in its securitization and re-securitization transactions. VIEs are defined as entities in which equity investors (i) do not have the characteristics of a controlling financial interest, or (ii) do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The entity that consolidates a VIE is known as its primary beneficiary, and is generally the entity with (i) the power to direct the activities that most significantly impact the VIEs’ economic performance, and (ii) the right to receive benefits from the VIE or the obligation to absorb losses of the VIE that could be significant to the VIE. For VIEs that do not have substantial on-going activities, the power to direct the activities that most significantly impact the VIEs’ economic performance may be determined by an entity’s involvement with the design and structure of the VIE.

The trusts are structured as pass through entities that receive principal and interest on the underlying collateral and distribute those payments to the security holders. The assets held by the securitization entities are restricted in that they can only be used to fulfill the obligations of the securitization entity. The Company’s risks associated with its involvement with these VIEs are limited to its risks and rights as a holder of the security it has retained.

Determining the primary beneficiary of a VIE requires significant judgment. The Company determined that for the securitizations it consolidates, its ownership provides the Company with the obligation to absorb losses or the right to receive benefits from the VIE that could be significant to the VIE. In addition, the Company has the power to direct the activities of the VIEs that most significantly impact the VIEs’ economic performance (“power”) such as rights to direct servicer activity or the Company was determined to have power in connection with its involvement with the purpose and design of the VIE.

The Company’s interest in the assets held by these securitization vehicles, which are consolidated on the Company’s Statements of Financial Condition, is restricted by the structural provisions of these trusts, and a recovery of the Company’s investment in the vehicles will be limited by each entity’s distribution provisions. The liabilities of the securitization vehicles, which are also consolidated on the Company’s Statements of Financial Condition, are non-recourse to the Company, and can generally only be satisfied from each securitization vehicle’s respective asset pool.


7



The assets of securitization entities are comprised of senior classes of residential mortgage backed securities (“RMBS”) or residential mortgage loans. See Notes 3, 4 and 8 for further discussion of the characteristics of the securities and loans in the Company’s portfolio.

(b) Statements of Financial Condition Presentation

The Company’s Consolidated Statements of Financial Condition include both the Company’s direct assets and liabilities and the assets and liabilities of consolidated securitization vehicles. Assets of each consolidated VIE can only be used to satisfy the obligations of that VIE, and the liabilities of consolidated VIEs are non-recourse to the Company. The Company is not obligated to provide, nor does it intend to provide, any financial support to these consolidated securitization vehicles. The notes to the consolidated financial statements describe the Company’s assets and liabilities including the assets and liabilities of consolidated securitization vehicles. See Note 8 for additional information related to the Company’s investments in consolidated securitization vehicles.

(c) Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although the Company’s estimates contemplate current conditions and how it expects them to change in the future, it is reasonably possible that actual conditions could be materially different than anticipated in those estimates, which could have a material adverse impact on the Company’s results of operations and its financial condition. Management has made significant estimates including in accounting for income recognition and OTTI on Agency and Non-Agency RMBS and IO MBS (Note 3), valuation of Agency MBS and Non-Agency RMBS (Notes 3 and 5), residential mortgage loans (Note 4), securitized debt (Note 7) and derivative instruments (Notes 5 and 9). Actual results could differ materially from those estimates.

(d) Significant Accounting Policies

There have been no significant changes to the Company's accounting policies included in Note 2 to the consolidated financial statements of the Company’s Form 10-K for the year ended December 31, 2016, other than the significant accounting policies disclosed below.

Income Taxes

The Company does not have any unrecognized tax positions that would affect its financial statements or require disclosure. No accruals for penalties and interest were necessary as of March 31, 2017 or December 31, 2016.

Fair Value Disclosure

A complete discussion of the methodology utilized by the Company to estimate the fair value of its financial instruments is included in Note 5 to these consolidated financial statements.

(e) Recent Accounting Pronouncements

Business Combinations - (Topic 805)

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations - Clarifying the Definition of a Business. This update clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under the current implementation guidance in Topic 805, there are three elements of a business-inputs, processes, and outputs. While an integrated set of assets and activities (collectively referred to as a “set”) that is a business usually has outputs, outputs are not required to be present. The amendments in this Update provide a screen to determine when a set is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated. The guidance in the ASU is effective for the Company as of January 1, 2018. Early adoption is allowed. The amendments in this update should be applied prospectively on or after the effective date. No disclosures are required at transition. The Company is not planning to early adopt and is currently evaluating what impact this update will have on the consolidated financial statements.


8



Statement of Cash Flows - Restricted Cash - (Topic 230)

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows - Restricted Cash. This update requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this Update do not provide a definition of restricted cash or restricted cash equivalents. The guidance in the ASU is effective for the Company as of January 1, 2018. Early adoption is allowed. The amendments in this update should be applied using a retrospective transition method to each period presented. The Company is not planning to early adopt and is currently evaluating what impact this update will have on the consolidated financial statements.

Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments - (Topic 230)

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments. This update provides guidance on eight specific cash flow issues. The guidance is intended to reduce diversity in practice on those issues across all industries. The guidance in the ASU is effective for the Company as of January 1, 2018. Early adoption is allowed. The guidance is to be applied retrospectively, unless it is impracticable to do so for an issue, then the amendments related to that issue would be applied prospectively. The Company did not elect to early adopt the provisions of this update. The Company is currently evaluating what impact this update will have on the consolidated financial statements.

Financial Instruments - Credit Losses - (Topic 326)

In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. This update replaces the current model for recognizing credit losses from an incurred credit loss model to a current expected credit loss (CECL) model for instruments measured at amortized cost and requires entities to record allowances for available-for-sale (AFS) debt securities when the fair value of an AFS debt security is below the amortized cost of the asset rather than reduce the carrying amount, as we do under the current OTTI model. This update also simplifies the accounting model for purchased credit-impaired debt securities and loans. The changes in the allowances created in accordance with this update will be recorded in earnings. The update also expands the disclosure requirements regarding the Company's assumptions, models, and methods for estimating the expected credit losses. In addition, the Company will disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. The guidance in the ASU is effective for the Company as of January 1, 2020. Early adoption is allowed, beginning January 1, 2019. The standard requires entities to record a cumulative-effect adjustment to the statement of financial position as of the beginning of the first reporting period in which the guidance is effective. The Company is currently evaluating what impact this update will have on the consolidated financial statements.

Share Based Payments - (Topic 718)

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. Under this update companies will no longer record excess tax benefits and certain tax deficiencies associated with an award of equity instruments in additional paid-in capital. Instead, they will record all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement when the awards vest or are settled, and additional paid-in capital pools will be eliminated. The updated guidance will also allow the Company to repurchase more shares than it can today for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as they occur. The guidance is to be applied using a modified retrospective transition method with a cumulative-effect adjustment recorded in retained earnings. The Company has adopted this guidance as of January 1, 2017. The adoption of this guidance did not have a significant impact on the Company's financial statements.
 
Contingent Put and Call Options in Debt Instruments - (Topic 815)

In March 2016, the FASB issued ASU No. 2016-06, Contingent Put and Call Options in Debt Instruments Accounting.  This update clarifies that when a call or put option in a debt instrument can accelerate the repayment of principal on the debt instrument, a reporting entity does not need to assess whether the contingent event that triggers the ability to exercise the call or put option is related to interest rates or credit risk in determining whether the option should be accounted for separately as a derivative. The new guidance applies to existing debt instruments (or hybrid financial instruments that are determined to have a debt host) using a modified retrospective method as of the beginning of the period of adoption. The company has adopted this guidance as of January 1, 2017. The adoption of this guidance did not have a significant impact on the Company’s financial statements.

9




Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships - (Topic 815)

In March 2016, the FASB issued ASU No. 2016-05, Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. The amendments in this update clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of itself, require de-designation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The company has adopted this guidance as of January 1, 2017. The Company currently does not apply hedge accounting for GAAP reporting purposes, therefore this guidance did not have a significant impact on the Company’s consolidated financial statements.

Financial Instruments-Overall (Subtopic 825-10)

In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. This update changes how the Company will present changes in the fair value of financial liabilities measured under the fair value option that are attributable to our own credit.  Under the updated guidance, the Company will record changes in instrument-specific credit risk for financial liabilities measured under the fair value option in other comprehensive income.  The update also requires fair value measurement for equity investments that do not result in consolidation and are not accounted for under the equity method to be measured at fair value with any changes in fair value recognized in net income.  The update also eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost. In addition, the Company will have to use the exit price notion when measuring the fair value of financial instruments measured at amortized cost for disclosure purposes.  The guidance in the ASU is effective for the Company as of January 1, 2018. Early adoption for certain provisions of the update is allowed.  Any adjustment as a result of the adoption of this standard will be recorded as a cumulative-effect adjustment to beginning retained earnings as of the first period in which the guidance is adopted.  The Company did not elect to early adopt the provisions of this update and is currently evaluating what impact this update will have on the consolidated financial statements.

3. Mortgage-Backed Securities

The Company classifies its Non-Agency RMBS as senior, senior IO, subordinated, or subordinated IO. The Company also invests in residential, commercial and IO Agency MBS. Senior interests in Non-Agency RMBS are considered to be entitled to the first principal repayments in their pro-rata ownership interests at the acquisition date. The tables below present amortized cost, fair value and unrealized gain/losses of Company's MBS investments as of March 31, 2017 and December 31, 2016.
 
 
March 31, 2017
 
 
 
 
 
 
(dollars in thousands)
 
 
 
 
 
Principal or Notional Value
Total Premium
Total Discount
Amortized Cost
Fair Value
Gross Unrealized Gains
Gross Unrealized Losses
Net Unrealized Gain/(Loss)
Non-Agency RMBS
 
 
 
 
 
 
 
 
Senior
$
3,060,690

$
214

$
(1,361,946
)
$
1,698,958

$
2,438,623

$
739,946

$
(281
)
$
739,665

Senior, interest-only
5,434,402

287,220


287,220

239,511

16,095

(63,804
)
$
(47,709
)
Subordinated
662,469

15,360

(212,416
)
465,413

538,459

74,739

(1,693
)
$
73,046

Subordinated, interest-only
263,126

13,627


13,627

11,798

103

(1,932
)
$
(1,829
)
Agency MBS
 

 

 

 

 

 

 



Residential
2,480,534

144,287


2,624,821

2,587,928

10,566

(47,459
)
$
(36,893
)
Commercial
1,393,290

37,763

(2,761
)
1,428,292

1,382,734

1,334

(46,892
)
$
(45,558
)
Interest-only
3,248,168

139,313


139,313

131,189

877

(9,001
)
$
(8,124
)
Total
$
16,542,679

$
637,784

$
(1,577,123
)
$
6,657,644

$
7,330,242

$
843,660

$
(171,062
)
$
672,598



10



 
 
December 31, 2016
 
 
 
 
 
 
(dollars in thousands)
 
 
 
 
 
Principal or Notional Value
Total Premium
Total Discount
Amortized Cost
Fair Value
Gross Unrealized Gains
Gross Unrealized Losses
Net Unrealized Gain/(Loss)
Non-Agency RMBS
 
 
 
 
 
 
 
 
Senior
$
3,190,947

$
231

$
(1,412,058
)
$
1,779,120

$
2,511,003

$
732,133

$
(250
)
$
731,883

Senior, interest-only
5,648,339

292,396


292,396

253,539

18,674

(57,531
)
(38,857
)
Subordinated
673,259

16,352

(212,734
)
476,877

553,498

77,857

(1,236
)
76,621

Subordinated, interest-only
266,927

13,878


13,878

12,024


(1,854
)
(1,854
)
Agency MBS
 

 

 

 

 

 

 

 

Residential
2,594,570

149,872


2,744,442

2,705,978

11,235

(49,699
)
(38,464
)
Commercial
1,331,543

37,782

(2,688
)
1,366,637

1,316,975

175

(49,837
)
(49,662
)
Interest-only
3,356,491

152,175


152,175

144,800

1,893

(9,268
)
(7,375
)
Total
$
17,062,076

$
662,686

$
(1,627,480
)
$
6,825,525

$
7,497,817

$
841,967

$
(169,675
)
$
672,292


The table below presents changes in accretable yield, or the excess of the security’s cash flows expected to be collected over the Company’s investment, solely as it pertains to the Company’s Non-Agency RMBS portfolio accounted for according to the provisions of ASC 310-30.

 
For the Quarters Ended
 
March 31, 2017
March 31, 2016
 
(dollars in thousands)
Balance at beginning of period
$
1,550,110

$
1,742,744

Purchases
8,216

20,183

Yield income earned
(68,827
)
(72,169
)
Reclassification (to) from non-accretable difference
23,952

35,783

Sales and deconsolidation
(35
)

Balance at end of period
$
1,513,416

$
1,726,541


The table below presents the outstanding principal balance and related amortized cost at March 31, 2017 and December 31, 2016 as it pertains to the Company’s Non-Agency RMBS portfolio accounted for according to the provisions of ASC 310-30.
 
For the Quarter Ended
For the Year Ended
 
March 31, 2017
December 31, 2016
 
(dollars in thousands)
Outstanding principal balance:
 
 
Beginning of period
$
3,138,265

$
3,550,698

End of period
$
3,042,276

$
3,138,265

Amortized cost:
 

 

Beginning of period
$
1,695,079

$
1,958,726

End of period
$
1,635,565

$
1,695,079


The following tables present the gross unrealized losses and estimated fair value of the Company’s RMBS by length of time that such securities have been in a continuous unrealized loss position at March 31, 2017 and December 31, 2016. All securities in an unrealized loss position have been evaluated by the Company for OTTI as discussed in Note 2(d) of 2016, Form 10-K.


11



 
 
 
March 31, 2017
 
 
 
 
 
 
 


(dollars in thousands)
 
 
 
 
 
 
 
Unrealized Loss Position for Less than 12 Months
 
Unrealized Loss Position for 12 Months or More
 
Total
 
Estimated Fair Value
Unrealized Losses
Number of Securities
 
Estimated Fair Value
Unrealized Losses
Number of Securities
 
Estimated Fair Value
Unrealized Losses
Number of Securities
Non-Agency RMBS
 
 
 
 
 
 
 
 
 
 
 
Senior
$
9,776

$
(281
)
2

 
$

$


 
$
9,776

$
(281
)
2
Senior, interest-only
82,622

(16,387
)
59

 
76,566

(47,417
)
91

 
159,188

(63,804
)
150
Subordinated
27,875

(776
)
4

 
3,160

(917
)
4

 
31,035

(1,693
)
8
Subordinated, interest-only
609

(345
)
2

 
4,963

(1,587
)
2

 
5,572

(1,932
)
4
Agency MBS
 

 



 


 

 

 
 

 

 
Residential
2,243,923

(45,850
)
109

 
53,638

(1,609
)
1

 
2,297,561

(47,459
)
110
Commercial
1,164,212

(43,044
)
580

 
51,932

(3,848
)
46

 
1,216,144

(46,892
)
626
Interest-only
65,126

(2,600
)
22

 
46,816

(6,401
)
15

 
111,942

(9,001
)
37
Total
$
3,594,143

$
(109,283
)
778

 
$
237,075

$
(61,779
)
159

 
$
3,831,218

$
(171,062
)
937

 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
(dollars in thousands)
 
 
 
 
 
 
 
Unrealized Loss Position for Less than 12 Months
 
Unrealized Loss Position for 12 Months or More
 
Total
 
Estimated Fair Value
Unrealized Losses
Number of Securities
 
Estimated Fair Value
Unrealized Losses
Number of Securities
 
Estimated Fair Value
Unrealized Losses
Number of Securities
Non-Agency RMBS
 
 
 
 
 
 
 
 
 
 
 
Senior
$
12,384

$
(250
)
3
 
$

$


 
$
12,384

$
(250
)
3
Senior, interest-only
96,399

(13,600
)
62
 
78,516

(43,931
)
86

 
174,915

(57,531
)
148
Subordinated
56,015

(412
)
7
 
2,826

(824
)
4

 
58,841

(1,236
)
11
Subordinated, interest-only
748

(230
)
2
 
11,276

(1,624
)
3

 
12,024

(1,854
)
5
Agency MBS
 

 

 
 
 

 

 

 
 

 

 
Residential
2,338,910

(48,084
)
106
 
54,943

(1,615
)
1

 
2,393,853

(49,699
)
107
Commercial
1,247,923

(45,802
)
646
 
51,733

(4,035
)
46

 
1,299,656

(49,837
)
692
Interest-only
63,506

(2,170
)
20
 
52,963

(7,098
)
16

 
116,469

(9,268
)
36
Total
$
3,815,885

$
(110,548
)
846
 
$
252,257

$
(59,127
)
156

 
$
4,068,142

$
(169,675
)
1002

At March 31, 2017, the Company had the intent to sell ten Agency MBS positions collateralized by commercial property which were in an unrealized loss position. These Commercial Agency MBS positions had an unrealized loss of $2 million at March 31, 2017. Therefore, the Company recorded an other-than-temporary impairment loss for this amount during the current reporting period. There were no other MBS securities at March 31, 2017 that were in an unrealized loss position, and the Company intended to sell, or it was more likely than not that the Company would be required to sell these RMBS before recovery of their amortized cost basis, which may be at their maturity. With respect to RMBS held by consolidated VIEs, the ability of any entity to cause the sale by the VIE prior to the maturity of these RMBS is either expressly prohibited, not probable, or is limited to specified events of default, none of which have occurred as of March 31, 2017.

Gross unrealized losses on the Company’s Agency residential and commercial MBS were $94 million and $100 million as of March 31, 2017 and December 31, 2016, respectively. Given the inherent credit quality of Agency MBS, the Company does not consider any of the current impairments on its Agency MBS to be credit related. In evaluating whether it is more likely than not that it will be required to sell any impaired security before its anticipated recovery, which may be at their maturity, the Company considers the significance of each investment, the amount of impairment, the projected future performance of such impaired securities, as well as the Company’s current and anticipated leverage capacity and liquidity position. Based on these analyses, the Company determined that at March 31, 2017 and December 31, 2016, unrealized losses on its Agency MBS were temporary.

Gross unrealized losses on the Company’s Non-Agency RMBS (excluding Non-Agency IO MBS strips which are reported at fair value with changes in fair value recorded in earnings) were $2 million and $1 million at March 31, 2017 and December 31, 2016, respectively. Based upon the most recent evaluation, the Company does not consider these unrealized losses to be indicative of OTTI and does not believe that these unrealized losses are credit related, but rather are due to other

12



factors. The Company has reviewed its Non-Agency RMBS that are in an unrealized loss position to identify those securities with losses that are other-than-temporary based on an assessment of changes in cash flows expected to be collected for such RMBS, which considers recent bond performance and expected future performance of the underlying collateral.
A summary of the OTTI included in earnings for the quarters ended March 31, 2017 and 2016 is presented below.

 
For the Quarter Ended
 
March 31, 2017
March 31, 2016
 
(dollars in thousands)
Total other-than-temporary impairment losses
$
(2,713
)
$
(4,423
)
Portion of loss recognized in other comprehensive income (loss)
(15,988
)
(6,255
)
Net other-than-temporary credit impairment losses
$
(18,701
)
$
(10,678
)
 
The following table presents a roll forward of the credit loss component of OTTI on the Company’s Non-Agency RMBS for which a portion of loss was previously recognized in OCI. The table delineates between those securities that are recognizing OTTI for the first time as opposed to those that have previously recognized OTTI.

 
For the Quarter Ended
 
March 31, 2017
March 31, 2016
 
(dollars in thousands)
Cumulative credit loss beginning balance
$
556,485

$
529,112

Additions:
 

 

Other-than-temporary impairments not previously recognized

10,326

Reductions for securities sold or deconsolidated during the period
(7,443
)
(242
)
Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments
16,726

352

Reductions for increases in cash flows expected to be collected over the remaining life of the securities
(7,539
)
(172
)
Cumulative credit impairment loss ending balance
$
558,229

$
539,376


Cash flows generated to determine net other-than-temporary credit impairment losses recognized in earnings are estimated using significant unobservable inputs. The significant inputs used to measure the component of OTTI recognized in earnings for the Company’s Non-Agency RMBS are summarized as follows:


13



 
For the Quarter Ended
 
March 31, 2017
March 31, 2016
Loss Severity
 
 
Weighted Average
64%
58%
Range
63% - 64%
44% - 79%
60+ days delinquent
 
 
Weighted Average
19%
20%
Range
11% - 25%
0% - 40%
Credit Enhancement (1)

 
Weighted Average
22%
28%
Range
0% - 37%
0% - 100%
3 Month CPR
 
 
Weighted Average
12%
5%
Range
4% - 24%
0% - 19%
12 Month CPR
 
 
Weighted Average
10%
4%
Range
4% - 19%
4% - 21%
(1) Calculated as the combined credit enhancement to the Re-REMIC and underlying from each of their respective capital structures.

The following tables present a summary of unrealized gains and losses at March 31, 2017 and December 31, 2016. IO MBS included in the tables below represent the right to receive a specified portion of the contractual interest cash flows of the underlying principal balance of specific securities. At March 31, 2017, IO MBS had a net unrealized loss of $58 million and had an amortized cost of $440 million. At December 31, 2016, IO MBS had a net unrealized loss of $48 million and had an amortized cost of $458 million. The fair value of IOs at March 31, 2017 and December 31, 2016 was $382 million and $410 million, respectively. All changes in fair value of IOs are reflected in Net Income in the Consolidated Statements of Operations.

 
 
March 31, 2017
 
 
 
 
 
(dollars in thousands) 
 
 
 
 
Gross Unrealized Gain Included in Accumulated Other Comprehensive Income
Gross Unrealized Gain Included in Cumulative Earnings
Total Gross Unrealized Gain
Gross Unrealized Loss Included in Accumulated Other Comprehensive Income
Gross Unrealized Loss Included in Cumulative Earnings
Total Gross Unrealized Loss
Non-Agency RMBS
 
 
 
 
 
 
Senior
$
739,946

$

$
739,946

$
(281
)
$

$
(281
)
Senior, interest-only

16,095

16,095


(63,804
)
(63,804
)
Subordinated
70,572

4,167

74,739

(75
)
(1,618
)
(1,693
)
Subordinated, interest-only

103

103


(1,932
)
(1,932
)
Agency MBS
 

 

 
 

 

 
Residential
10,566


10,566

(47,459
)

(47,459
)
Commercial
1,334


1,334

(46,892
)

(46,892
)
Interest-only

877

877


(9,001
)
(9,001
)
Total
$
822,418

$
21,242

$
843,660

$
(94,707
)
$
(76,355
)
$
(171,062
)

14



 
 
December 31, 2016
 
 
 
 
 
(dollars in thousands)  
 
 
 
 
Gross Unrealized Gain Included in Accumulated Other Comprehensive Income
Gross Unrealized Gain Included in Cumulative Earnings
Total Gross Unrealized Gain
Gross Unrealized Loss Included in Accumulated Other Comprehensive Income
Gross Unrealized Loss Included in Cumulative Earnings
Total Gross Unrealized Loss
Non-Agency RMBS
 
 
 
 
 
 
Senior
$
732,133

$

$
732,133

$
(250
)
$

$
(250
)
Senior, interest-only

18,674

18,674


(57,531
)
(57,531
)
Subordinated
74,584

3,273

77,857

(235
)
(1,001
)
(1,236
)
Subordinated, interest-only




(1,854
)
(1,854
)
Agency MBS
 

 

 

 

 

 

Residential
11,235


11,235

(49,699
)

(49,699
)
Commercial
175


175

(49,837
)

(49,837
)
Interest-only

1,893

1,893


(9,268
)
(9,268
)
Total
$
818,127

$
23,840

$
841,967

$
(100,021
)
$
(69,654
)
$
(169,675
)

Changes in prepayments, actual cash flows, and cash flows expected to be collected, among other items, are affected by the collateral characteristics of each asset class. The Company chooses assets for the portfolio after carefully evaluating each investment’s risk profile.

The following tables provide a summary of the Company’s MBS portfolio at March 31, 2017 and December 31, 2016.
 
March 31, 2017
 
Principal or Notional Value
at Period-End
(dollars in thousands)
Weighted Average Amortized
Cost Basis
Weighted Average Fair Value
Weighted Average
Coupon
Weighted Average Yield at Period-End (1)
Non-Agency RMBS
 
 
 
 
Senior
$
3,060,690

$
55.51

$
79.68

4.4
%
15.8
%
Senior, interest-only
5,434,402

5.29

4.41

1.4
%
10.9
%
Subordinated
662,469

70.25

81.28

3.8
%
9.1
%
Subordinated, interest-only
263,126

5.18

4.48

1.0
%
12.8
%
Agency MBS
 

 

 

 

 

Residential pass-through
2,480,534

105.82

104.33

3.9
%
3.0
%
Commercial pass-through
1,393,290

102.51

99.24

3.6
%
2.9
%
Interest-only
3,248,168

4.29

4.04

0.8
%
3.6
%
(1) Bond Equivalent Yield at period end.
 
December 31, 2016
 
Principal or Notional Value at Period-End
(dollars in thousands)
Weighted Average Amortized
Cost Basis
Weighted Average Fair Value
Weighted Average
Coupon
Weighted Average Yield at Period-End (1)
Non-Agency RMBS
 
 
 
 
Senior
$
3,190,947

$
55.76

$
78.69

4.3
%
15.5
%
Senior, interest-only
5,648,339

5.18

4.49

1.5
%
11.7
%
Subordinated
673,259

70.83

82.21

3.8
%
9.2
%
Subordinated, interest-only
266,927

5.20

4.50

1.1
%
13.5
%
Agency MBS
 

 

 

 

 

Residential pass-through
2,594,570

105.78

104.29

3.9
%
3.0
%
Commercial pass-through
1,331,543

102.64

98.91

3.6
%
2.9
%
Interest-only
3,356,491

4.53

4.31

0.8
%
3.5
%
(1) Bond Equivalent Yield at period end.

15




The following table presents the weighted average credit rating, based on the lowest rating available, of the Company’s Non-Agency RMBS portfolio at March 31, 2017 and December 31, 2016.

 
March 31, 2017

December 31, 2016

AAA
0.3
%
0.3
%
AA
0.3
%
0.3
%
A
0.6
%
0.7
%
BBB
0.8
%
0.7
%
BB
2.3
%
3.0
%
B
3.8
%
3.9
%
Below B or not rated
91.9
%
91.1
%
Total
100.0
%
100.0
%

Actual maturities of MBS are generally shorter than the stated contractual maturities. Actual maturities of the Company’s MBS are affected by the contractual lives of the underlying mortgages, periodic payments of principal and prepayments of principal. The following tables provide a summary of the fair value and amortized cost of the Company’s MBS at March 31, 2017 and December 31, 2016 according to their estimated weighted-average life classifications. The weighted-average lives of the MBS in the tables below are based on lifetime expected prepayment rates using an industry prepayment model for the Agency MBS portfolio and the Company’s prepayment assumptions for the Non-Agency RMBS. The prepayment model considers current yield, forward yield, steepness of the interest rate curve, current mortgage rates, mortgage rates of the outstanding loan, loan age, margin, and volatility.
 
March 31, 2017
 
(dollars in thousands) 
 
Weighted Average Life
 
Less than one year
Greater than one year and less
than five years
Greater than five years and less
than ten years
Greater than ten years
Total
Fair value
 
 
 
 
 
Non-Agency RMBS
 
 
 
 
 
Senior
$
13,049

$
559,748

$
1,149,305

$
716,521

$
2,438,623

Senior interest-only
254

40,115

107,971

91,171

239,511

Subordinated

91,937

222,181

224,341

538,459

Subordinated interest-only


11,798


11,798

Agency MBS
 

 

 

 

 

Residential

14,298

2,573,630


2,587,928

Commercial

46,882

16,676

1,319,176

1,382,734

Interest-only

92,969

33,509

4,711

131,189

Total fair value
$
13,303

$
845,949

$
4,115,070

$
2,355,920

$
7,330,242

Amortized cost
 

 

 

 

 

Non-Agency RMBS
 
 

 

 

 

Senior
$
11,800

$
420,613

$
783,176

$
483,369

$
1,698,958

Senior interest-only
1,532

49,283

135,893

100,512

287,220

Subordinated

76,349

183,184

205,880

465,413

Subordinated interest-only


13,627


13,627

Agency MBS
 

 

 

 

 

Residential

14,296

2,610,525


2,624,821

Commercial

48,568

17,239

1,362,485

1,428,292

Interest-only

95,470

39,191

4,652

139,313

Total amortized cost
$
13,332

$
704,579

$
3,782,835

$
2,156,898

$
6,657,644


16



 
December 31, 2016
 
(dollars in thousands)
 
Weighted Average Life
 
Less than one year
Greater than one year and less
than five years
Greater than five years and less
than ten years
Greater than ten years
Total
Fair value
 
 
 
 
 
Non-Agency RMBS
 
 
 
 
 
Senior
$
25,612

$
508,979

$
1,267,000

$
709,412

$
2,511,003

Senior interest-only
417

37,796

115,780

99,546

253,539

Subordinated

94,793

238,630

220,075

553,498

Subordinated interest-only


12,024


12,024

Agency MBS
 

 

 

 

 

Residential

429,869

2,276,109


2,705,978

Commercial

47,354

16,833

1,252,788

1,316,975

Interest-only

75,863

63,715

5,222

144,800

Total fair value
$
26,029

$
1,194,654

$
3,990,091

$
2,287,043

$
7,497,817

Amortized cost
 

 

 

 

 

Non-Agency RMBS
 
 

 

 

 

Senior
$
21,423

$
403,250

$
868,624

$
485,823

$
1,779,120

Senior interest-only
1,992

50,252

134,642

105,510

292,396

Subordinated

76,287

195,538

205,052

476,877

Subordinated interest-only


13,878


13,878

Agency MBS
 

 

 

 

 

Residential

438,270

2,306,172


2,744,442

Commercial

49,027

17,247

1,300,363

1,366,637

Interest-only

77,598

69,333

5,244

152,175

Total amortized cost
$
23,415

$
1,094,684

$
3,605,434

$
2,101,992

$
6,825,525


The Non-Agency RMBS portfolio is subject to credit risk. The Non-Agency RMBS portfolio is primarily collateralized by Alt-A first lien mortgages. An Alt-A mortgage is a type of U.S. mortgage that, for various reasons, is considered riskier than A-paper, or prime, and less risky than subprime, the riskiest category. Alt-A interest rates, which are determined by credit risk, therefore tend to be between those of prime and subprime home loans. Typically, Alt-A mortgages are characterized by borrowers with less than full documentation, lower credit scores and higher loan-to-value ratios. At origination of the loan, Alt-A mortgage securities are defined as Non-Agency RMBS where (i) the underlying collateral has weighted average FICO scores between 680 and 720 or (ii) the FICO scores are greater than 720 and RMBS have 30% or less of the underlying collateral composed of full documentation loans. At March 31, 2017 and December 31, 2016, 68% of the Non-Agency RMBS collateral was classified as Alt-A, respectively. At March 31, 2017 and December 31, 2016, 13% and 14% of the Non-Agency RMBS collateral was classified as prime, respectively. The remaining Non-Agency RMBS collateral is classified as subprime.

The Non-Agency RMBS in the Portfolio have the following collateral characteristics at March 31, 2017 and December 31, 2016.
 
March 31, 2017
December 31, 2016
Weighted average maturity (years)
 
21.4

 
21.6

Weighted average amortized loan to value (1)
 
66.2
%
 
66.5
%
Weighted average FICO (2)
 
674

 
675

Weighted average loan balance (in thousands)
 
$
320

 
$
319

Weighted average percentage owner occupied
 
83.3
%
 
83.2
%
Weighted average percentage single family residence
 
65.8
%
 
65.8
%
Weighted average current credit enhancement
 
2.3
%
 
2.3
%
Weighted average geographic concentration of top four states
CA
32.1
%
CA
32.1
%
 
FL
8.2
%
FL
8.1
%
 
NY
8.1
%
NY
7.9
%
 
NJ
2.7
%
NJ
2.7
%
(1) Value represents appraised value of the collateral at the time of loan origination.
(2) FICO as determined at the time of loan origination.

17




The table below presents the origination year of the underlying loans related to the Company’s portfolio of Non-Agency RMBS at March 31, 2017 and December 31, 2016.

Origination Year
March 31, 2017
December 31, 2016

2003 and prior
3.6
%
3.6
%
2004
4.2
%
4.2
%
2005
20.4
%
20.2
%
2006
37.7
%
38.0
%
2007
31.5
%
31.3
%
2008
1.8
%
1.8
%
2009 and later
0.8
%
0.9
%
Total
100.0
%
100.0
%

Gross realized gains and losses are recorded in “Net realized gains (losses) on sales of investments” on the Company’s Consolidated Statements of Operations. The proceeds and gross realized gains and gross realized losses from sales of investments for the quarters ended March 31, 2017 and 2016 are as follows:

 
For the Quarter Ended
 
March 31, 2017
March 31, 2016
 
(dollars in thousands)
Proceeds from sales
$
20,063

$
270,479

Gross realized gains
5,187

1,695

Gross realized losses
(20
)
(4,369
)
Net realized gain (loss)
$
5,167

$
(2,674
)

Included in the gross realized gains for the quarter ended March 31, 2017 in the table above are exchanges of securities with a fair value of $20 million, the Company exchanged its investment in a re-remic security for the underlying collateral supporting the group related to the exchanged asset.  These exchanges were treated as non-cash sales and purchases and resulted in a realized gain of $5 million reflected in earnings for the quarter ended March 31, 2017. There were no such exchanges during the quarter ended March 31, 2016.

4. Securitized Loans Held for Investment

The Securitized loans held for investment is comprised primarily of loans collateralized by seasoned subprime residential mortgages. Additionally, it includes non-conforming, single family, owner occupied, jumbo, prime residential mortgages.

At March 31, 2017, all securitized loans held for investment are carried at fair value. See Note 5 for a discussion on how the Company determines the fair values of the securitized loans held for investment. As changes in the fair value of these securitized loans are reflected in earnings, the Company does not estimate or record a loan loss provision. The total amortized cost of our Securitized loans held for investments was $12.4 billion and $8.6 billion as of March 31, 2017 and December 31, 2016, respectively.

The following table provides a summary of the changes in the carrying value of securitized loans held for investment at fair value at March 31, 2017 and December 31, 2016:


18



 
For the Quarter Ended
For the Year Ended
 
March 31, 2017
December 31, 2016
 
(dollars in thousands)
Balance, beginning of period
$
8,753,653

$
4,768,416

Purchases
4,165,322

4,897,370

Principal paydowns
(324,851
)
(1,022,414
)
Sales and settlements
1,289

5,007

Net periodic accretion (amortization)
(3,109
)
(41,363
)
Change in fair value
120,969

146,637

Balance, end of period
$
12,713,273

$
8,753,653


The primary cause of the change in fair value is due to changes in credit risk of the portfolio.

Residential mortgage loans

The securitized loan portfolio for all residential mortgages were originated during the following years:

Origination Year
March 31, 2017

December 31, 2016

2002 and prior
8.2
%
8.9
%
2003
7.0
%
5.2
%
2004
15.4
%
11.9
%
2005
20.7
%
20.5
%
2006
20.8
%
22.0
%
2007
19.1
%
20.9
%
2008
6.0
%
6.5
%
2009
0.5
%
0.6
%
2010 and later
2.3
%
3.5
%
Total
100.0
%
100.0
%

The following table presents a summary of key characteristics of the securitized residential loan portfolio at March 31, 2017 and December 31, 2016:
 
March 31, 2017
December 31, 2016
Number of loans
 
140,899

 
95,155

Weighted average maturity (years)
 
19.0

 
19.8

Weighted average loan to value (1)
 
87.3
%
 
86.9
%
Weighted average FICO (1)
 
640

 
627

Weighted average loan balance (in thousands)
 
$
90

 
$
93

Weighted average percentage owner occupied
 
97.0
%
 
96.6
%
Weighted average percentage single family residence
 
86.0
%
 
85.0
%
Weighted average geographic concentration of top five states
CA
9.2
%
CA
10.0
%
 
FL
6.8
%
FL
6.7
%
 
OH
6.4
%
OH
6.5
%
 
PA
5.5
%
VA
5.9
%
 
VA
5.5
%
NC
5.1
%
(1) As provided by the Trustee.

The following table summarizes the outstanding principal balance of the residential loan portfolio which are 30 days delinquent and greater as reported by the servicer at March 31, 2017 and December 31, 2016.


19



 
30 Days Delinquent
60 Days Delinquent
90+ Days Delinquent
Bankruptcy
Foreclosure
REO
Total
 
(dollars in thousands)
March 31, 2017
$
376,365

$
127,936

$
235,111

$
198,395

$
187,021

$
41,158

$
1,165,986

December 31, 2016
$
363,899

$
140,495

$
190,991

$
207,364

$
203,265

$
40,709

$
1,146,723


The fair value of residential mortgage loans 90 days or more past due is $499 million and $449 million as of March 31, 2017 and December 31, 2016, respectively.

Real estate owned

Real estate owned (“REO”) represents properties which the Company has received the legal title of the property to satisfy the outstanding loan. REO is re-categorized from loan to REO when the Company takes legal title of the property. REO assets are measured and reported at the estimated fair value less the estimated cost to sell at the end of each reporting period. At the time the asset is re-categorized, any difference between the previously recorded loan balance and the carrying value of the REO at the time the Company takes legal title of the property, is recognized as a loss. All REO assets of the Company are held-for-sale and it is the Company’s intention to sell the property in the shortest time possible to maximize their return and recovery on the previously recorded loan. The carrying value of REO assets at March 31, 2017 and December 31, 2016 was $12 million and $13 million, respectively, and were recorded in Other Assets on the Company’s consolidated statements of financial condition.

5. Fair Value Measurements

The Company applies fair value guidance in accordance with GAAP to account for its financial instruments. The Company categorizes its financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. Financial assets and liabilities recorded at fair value on the Consolidated Statements of Financial Condition or disclosed in the related notes are categorized based on the inputs to the valuation techniques as follows:

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets and liabilities in active markets.

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 – inputs to the valuation methodology are unobservable and significant to fair value.

Fair value measurements categorized within Level 3 are sensitive to changes in the assumptions or methodology used to determine fair value and such changes could result in a significant increase or decrease in the fair value. Any changes to the valuation methodology are reviewed by management to ensure the changes are appropriate. As markets and products evolve and the pricing for certain products becomes more transparent, the Company will continue to refine its valuation methodologies. The methodology utilized by the Company for the periods presented is unchanged. The methods used to produce a fair value calculation may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company believes its valuation methods are appropriate and consistent with other market participants. Using different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The Company uses inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced.

During times of market dislocation, the observability of prices and inputs can be difficult for certain investments. If third party pricing services are unable to provide a price for an asset, or if the price provided by them is deemed unreliable by the Company, then the asset will be valued at its fair value as determined by the Company without validation to third-party pricing. Illiquid investments typically experience greater price volatility as an active market does not exist. Observability of prices and inputs can vary significantly from period to period and may cause instruments to change classifications within the three level hierarchy.

A description of the methodologies utilized by the Company to estimate the fair value of its financial instruments by instrument class follows:

20



Agency MBS and Non-Agency RMBS

The Company determines the fair value of all of its investment securities based on discounted cash flows utilizing an internal pricing model that incorporates factors such as coupon, prepayment speeds, loan size, collateral composition, borrower characteristics, expected interest rates, life caps, periodic caps, reset dates, collateral seasoning, delinquency, expected losses, expected default severity, credit enhancement, and other pertinent factors. To corroborate that the estimates of fair values generated by these internal models are reflective of current market prices, the Company compares the fair values generated by the model to non-binding independent prices provided by two independent third party pricing services. For certain highly liquid asset classes, such as Agency fixed-rate pass-through bonds, the Company’s valuations are also compared to quoted prices for To-Be-Announced (“TBA”) securities.

Each quarter the Company develops thresholds which are determined utilizing current bid/ask spreads, liquidity, price volatility and other factors as appropriate. If internally developed model prices differ from the independent prices provided by greater than a market derived predetermined threshold for the period, the Company highlights these differences for further review, both internally and with the third party pricing service. The Company obtains the inputs used by the third party pricing services and compares them to the Company’s inputs. The Company updates its own inputs if the Company determines the third party pricing inputs more accurately reflect the current market environment. If the Company believes that its internally developed inputs more accurately reflect the current market environment, it will request that the third party pricing service review market factors that may not have been considered by the third party pricing service and provide updated prices. The Company reconciles and resolves all pricing differences in excess of the predetermined thresholds before a final price is established. At March 31, 2017, ten investment holdings with an internally developed fair value of $103 million had a difference between the model generated prices and third party prices provided in excess of the derived predetermined threshold for the period. The internally developed prices were $7 million higher than the third party prices provided of $96 million. After review and discussion, the Company affirmed and valued the investments at the higher internally developed prices. No other differences were noted at March 31, 2017 in excess of the derived predetermined threshold for the period. At December 31, 2016, ten investment holdings with an internally developed fair value of $123 million had a difference between the model generated prices and third party prices provided in excess of the derived predetermined threshold for the period. The internally developed prices were $16 million higher than the third party prices provided of $107 million. After review and discussion, the Company affirmed and valued the investments at the higher internally developed prices.

The Company’s estimate of prepayment, default and severity curves all involve judgment and assumptions that are deemed to be significant to the fair value measurement process, which renders the resulting Non-Agency RMBS fair value estimates Level 3 inputs in the fair value hierarchy. As the fair values of Agency MBS are more observable, these investments are classified as level 2 in the fair value hierarchy.

Interest-Only MBS:

The Company accounts for the IO MBS strips at fair value with changes in fair value reported in earnings. The IO MBS strips are included in MBS, at fair value, on the accompanying Consolidated Statements of Financial Condition.

Included in Non-Agency RMBS, at fair value on the Consolidated Statements of Financial Condition are IO MBS strips carried at fair value with changes in fair value reflected in earnings of $251 million and $266 million as of March 31, 2017 and December 31, 2016. Included in Agency MBS, at fair value on the Consolidated Statements of Financial Condition are IO MBS strips carried at fair value with changes in fair value reflected in earnings of $131 million and $145 million as of March 31, 2017 and December 31, 2016. Interest income on all IO MBS securities was $9 million and $12 million for the quarters ended March 31, 2017 and 2016, respectively.

Non-Agency RMBS:

The Company has elected the fair value option for certain interests in Non-Agency RMBS which we refer to as the overcollateralization classes. The cash flows for these holdings are generally subordinate to all other interests of the trusts and generally only pay out funds when certain ratios are met and excess cash holdings, as determined by the trustee, are available for distribution to the overcollateralization class. Many of the investments in this group have no current cash flows and may not ever pay cash flows, depending on the loss experience of the collateral group supporting the investment. Estimating future cash flows for this group of Non-Agency RMBS investments is highly subjective and uncertain; therefore, the Company has elected to carry these holdings at fair value with changes in fair value reflected in earnings.

Changes in fair value are presented in Net unrealized gains (losses) on financial instruments at fair value on the Consolidated Statements of Operations. The fair value of the Non-Agency RMBS carried at fair value with changes in fair value reflected in earnings is $18 million and $19 million as of March 31, 2017 and December 31, 2016, respectively.

21




Securitized Loans Held for Investment
Securitized loans consisting of seasoned subprime residential mortgage loans:
The Company estimates the fair value of its securitized loans held for investment consisting of seasoned subprime residential mortgage loans on a loan by loan basis using an internally developed model which compares the loan held by the Company with a loan currently offered in the market. The loan price is adjusted in the model by considering the loan factors which would impact the value of a loan. These loan factors include: loan coupon as compared to coupon currently available in the market, FICO, loan-to-value ratios, delinquency history, owner occupancy, and property type, among other factors. A baseline is developed for each significant loan factor and adjusts the price up or down depending on how that factor for each specific loan compares to the baseline rate. Generally, the most significant impact on loan value is the loan interest rate as compared to interest rates currently available in the market and delinquency history. These two factors are based on relevant observable inputs.

The Company also monitors market activity to identify trades which may be used to compare internally developed prices; however, as the portfolio of loans held at fair value is a seasoned subprime pool of mortgage loans, comparable loan pools are not common or directly comparable. There are limited transactions in the market place to develop a comprehensive direct range of values. However, if market data becomes available, the Company will compare this data to the internally developed prices to ensure reasonableness of the valuation.

The Company reviews the fair values generated by the model to determine whether prices are reflective of the current market by corroborating its estimates of fair value by comparing the results to non-binding independent prices provided by two independent third party pricing services for the loan portfolio. Each quarter the Company develops thresholds which are determined utilizing a senior securitization market for a similar pool of loans.

If the internally developed fair values of the loan pools differ from the independent prices provided by greater than a predetermined threshold for the period, the Company highlights these differences for further review, both internally and with the third party pricing service. The Company obtains certain inputs used by the third party pricing services and evaluates them for reasonableness. The Company updates its own model if the Company determines the third party pricing inputs more accurately reflect the current market environment or observed information from the third party vendors. If the Company believes that its internally developed inputs more accurately reflect the current market environment, it will request that the third party pricing service review market factors that may not have been considered by the third party pricing service. The Company reconciles and resolves all pricing differences in excess of the predetermined thresholds before a final price is established.

At March 31, 2017, the internally developed fair values of loan pools of $700 million had a difference between the model generated prices and third party prices provided in excess of the derived predetermined threshold for the period. The internally developed prices were $42 million lower than the third party prices provided of $742 million. After review and discussion, the Company affirmed and valued the investments at the lower internally developed prices. At December 31, 2016, the internally developed fair values of loan pools of $1.60 billion had a difference between the model generated prices and third party prices provided in excess of the derived predetermined threshold for the period. The internally developed prices were $50 million higher than the third party prices provided of $1.55 billion. After review and discussion, the Company affirmed and valued the investments at the higher internally developed prices. No other differences were noted at March 31, 2017 and December 31, 2016 in excess of the derived predetermined threshold for the period.

The Company’s estimates of fair value of securitized loans held for investment involve management judgment and assumptions that are deemed to be significant to the fair value measurement process, which renders the resulting fair value estimates level 3 inputs in the fair value hierarchy.

Securitized loans collateralized by jumbo, prime residential mortgages:

The securitized loans collateralized by jumbo, prime residential mortgages are carried at fair value. The securitized loans are held as part of a consolidated Collateralized Financing Entity (“CFE”). A CFE is a variable interest entity that holds financial assets, issues beneficial interests in those assets and has no more than nominal equity and the beneficial interests have contractual recourse only to the related assets of the CFE. Accounting guidance for CFEs allow the Company to elect to measure the CFE’s financial assets using the fair value of the CFE’s financial liabilities as the fair values of the financial liabilities of the CFE are more observable. Therefore, the fair value of the securitized loans collateralized by jumbo, prime residential mortgages is based on the fair value of the securitized debt. See discussion of the fair value of Securitized Debt, collateralized by Loans Held for Investment at fair value below.


22



As the more observable Securitized debt, collateralized by loans held for investment are considered level 3 in the fair value hierarchy, the Securitized loans collateralized by jumbo, prime residential mortgages are also level 3 in the fair value hierarchy.

Securitized Debt, collateralized by Non-Agency RMBS

The Company carries securitized debt, collateralized by Non-Agency RMBS at the principal balance outstanding plus unamortized premiums, less unaccreted discounts recorded in connection with the financing of the loans or RMBS with third parties. The Company estimates the fair value of securitized debt, collateralized by Non-Agency RMBS by estimating the future cash flows associated with the underlying assets collateralizing the secured debt outstanding. The Company models the fair value of each underlying asset by considering, among other items, the structure of the underlying security, coupon, servicer, delinquency, actual and expected defaults, actual and expected default severities, reset indices, and prepayment speeds in conjunction with market research for similar collateral performance and management’s expectations of general economic conditions in the sector and other economic factors. This process, including the review process, is consistent with the process used for Agency MBS and Non-Agency RMBS using internal models. For further discussion of the valuation process and benchmarking process, see Agency MBS and Non-Agency RMBS discussion herein.

The Company’s estimates of fair value of securitized debt, collateralized by Non-Agency RMBS involve management’s judgment and assumptions that are deemed to be significant to the fair value measurement process, which renders the resulting fair value estimates level 3 inputs in the fair value hierarchy.

Securitized Debt, collateralized by Loans Held for Investment

The Company determines the fair value of securitized debt, collateralized by loans held for investment based on discounted cash flows utilizing an internal pricing model that incorporates factors such as coupon, prepayment speeds, loan size, collateral composition, borrower characteristics, expected interest rates, life caps, periodic caps, reset dates, collateral seasoning, expected losses, expected default severity, credit enhancement, and other pertinent factors. This process, including the review process, is consistent with the process used for Agency MBS and Non-Agency RMBS using internal models. For further discussion of the valuation process and benchmarking process, see Agency MBS and Non-Agency RMBS discussion herein.

The Company’s estimates of fair value of securitized debt, collateralized by loans held for investment involve management’s judgment and assumptions that are deemed to be significant to the fair value measurement process, which renders the resulting fair value estimates level 3 inputs in the fair value hierarchy.

Derivatives

Interest Rate Swaps and Swaptions

The Company uses clearing exchange market prices to determine the fair value of its exchange cleared interest rate swaps. For bi-lateral swaps, the Company determines the fair value based on the net present value of expected future cash flows on the swap. The Company uses option pricing model to determine the fair value of its swaptions. For bi-lateral swaps and swaptions, the Company compares its own estimate of fair value with counterparty prices to evaluate for reasonableness. Both the clearing exchange and counter-party pricing quotes, incorporate common market pricing methods, including a spread measurement to the Treasury yield curve or interest rate swap curve as well as underlying characteristics of the particular contract. Interest rate swaps and swaptions are modeled by the Company by incorporating such factors as the term to maturity, swap curve, overnight index swap rates, and the payment rates on the fixed portion of the interest rate swaps. The Company has classified the characteristics used to determine the fair value of interest rate swaps as Level 2 inputs in the fair value hierarchy.

Treasury Futures

The fair value of Treasury futures is determined by quoted market prices for similar financial instruments in an active market. The Company has classified the characteristics used to determine the fair value of Treasury futures as Level 1 inputs in the fair value hierarchy.

Repurchase Agreements

Repurchase agreements are collateralized financing transactions utilized by the Company to acquire investment securities. Due to the short term nature of these financial instruments, the Company estimates the fair value of these repurchase agreements using the contractual obligation plus accrued interest payable.

Short-term Financial Instruments

23




The carrying value of cash and cash equivalents, accrued interest receivable, receivable for securities sold, dividends payable, payable for securities purchased and accrued interest payable are considered to be a reasonable estimate of fair value due to the short term nature and low credit risk of these short-term financial instruments.

The Company’s financial assets and liabilities carried at fair value on a recurring basis, including the level in the fair value hierarchy, at March 31, 2017 and December 31, 2016 is presented below.

 
March 31, 2017
 
(dollars in thousands)  
 
Level 1
Level 2
Level 3
Counterparty and Cash Collateral, netting
Total
Assets:
 

 

 

 

 

Non-Agency RMBS, at fair value
$

$

$
3,228,391

$

$
3,228,391

Agency MBS, at fair value

4,101,851



4,101,851

Securitized loans held for investment, at fair value


12,713,273


12,713,273

Derivatives
136

23,957


(13,204
)
10,889

 
 
 
 
 
 
Liabilities:
 

 

 

 

 

Securitized debt at fair value, collateralized by loans held for investment


(10,111,293
)

(10,111,293
)
Derivatives
(919
)
(14,695
)

13,987

(1,627
)
Total
$
(783
)
$
4,111,113

$
5,830,371

$
783

$
9,941,484


 
December 31, 2016
 
(dollars in thousands)
 
Level 1
Level 2
Level 3
Counterparty and Cash Collateral, netting
Total
Assets:
 
 
 
 
 
Non-Agency RMBS, at fair value
$

$

3,330,063

$

$
3,330,063

Agency MBS, at fair value

4,167,754



4,167,754

Securitized loans held for investment, at fair value


8,753,653