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, 2018
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,” “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, 2018
Common Stock, $0.01 par value
186,970,122





CHIMERA INVESTMENT CORPORATION

FORM 10-Q
TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
 
 
 




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, 2018
December 31, 2017
Assets:
 
 
Cash and cash equivalents
$
100,752

$
63,569

Non-Agency RMBS, at fair value
2,760,711

2,851,316

Agency MBS, at fair value
4,557,799

4,364,828

Loans held for investment, at fair value
13,619,995

13,678,263

Accrued interest receivable
98,669

100,789

Other assets
99,631

114,391

Derivatives, at fair value, net
93,171

48,914

Total assets (1)
$
21,330,728

$
21,222,070

Liabilities:
 

 

Repurchase agreements ($8.7 billion and $8.8 billion, pledged as collateral, respectively)
$
7,202,924

$
7,250,452

Securitized debt, collateralized by Non-Agency RMBS ($1.5 billion and $1.6 billion pledged as collateral, respectively)
194,967

205,780

Securitized debt at fair value, collateralized by loans held for investment ($13.2 billion and $13.3 billion pledged as collateral, respectively)
9,321,154

9,388,657

Payable for investments purchased
766,250

567,440

Accrued interest payable
69,929

61,888

Dividends payable
95,335

95,365

Accounts payable and other liabilities
9,426

17,191

Derivatives, at fair value, net

320

Total liabilities (1)
$
17,659,985

$
17,587,093






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 shares issued and outstanding, respectively ($325,000 liquidation preference)
130

130

Common stock: par value $0.01 per share; 300,000,000 shares authorized, 186,969,715 and 187,809,288 shares issued and outstanding, respectively
1,870

1,878

Additional paid-in-capital
3,814,391

3,826,691

Accumulated other comprehensive income
709,244

796,902

Cumulative earnings
3,206,859

2,967,852

Cumulative distributions to stockholders
(4,061,809
)
(3,958,534
)
Total stockholders' equity
$
3,670,743

$
3,634,977

Total liabilities and stockholders' equity
$
21,330,728

$
21,222,070


(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, 2018 and December 31, 2017, total assets of consolidated VIEs were $14,878,283 and $14,987,464, respectively, and total liabilities of consolidated VIEs were $9,553,852 and $9,631,820, 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, 2018
March 31, 2017
Net interest income:


Interest income (1)
$
297,132

$
251,344

Interest expense (2)
149,251

110,231

Net interest income
147,881

141,113

Other-than-temporary impairments:
 

 

Total other-than-temporary impairment losses
(294
)
(2,713
)
Portion of loss recognized in other comprehensive income
(864
)
(15,988
)
Net other-than-temporary credit impairment losses
(1,158
)
(18,701
)
Other investment gains (losses):
 

 

Net unrealized gains (losses) on derivatives
81,419

4,896

Net realized gains (losses) on derivatives
13,085

(9,358
)
Net gains (losses) on derivatives
94,504

(4,462
)
Net unrealized gains (losses) on financial instruments at fair value
14,466

72,243

Net realized gains (losses) on sales of investments

5,167

Gains (losses) on extinguishment of debt
9,670


Total other gains (losses)
118,640

72,948






Other expenses:
 

 

Compensation and benefits
8,411

7,556

General and administrative expenses
5,489

4,040

Servicing fees
11,334

9,588

Deal expenses
1,088

11,353

Total other expenses
26,322

32,537

Income (loss) before income taxes
239,041

162,823

Income taxes
34

16

Net income (loss)
$
239,007

$
162,807






Dividend on preferred stock
9,400

5,283






Net income (loss) available to common shareholders
$
229,607

$
157,524






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


 

Basic
$
1.22

$
0.84

Diluted
$
1.22

$
0.84






Weighted average number of common shares outstanding:
 

 

Basic
187,553,281

187,761,748

Diluted
188,176,753

188,195,061






Dividends declared per share of common stock
$
0.50

$
0.50








(1) Includes interest income of consolidated VIEs of $235,026 and $192,989 for the quarters ended March 31, 2018 and 2017, respectively. See Note 8 to consolidated financial statements for further discussion.
(2) Includes interest expense of consolidated VIEs of $99,614 and $82,684 for the quarters ended March 31, 2018 and 2017, 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, 2018
March 31, 2017
Comprehensive income (loss):
 

Net income (loss)
$
239,007

$
162,807

Other comprehensive income:
 

Unrealized gains (losses) on available-for-sale securities, net
(88,816
)
(3,910
)
Reclassification adjustment for net losses included in net income for other-than-temporary credit impairment losses
1,158

18,701

Reclassification adjustment for net realized losses (gains) included in net income

(5,186
)
Other comprehensive income (loss)
(87,658
)
9,605

Comprehensive income (loss) before preferred stock dividends
$
151,349

$
172,412

Dividends on preferred stock
$
9,400

$
5,283

Comprehensive income (loss) available to common stock shareholders
$
141,949

$
167,129




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, 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

 
 
 
 
 
 
 
 
 
Balance, December 31, 2017
$
58

$
130

$
1,878

$
3,826,691

$
796,902

$
2,967,852

$
(3,958,534
)
$
3,634,977

Net income (loss)





239,007


239,007

Other comprehensive income (loss)




(87,658
)


(87,658
)
Repurchase of common stock


(8
)
(14,826
)



(14,834
)
Stock based compensation



2,526




2,526

Common dividends declared






(93,875
)
(93,875
)
Preferred dividends declared






(9,400
)
(9,400
)
Balance, March 31, 2018
$
58

$
130

$
1,870

$
3,814,391

$
709,244

$
3,206,859

$
(4,061,809
)
$
3,670,743



See accompanying notes to consolidated financial statements.

5



CHIMERA INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(Unaudited)
 
For the Quarters Ended
 
March 31, 2018
March 31, 2017
Cash Flows From Operating Activities:
Net income
$
239,007

$
162,807

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
(Accretion) amortization of investment discounts/premiums, net
2,521

(13,712
)
Accretion (amortization) of deferred financing costs and securitized debt discounts/premiums, net
(693
)
5,109

Amortization of swaption premium
727

3,303

Net unrealized losses (gains) on derivatives
(81,419
)
(4,896
)
Margin (paid) received on derivatives
43,891

4,974

Net unrealized losses (gains) on financial instruments at fair value
(14,466
)
(72,243
)
Net realized losses (gains) on sales of investments

(5,167
)
Net other-than-temporary credit impairment losses
1,158

18,701

(Gain) loss on extinguishment of debt
(9,670
)

Equity-based compensation expense
2,526

1,119

Changes in operating assets:


 

Decrease (increase) in accrued interest receivable, net
2,120

(19,972
)
Decrease (increase) in other assets
12,501

(30,275
)
Changes in operating liabilities:


 

Increase (decrease) in accounts payable and other liabilities
(7,766
)
(7,517
)
Increase (decrease) in accrued interest payable, net
8,041

18,929

Net cash provided by (used in) operating activities
$
198,478

$
61,160

Cash Flows From Investing Activities:
Agency MBS portfolio:
 

 

Purchases
$
(217,579
)
$
(113,599
)
Principal payments
109,645

115,237

Non-Agency RMBS portfolio:
 



Purchases

(5,663
)
Principal payments
96,988

127,929

Loans held for investment:
 



Purchases
(369,583
)
(4,165,322
)
Principal payments
443,755

324,851

Net cash provided by (used in) investing activities
$
63,226

$
(3,716,567
)
Cash Flows From Financing Activities:
Proceeds from repurchase agreements
$
13,951,070

$
6,551,098

Payments on repurchase agreements
(13,997,248
)
(6,300,798
)
Net proceeds from preferred stock offerings

314,429

Payments on repurchase of common stock
(14,834
)

Proceeds from securitized debt borrowings, collateralized by loans held for investment
509,066

3,457,535

Payments on securitized debt borrowings, collateralized by loans held for investment
(558,917
)
(331,290
)
Payments on securitized debt borrowings, collateralized by Non-Agency RMBS
(10,353
)
(31,320
)
Common dividends paid
(93,905
)
(94,056
)
Preferred dividends paid
(9,400
)
(5,349
)
Net cash provided by (used in) financing activities
$
(224,521
)
$
3,560,249

Net increase (decrease) in cash and cash equivalents
37,183

(95,158
)
Cash and cash equivalents at beginning of period
63,569

177,714

Cash and cash equivalents at end of period
$
100,752

$
82,556

 
 
 

6



Supplemental disclosure of cash flow information:
Interest received
$
301,772

$
217,660

Interest paid
$
141,903

$
86,193

Non-cash investing activities:
 

 

Payable for investments purchased
$
766,250

$
473,269

Net change in unrealized gain (loss) on available-for sale securities
$
(87,658
)
$
9,605

 
 
 
Non-cash financing activities:
 

 

    Common dividends declared, not yet paid
$
95,335

$
94,625



See accompanying notes to consolidated financial statements.

7



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 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 structure 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 only be satisfied from each securitization vehicle’s respective asset pool.

The assets of securitization entities are comprised 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.

8



(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, 2017, 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, 2018 or December 31, 2017.

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

Income Statement - Reporting Comprehensive Income - (Topic 220)

In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users. However, because the amendments only relate to the reclassification of the income tax effects of the Tax Cuts and Jobs Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The amendments in this Update also require certain disclosures about stranded tax effects. The guidance in the ASU is effective for the Company as of January 1, 2019. Early adoption is allowed. The Company is not planning to early adopt and is currently evaluating what impact this update will have on the consolidated financial statements.

Derivatives and Hedging - Targeted improvements to Accounting for Hedging Activities (Topic 815)

In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging - Targeted improvements to Accounting for Hedging Activities. This update is issued with the objective of improving the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. In addition, the amendments in this update make certain targeted improvements to simplify the application of the hedge accounting guidance in

9



current GAAP. The guidance in the ASU is effective for the Company as of January 1, 2019. Early adoption is allowed. The Company is not planning to early adopt and is currently evaluating what impact this update will have on the consolidated financial statements.

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 Company has adopted this guidance as of January 1, 2018. The adoption of this guidance did not have a
significant impact on the Company's consolidated financial statements.

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 Company has adopted this guidance as of January 1, 2018. The adoption of
this guidance did not have a significant impact on the Company's 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 Company has adopted this guidance as of January 1, 2018. The adoption of
this guidance did not have a significant impact on the Company's consolidated Statements of Cash Flows.

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 the Company does 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.

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

10



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 Company has adopted this guidance
as of January 1, 2018. The adoption of this guidance did not have a significant impact on the Company's 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, 2018 and December 31, 2017.
 
 
March 31, 2018
 
 
 
 
 
 
(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
$
2,627,375

$
867

$
(1,210,583
)
$
1,417,659

$
2,153,327

$
736,149

$
(481
)
$
735,668

Senior, interest-only
4,646,297

251,692


251,692

197,593

16,197

(70,296
)
(54,099
)
Subordinated
495,128

10,319

(172,024
)
333,423

401,699

68,452

(176
)
68,276

Subordinated, interest-only
196,208

7,225


7,225

8,092

1,388

(521
)
867

Agency MBS
 

 

 

 

 

 

 



Residential
2,265,632

125,940


2,391,572

2,312,635

3,201

(82,138
)
(78,937
)
Commercial
2,153,980

50,889

(4,600
)
2,200,269

2,147,644

3,042

(55,667
)
(52,625
)
Interest-only
2,960,181

104,603


104,603

97,520

827

(7,910
)
(7,083
)
Total
$
15,344,801

$
551,535

$
(1,387,207
)
$
6,706,443

$
7,318,510

$
829,256

$
(217,189
)
$
612,067


 
 
December 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
$
2,733,926

$
540

$
(1,257,103
)
$
1,477,363

$
2,231,415

$
754,234

$
(182
)
$
754,052

Senior, interest-only
4,862,461

262,996


262,996

210,850

15,761

(67,907
)
(52,146
)
Subordinated
501,455

10,571

(177,206
)
334,820

401,225

66,704

(299
)
66,405

Subordinated, interest-only
201,378

7,369


7,369

7,826

902

(445
)
457

Agency MBS
 

 

 

 

 

 

 

 

Residential
2,227,128

123,245


2,350,373

2,322,180

5,706

(33,899
)
(28,193
)
Commercial
1,894,594

47,430

(4,685
)
1,937,339

1,938,281

17,041

(16,099
)
942

Interest-only
3,021,840

111,277


111,277

104,367

834

(7,744
)
(6,910
)
Total
$
15,442,782

$
563,428

$
(1,438,994
)
$
6,481,537

$
7,216,144

$
861,182

$
(126,575
)
$
734,607


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.


11



 
For the Quarters Ended
 
March 31, 2018
March 31, 2017
 
(dollars in thousands)
Balance at beginning of period
$
1,303,590

$
1,550,110

Purchases

8,216

Yield income earned
(59,732
)
(68,827
)
Reclassification (to) from non-accretable difference
50,026

23,952

Sales and deconsolidation
112

(35
)
Balance at end of period
$
1,293,996

$
1,513,416


The table below presents the outstanding principal balance and related amortized cost at March 31, 2018 and December 31, 2017 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, 2018
December 31, 2017
 
(dollars in thousands)
Outstanding principal balance:
 
 
Beginning of period
$
2,673,350

$
3,138,265

End of period
$
2,581,229

$
2,673,350

Amortized cost:
 

 

Beginning of period
$
1,381,839

$
1,695,079

End of period
$
1,334,327

$
1,381,839


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, 2018 and December 31, 2017. All securities in an unrealized loss position have been evaluated by the Company for OTTI as discussed in Note 2(d) of 2017, Form 10-K.

 
 
 
March 31, 2018
 
 
 
 
 
 
 


(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
$
35,069

$
(481
)
1

 
$

$


 
$
35,069

$
(481
)
1

Senior, interest-only
27,994

(2,206
)
20

 
109,181

(68,090
)
118

 
137,175

(70,296
)
138

Subordinated
1,857

(85
)
11

 
4,186

(91
)
3

 
6,043

(176
)
14

Subordinated, interest-only



 
819

(521
)
3

 
819

(521
)
3

Agency MBS
 

 



 


 

 

 
 

 

 

Residential
746,346

(19,528
)
32

 
1,383,334

(62,610
)
94

 
2,129,680

(82,138
)
126

Commercial
1,584,221

(50,604
)
402

 
113,327

(5,063
)
55

 
1,697,548

(55,667
)
457

Interest-only
13,338

(683
)
7

 
52,347

(7,227
)
23

 
65,685

(7,910
)
30

Total
$
2,408,825

$
(73,587
)
473

 
$
1,663,194

$
(143,602
)
296

 
$
4,072,019

$
(217,189
)
769



12



 
 
 
December 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
$
35,229

$
(182
)
1

 
$

$


 
$
35,229

$
(182
)
1

Senior, interest-only
28,129

(1,724
)
27

 
120,120

(66,183
)
120

 
148,249

(67,907
)
147

Subordinated
235

(38
)
7

 
6,261

(261
)
5

 
6,496

(299
)
12

Subordinated, interest-only



 
945

(445
)
3

 
945

(445
)
3

Agency MBS
 

 

 

 
 

 

 

 
 

 

 

Residential
660,103

(5,197
)
21

 
1,471,464

(28,702
)
93

 
2,131,567

(33,899
)
114

Commercial
830,889

(11,695
)
176

 
161,980

(4,404
)
91

 
992,869

(16,099
)
267

Interest-only
15,142

(641
)
7

 
57,875

(7,103
)
24

 
73,017

(7,744
)
31

Total
$
1,569,727

$
(19,477
)
239

 
$
1,818,645

$
(107,098
)
336

 
$
3,388,372

$
(126,575
)
575


At March 31, 2018, the Company did not intend to sell any of its RMBS that were in an unrealized loss position, and it was not 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. 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 at the quarter ended March 31, 2017. 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, 2018.

Gross unrealized losses on the Company’s Agency residential and commercial MBS (excluding Agency MBS which are reported at fair value with changes in fair value recorded in earnings) were $97 million and $41 million as of March 31, 2018 and December 31, 2017, 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, 2018 and December 31, 2017, unrealized losses on its Agency MBS were temporary.

Gross unrealized losses on the Company’s Non-Agency RMBS (excluding Non-Agency MBS which are reported at fair value with changes in fair value recorded in earnings) were $572 thousand and $283 thousand at March 31, 2018 and December 31, 2017, 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 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, 2018 and 2017 are presented below.

 
For the Quarter Ended
 
March 31, 2018
March 31, 2017
 
(dollars in thousands)
Total other-than-temporary impairment losses
$
(294
)
$
(2,713
)
Portion of loss recognized in other comprehensive income (loss)
(864
)
(15,988
)
Net other-than-temporary credit impairment losses
$
(1,158
)
$
(18,701
)
 

13



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 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 Quarters Ended
 
March 31, 2018
March 31, 2017
 
(dollars in thousands)
Cumulative credit loss beginning balance
$
591,521

$
556,485

Additions:
 

 

Other-than-temporary impairments not previously recognized
1,140


Reductions for securities sold or deconsolidated during the period
(173
)
(7,443
)
Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments
18

16,726

Reductions for increases in cash flows expected to be collected over the remaining life of the securities
(6,450
)
(7,539
)
Cumulative credit impairment loss ending balance
$
586,056

$
558,229


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 for the periods reported are summarized as follows:

 
For the Quarter Ended
 
March 31, 2018
March 31, 2017
Loss Severity
 
 
Weighted Average
100%
64%
Range
34% - 132%
63% - 64%
60+ days delinquent
 
 
Weighted Average
18%
19%
Range
16% - 19%
11% - 25%
Credit Enhancement (1)

 
Weighted Average
17%
22%
Range
0% - 51%
0% - 37%
3 Month CPR
 
 
Weighted Average
27%
12%
Range
3% - 39%
4% - 24%
12 Month CPR
 
 
Weighted Average
15%
10%
Range
3% - 20%
4% - 19%
(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, 2018 and December 31, 2017.

14



 
 
March 31, 2018
 
 
 
 
 
(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
$
736,149

$

$
736,149

$
(481
)
$

$
(481
)
Senior, interest-only

16,197

16,197


(70,296
)
(70,296
)
Subordinated
65,248

3,204

68,452

(91
)
(85
)
(176
)
Subordinated, interest-only

1,388

1,388


(521
)
(521
)
Agency MBS
 

 

 
 

 

 
Residential
3,142

59

3,201

(64,913
)
(17,225
)
(82,138
)
Commercial
2,762

280

3,042

(32,572
)
(23,095
)
(55,667
)
Interest-only

827

827


(7,910
)
(7,910
)
Total
$
807,301

$
21,955

$
829,256

$
(98,057
)
$
(119,132
)
$
(217,189
)
 
 
December 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
$
754,234

$

$
754,234

$
(182
)
$

$
(182
)
Senior, interest-only

15,761

15,761


(67,907
)
(67,907
)
Subordinated
62,989

3,715

66,704

(102
)
(197
)
(299
)
Subordinated, interest-only

902

902


(445
)
(445
)
Agency MBS
 

 

 

 

 

 

Residential
5,706


5,706

(29,083
)
(4,816
)
(33,899
)
Commercial
15,462

1,579

17,041

(12,122
)
(3,977
)
(16,099
)
Interest-only

834

834


(7,744
)
(7,744
)
Total
$
838,391

$
22,791

$
861,182

$
(41,489
)
$
(85,086
)
$
(126,575
)

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, 2018 and December 31, 2017.
 
March 31, 2018
 
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
$
2,627,375

$
53.96

$
81.96

4.6
%
17.1
%
Senior, interest-only
4,646,297

5.42

4.25

1.3
%
7.0
%
Subordinated
495,128

67.34

81.13

4.1
%
9.3
%
Subordinated, interest-only
196,208

3.68

4.12

0.8
%
12.4
%
Agency MBS
 

 

 

 

 

Residential pass-through
2,265,632

105.56

102.07

3.9
%
3.0
%
Commercial pass-through
2,153,980

102.15

99.71

3.6
%
3.3
%
Interest-only
2,960,181

3.53

3.29

0.7
%
3.2
%
(1) Bond Equivalent Yield at period end.

15



 
December 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
$
2,733,926

$
54.04

$
81.62

4.6
%
16.7
%
Senior, interest-only
4,862,461

5.41

4.34

1.3
%
8.0
%
Subordinated
501,455

66.77

80.01

4.1
%
9.6
%
Subordinated, interest-only
201,378

3.66

3.89

0.8
%
11.8
%
Agency MBS
 

 

 

 

 

Residential pass-through
2,227,128

105.53

104.27

3.8
%
2.9
%
Commercial pass-through
1,894,594

102.26

102.31

3.6
%
3.2
%
Interest-only
3,021,840

3.68

3.45

0.7
%
3.4
%
(1) Bond Equivalent Yield at period end.
The following table presents the weighted average credit rating of the Company’s Non-Agency RMBS portfolio at March 31, 2018 and December 31, 2017.

 
March 31, 2018
December 31, 2017

AAA
0.3
%
0.3
%
AA
0.5
%
0.3
%
A
0.5
%
0.6
%
BBB
1.7
%
1.9
%
BB
2.2
%
2.5
%
B
2.3
%
2.3
%
Below B
58.2
%
59.6
%
Not Rated
34.3
%
32.5
%
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, 2018 and December 31, 2017 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.

16



 
March 31, 2018
 
(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
$
164

$
545,119

$
979,210

$
628,834

$
2,153,327

Senior interest-only
28

32,448

84,826

80,291

197,593

Subordinated

70,172

128,691

202,836

401,699

Subordinated interest-only

408

7,684


8,092

Agency MBS
 

 

 

 

 

Residential


2,288,702

23,933

2,312,635

Commercial

15,764

19,377

2,112,503

2,147,644

Interest-only

68,737

24,227

4,556

97,520

Total fair value
$
192

$
732,648

$
3,532,717

$
3,052,953

$
7,318,510

Amortized cost
 

 

 

 

 

Non-Agency RMBS
 
 

 

 

 

Senior
$
162

$
400,387

$
613,201

$
403,909

$
1,417,659

Senior interest-only
243

45,734

113,981

91,734

251,692

Subordinated

57,559

97,904

177,960

333,423

Subordinated interest-only

493

6,732


7,225

Agency MBS
 

 

 

 

 

Residential


2,366,843

24,729

2,391,572

Commercial

15,887

20,490

2,163,892

2,200,269

Interest-only

74,005

26,341

4,257

104,603

Total amortized cost
$
405

$
594,065

$
3,245,492

$
2,866,481

$
6,706,443

 
December 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
$
2,179

$
681,086

$
910,234

$
637,916

$
2,231,415

Senior interest-only
19

54,107

72,702

84,022

210,850

Subordinated

75,495

121,555

204,175

401,225

Subordinated interest-only

7,165

661


7,826

Agency MBS
 

 

 

 

 

Residential

21,777

2,300,403


2,322,180

Commercial

45,770

16,559

1,875,952

1,938,281

Interest-only

74,490

25,271

4,606

104,367

Total fair value
$
2,198

$
959,890

$
3,447,385

$
2,806,671

$
7,216,144

Amortized cost
 

 

 

 

 

Non-Agency RMBS
 
 

 

 

 

Senior
$
2,124

$
493,965

$
569,458

$
411,816

$
1,477,363

Senior interest-only
1,271

73,758

94,145

93,822

262,996

Subordinated

61,987

91,044

181,789

334,820

Subordinated interest-only

6,355

1,014


7,369

Agency MBS
 

 

 

 

 

Residential

22,069

2,328,304


2,350,373

Commercial

47,170

17,176

1,872,993

1,937,339

Interest-only

79,356

27,582

4,339

111,277

Total amortized cost
$
3,395

$
784,660

$
3,128,723

$
2,564,759

$
6,481,537



17



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, 2018 and December 31, 2017, 67% and 66% of the Non-Agency RMBS collateral was classified as Alt-A, respectively. At March 31, 2018 and December 31, 2017, 11% and 13% 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, 2018 and December 31, 2017.
 
March 31, 2018
December 31, 2017
Weighted average maturity (years)
 
20.5

 
20.7

Weighted average amortized loan to value (1)
 
64.3
%
 
64.4
%
Weighted average FICO (2)
 
697

 
697

Weighted average loan balance (in thousands)
 
$
316

 
$
314

Weighted average percentage owner occupied
 
83.9
%
 
84.4
%
Weighted average percentage single family residence
 
65.6
%
 
66.3
%
Weighted average current credit enhancement
 
2.3
%
 
2.2
%
Weighted average geographic concentration of top four states
CA
31.6
%
CA
31.7
%
 
NY
8.8
%
NY
8.5
%
 
FL
8.4
%
FL
8.3
%
 
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.

The table below presents the origination year of the underlying loans related to the Company’s portfolio of Non-Agency RMBS at March 31, 2018 and December 31, 2017.

Origination Year
March 31, 2018
December 31, 2017

2003 and prior
5.1
%
3.6
%
2004
5.8
%
4.3
%
2005
18.9
%
20.8
%
2006
43.1
%
38.2
%
2007
25.8
%
30.4
%
2008
0.4
%
1.8
%
2009 and later
0.9
%
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, 2018 and 2017 are as follows:


18



 
For the Quarter Ended
 
March 31, 2018
March 31, 2017
 
(dollars in thousands)
Proceeds from sales
$

$
20,063

 
 
 
Gross realized gains

5,187

Gross realized losses

(20
)
Net realized gain (loss)
$

$
5,167


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 for the quarter ended March 31, 2018.

4. Loans Held for Investment

The 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, 2018, all 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 Loans held for investment. As changes in the fair value of these loans are reflected in earnings, the Company does not estimate or record a loan loss provision. The total amortized cost of our Loans held for investment was $13.2 billion and $13.3 billion as of March 31, 2018 and December 31, 2017, respectively.

The following table provides a summary of the changes in the carrying value of Loans held for investment at fair value at March 31, 2018 and December 31, 2017:

 
For the Quarter Ended
For the Year Ended
 
March 31, 2018
December 31, 2017
 
(dollars in thousands)
Balance, beginning of period
$
13,678,263

$
8,753,653

Purchases
369,583

6,539,765

Principal paydowns
(443,755
)
(1,788,409
)
Sales and settlements
(6,865
)
2,876

Net periodic accretion (amortization)
(18,826
)
(35,803
)
Change in fair value
41,595

206,181

Balance, end of period
$
13,619,995

$
13,678,263


The primary cause of the change in fair value is due to market demand and changes in credit risk of mortgage loans.

Residential mortgage loans

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

19



Origination Year
March 31, 2018
December 31, 2017

2002 and prior
7.4
%
7.5
%
2003
6.7
%
6.7
%
2004
14.5
%
14.6
%
2005
20.1
%
20.4
%
2006
23.1
%
23.1
%
2007
18.8
%
19.0
%
2008
6.0
%
6.0
%
2009
0.8
%
0.7
%
2010 and later
2.6
%
2.0
%
Total
100.0
%
100.0
%

The following table presents a summary of key characteristics of the residential loan portfolio at March 31, 2018 and December 31, 2017:
 
March 31, 2018
December 31, 2017
Number of loans
 
147,720

 
149,172

Weighted average maturity (years)
 
19.2

 
18.8

Weighted average loan to value (1)
 
87.7
%
 
88.0
%
Weighted average FICO (1)
 
631

 
631

Weighted average loan balance (in thousands)
 
$
91

 
$
91

Weighted average percentage owner occupied
 
94.2
%
 
95.0
%
Weighted average percentage single family residence
 
86.2
%
 
86.0
%
Weighted average geographic concentration of top five states
CA
9.1
%
CA
9.0
%
 
FL
7.2
%
FL
7.2
%
 
OH
6.0
%
OH
6.1
%
 
PA
5.6
%
PA
5.6
%
 
NY
5.6
%
VA
5.5
%
(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, 2018 and December 31, 2017.




 
30 Days Delinquent
60 Days Delinquent
90+ Days Delinquent
Bankruptcy
Foreclosure
REO
Total
Unpaid Principal/Notional
 
(dollars in thousands)
 
March 31, 2018
$957,935
$327,238
$443,963
$280,238
$225,306
$31,888
$2,266,568
$13,424,680
% of Unpaid Principal Balance
7.1%
2.4%
3.3%
2.1%
1.7%
0.2%
16.9%

 
 
 
 
 
 
 
 
 
December 31, 2017
$888,535
$353,810
$435,876
$272,778
$200,376
$31,008
$2,182,383
$13,525,820
% of Unpaid Principal Balance
6.6%
2.6%
3.2%
2.0%
1.5%
0.2%
16.1%


The fair value of residential mortgage loans 90 days or more past due was $585 million and $577 million as of March 31, 2018 and December 31, 2017, respectively.

Real estate owned


20



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, 2018 and December 31, 2017 was $12 million and $10 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, 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:
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.

21




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, 2018, fourteen investment holdings with an internally developed fair value of $177 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 $6 million lower than the third party prices provided of $183 million. After review and discussion, the Company affirmed and valued the investments at the lower internally developed prices. No other differences were noted at March 31, 2018 in excess of the derived predetermined threshold for the period. At December 31, 2017, four investment holdings with an internally developed fair value of $25 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 $3 million lower than the third party prices provided of $28 million. After review and discussion, the Company affirmed and valued the investments at the lower 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.

Loans Held for Investment
Loans consisting of seasoned subprime residential mortgage loans:
The Company estimates the fair value of its 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.

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 the securitization market.

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, 2018, the internally developed fair values of loan pools of $753 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 $23 million lower than the third party prices provided of $776 million. After review and discussion, the

22



Company affirmed and valued the investments at the lower internally developed prices. At December 31, 2017, there were no pricing differences in excess of the predetermined thresholds between the model generated prices and third party prices.

The Company’s estimates of fair value of 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.

Loans collateralized by jumbo, prime residential mortgages:

The loans collateralized by jumbo, prime residential mortgages are carried at fair value. The 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 loans collateralized by jumbo, prime residential mortgages is based on the fair value of the financial liabilities. See discussion of the fair value of Securitized Debt, collateralized by Loans Held for Investment at fair value below.

As the more observable financial liabilities are considered level 3 in the fair value hierarchy, the 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 process for determining the fair value of securitized debt, collateralized by loans held for investment is 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.

Fair value option

The table below shows the unpaid principal, fair value and impact of change in fair value on each of the financial instruments carried with fair value option as of March 31, 2018 and December 31, 2017 respectively:

23



 
March 31, 2018
 
(dollars in thousands)
 
Unpaid
Principal/
Notional
Fair Value
 
Quarter to Date Gain/(Loss) on Change in Fair Value
Assets:
 
 
 
 
Non-agency RMBS
 
 
 
 
Subordinated
 N/A

$
13,330

 
$
(398
)
Senior, interest-only
4,646,297

197,593

 
(1,953
)
Subordinated, interest-only
196,208

8,092

 
411

Agency MBS
 
 
 
 
Residential Pass-through
683,046

698,410

 
(12,351
)
Commercial Pass-through
855,065

845,779

 
(20,415
)
Interest-only
2,960,181

97,520

 
(173
)
Loans held for investment, at fair value
13,424,680

13,619,995

 
41,596

Liabilities:
 

 

 
 

Securitized debt at fair value, collateralized by loans held for investment
9,345,920

9,321,154

 
7,749


 
December 31, 2017
 
(dollars in thousands)
 
Unpaid
Principal/
Notional
Fair Value
 
Quarter to Date Gain/(Loss) on Change in Fair Value
Year to Date Gain/(Loss) on Change in Fair Value
Assets:
 
 
 
 
 
Non-agency RMBS
 
 
 
 
 
Subordinated
N/A

$
13,993

 
$
(545
)
$
1,246

Senior, interest-only
4,862,461

210,850

 
3,156

(13,290
)
Subordinated, interest-only
201,378

7,826

 
1,836

2,311

Agency MBS