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: September 30, 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 September 30, 2018
Common Stock, $0.01 par value
187,006,943





CHIMERA INVESTMENT CORPORATION

FORM 10-Q
TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
Consolidated Statements of Financial Condition as of September 30, 2018 (Unaudited) and December 31, 2017 (Derived from the audited consolidated financial statements as of December 31, 2017)
 
 
Consolidated Statements of Operations (Unaudited) for the quarters and nine months ended September 30, 2018 and 2017
 
 
Consolidated Statements of Comprehensive Income (Unaudited) for the quarters and nine months ended September 30, 2018 and 2017
 
 
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the nine months ended September 30, 2018 and 2017
 
 
Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2018 and 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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)
 
September 30, 2018
December 31, 2017
Assets:
 
 
Cash and cash equivalents
$
121,046

$
63,569

Non-Agency RMBS, at fair value
2,507,707

2,851,316

Agency MBS, at fair value
9,406,092

4,364,828

Loans held for investment, at fair value
12,729,559

13,678,263

Accrued interest receivable
114,798

100,789

Other assets
145,655

114,391

Derivatives, at fair value, net
155,069

48,914

Total assets (1)
$
25,179,926

$
21,222,070

Liabilities:
 

 

Repurchase agreements ($12.6 billion and $8.8 billion, pledged as collateral, respectively)
$
11,143,102

$
7,250,452

Securitized debt, collateralized by Non-Agency RMBS ($1.1 billion and $1.6 billion pledged as collateral, respectively)
167,718

205,780

Securitized debt at fair value, collateralized by loans held for investment ($12.5 billion and $13.3 billion pledged as collateral, respectively)
8,826,879

9,388,657

Payable for investments purchased
903,424

567,440

Accrued interest payable
110,228

61,888

Dividends payable
96,809

95,365

Accounts payable and other liabilities
18,585

17,191

Derivatives, at fair value, net

320

Total liabilities (1)
$
21,266,745

$
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

7.75% Series C cumulative redeemable: 10,400,000 and 0 shares issued and outstanding, respectively ($260,000 liquidation preference)
104


Common stock: par value $0.01 per share; 300,000,000 shares authorized, 187,006,943 and 187,809,288 shares issued and outstanding, respectively
1,870

1,878

Additional paid-in-capital
4,069,868

3,826,691

Accumulated other comprehensive income
627,936

796,902

Cumulative earnings
3,482,287

2,967,852

Cumulative distributions to stockholders
(4,269,072
)
(3,958,534
)
Total stockholders' equity
$
3,913,181

$
3,634,977

Total liabilities and stockholders' equity
$
25,179,926

$
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 September 30, 2018 and December 31, 2017 , total assets of consolidated VIEs were $13,703,646 and $14,987,464 , respectively, and total liabilities of consolidated VIEs were $9,032,119 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

For the Nine Months Ended

September 30, 2018
September 30, 2017

September 30, 2018
September 30, 2017
Net interest income:





Interest income (1)
$
321,715

$
296,813


$
925,282

$
836,801

Interest expense (2)
174,671

140,358


485,189

388,544

Net interest income
147,044

156,455


440,093

448,257

Other-than-temporary impairments:
 

 






Total other-than-temporary impairment losses
(772
)
(784
)

(1,871
)
(4,245
)
Portion of loss recognized in other comprehensive income
(6,461
)
(10,684
)

(15,651
)
(39,431
)
Net other-than-temporary credit impairment losses
(7,233
)
(11,468
)

(17,522
)
(43,676
)
Other investment gains (losses):
 

 






Net unrealized gains (losses) on derivatives
71,197

9,204


178,511

19,902

Realized gains (losses) on terminations of interest rate swaps




(16,143
)
Net realized gains (losses) on derivatives
2,881

(7,841
)

14,573

(28,680
)
Net gains (losses) on derivatives
74,078

1,363


193,084

(24,921
)
Net unrealized gains (losses) on financial instruments at fair value
(34,306
)
19,042


(38,204
)
159,047

Net realized gains (losses) on sales of investments
(6,123
)
1


(3,956
)
9,709

Gains (losses) on extinguishment of debt
9,263

(1
)

19,320

(48,016
)
Total other gains (losses)
42,912

20,405


170,244

95,819











Other expenses:
 

 





Compensation and benefits
8,642

7,533


25,741

22,759

General and administrative expenses
5,615

4,537


16,964

13,162

Servicing fees
9,766

10,715


31,044

31,193

Deal expenses
1,372

3,357


4,555

16,054

Total other expenses
25,395

26,142


78,304

83,168

Income (loss) before income taxes
157,328

139,250


514,511

417,232

Income taxes
7

18


76

172

Net income (loss)
$
157,321

$
139,232


$
514,435

$
417,060











Dividend on preferred stock
9,960

9,400


28,760

24,083











Net income (loss) available to common shareholders
$
147,361

$
129,832


$
485,675

$
392,977











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


 






Basic
$
0.79

$
0.69


$
2.59

$
2.09

Diluted
$
0.79

$
0.69


$
2.59

$
2.09











Weighted average number of common shares outstanding:


 






Basic
187,006,777

187,779,794


187,182,932

187,773,715

Diluted
187,584,958

188,192,111


187,705,831

188,176,757










Dividends declared per share of common stock
$
0.50

$
0.50


$
1.50

$
1.50












(1) Includes interest income of consolidated VIEs of $223,948 and $241,195 for the quarters ended September 30, 2018 and 2017 , respectively and interest income of consolidated VIEs of $688,720 and $668,621 for the nine months ended September 30, 2018 and 2017 . See Note 8 to consolidated financial statements for further discussion.
(2) Includes interest expense of consolidated VIEs of $99,622 and $101,856 for the quarters ended September 30, 2018 and 2017 , respectively and interest expense of consolidated VIEs of $298,744 and $290,264 for the nine months ended September 30, 2018 and 2017 . 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
For the Nine Months Ended

September 30, 2018
September 30, 2017
September 30, 2018
September 30, 2017
Comprehensive income (loss):
 



Net income (loss)
$
157,321

$
139,232

$
514,435

$
417,060

Other comprehensive income:
 



Unrealized gains (losses) on available-for-sale securities, net
(50,728
)
21,370

(181,885
)
59,114

Reclassification adjustment for net losses included in net income for other-than-temporary credit impairment losses
7,233

11,468

17,522

43,676

Reclassification adjustment for net realized losses (gains) included in net income
(220
)
(1
)
(4,603
)
(7,778
)
Other comprehensive income (loss)
(43,715
)
32,837

(168,966
)
95,012

Comprehensive income (loss) before preferred stock dividends
$
113,606

$
172,069

$
345,469

$
512,072

Dividends on preferred stock
$
9,960

$
9,400

$
28,760

$
24,083

Comprehensive income (loss) available to common stock shareholders
$
103,646

$
162,669

$
316,709

$
487,989




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
Series C 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)






417,060


417,060

Other comprehensive income (loss)





95,012



95,012

Stock based compensation



1

2,754




2,755

Common dividends declared







(282,275
)
(282,275
)
Preferred dividends declared







(24,083
)
(24,083
)
Issuance of preferred stock

130



314,299




314,429

Balance, September 30, 2017
$
58

$
130

$

$
1,878

$
3,825,832

$
813,118

$
2,860,244

$
(3,854,829
)
$
3,646,431

 
 
 
 
 
 
 
 
 
 
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)






514,435


514,435

Other comprehensive income (loss)





(168,966
)


(168,966
)
Repurchase of common stock



(8
)
(14,826
)



(14,834
)
Stock based compensation




6,571




6,571

Common dividends declared







(281,778
)
(281,778
)
Preferred dividends declared







(28,760
)
(28,760
)
Issuance of preferred stock


104


251,432




251,536

Balance, September 30, 2018
$
58

$
130

$
104

$
1,870

$
4,069,868

$
627,936

$
3,482,287

$
(4,269,072
)
$
3,913,181



See accompanying notes to consolidated financial statements.

5



CHIMERA INVESTMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(Unaudited)
 
For the Nine Months Ended
 
September 30, 2018
September 30, 2017
Cash Flows From Operating Activities:
Net income
$
514,435

$
417,060

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
(Accretion) amortization of investment discounts/premiums, net
22,421

(17,269
)
Accretion (amortization) of deferred financing costs and securitized debt discounts/premiums, net
(9,957
)
6,649

Amortization of swaption premium
1,316

5,468

Net unrealized losses (gains) on derivatives
(178,511
)
(19,902
)
Margin (paid) received on derivatives
27,653

(3,948
)
Net unrealized losses (gains) on financial instruments at fair value
38,204

(159,047
)
Net realized losses (gains) on sales of investments
3,956

(9,709
)
Net other-than-temporary credit impairment losses
17,522

43,676

(Gain) loss on extinguishment of debt
(19,320
)
48,016

Equity-based compensation expense
6,571

2,755

Changes in operating assets:




Decrease (increase) in accrued interest receivable, net
(14,009
)
(19,738
)
Decrease (increase) in other assets
24,568

(5,076
)
Changes in operating liabilities:




Increase (decrease) in accounts payable and other liabilities
6,468

4,635

Increase (decrease) in accrued interest payable, net
48,426

15,631

Net cash provided by (used in) operating activities
$
489,743

$
309,201

Cash Flows From Investing Activities:
Agency MBS portfolio:
 

 

Purchases
$
(5,319,958
)
$
(1,000,336
)
Sales
16,184

693,207

Principal payments
346,476

332,140

Non-Agency RMBS portfolio:
 

 

Purchases
(73,149
)
(7,978
)
Sales
19,928

5,045

Principal payments
440,722

459,854

Loans held for investment:
 

 

Purchases
(1,339,514
)
(5,835,799
)
Sales
754,806


Principal payments
1,430,802

1,298,855

Net cash provided by (used in) investing activities
$
(3,723,703
)
$
(4,055,012
)
Cash Flows From Financing Activities:
Proceeds from repurchase agreements
$
49,599,400

$
29,079,905

Payments on repurchase agreements
(45,705,850
)
(27,970,987
)
Net proceeds from preferred stock offerings
251,536

314,429

Payments on repurchase of common stock
(14,834
)

Proceeds from securitized debt borrowings, collateralized by loans held for investment
1,434,765

4,159,073

Payments on securitized debt borrowings, collateralized by loans held for investment
(1,927,854
)
(1,564,489
)
Payments on securitized debt borrowings, collateralized by Non-Agency RMBS
(36,633
)
(103,415
)
Common dividends paid
(280,893
)
(281,832
)
Preferred dividends paid
(28,200
)
(26,532
)
Net cash provided by (used in) financing activities
$
3,291,437

$
3,606,152


6



Net increase (decrease) in cash and cash equivalents
57,477

(139,659
)
Cash and cash equivalents at beginning of period
63,569

177,714

Cash and cash equivalents at end of period
$
121,046

$
38,055

 
 
 
Supplemental disclosure of cash flow information:
Interest received
$
933,693

$
799,808

Interest paid
$
446,806

$
366,284

Non-cash investing activities:
 

 

Payable for investments purchased
$
903,424

$
733,142

Receivable for investments sold
$

$
11,235

Net change in unrealized gain (loss) on available-for sale securities
$
(168,966
)
$
95,012

Retained beneficial interests
$
39,844

$

 
 
 
Non-cash financing activities:
 

 

    Dividends declared, not yet paid
$
96,809

$
95,000



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 nine 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; Chimera RR Holding LLC formed in April 2016, and Anacostia LLC, a TRS formed in June 2018.

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 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.


8



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.

(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 September 30, 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

Fair Value Measurement - Changes to the Disclosure Requirements for Fair Value Measurement (Topic 820)

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this update modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. It eliminates disclosure requirements for transfers between Level 1 and Level 2 of the fair value hierarchy and policies related to valuation processes and the timing of transfers between levels of the fair value hierarchy. It adds the following disclosure requirements, but it exempts nonpublic entities from these requirements: i) The changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements of instruments held at the end of the reporting period and ii) For recurring and nonrecurring Level 3 fair value measurements, the range and weighted averages used to develop significant unobservable inputs and how the weighted average was calculated, with certain exceptions. 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.

Income Statement - Reporting Comprehensive Income - (Topic 220)


9



In February 2018, the FASB issued ASU No. 2018-02, I ncome 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 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.

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 not planning to early adopt 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 September 30, 2018 and December 31, 2017 .

10



 
 
September 30, 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
$
2,413,931

$
566

$
(1,148,263
)
$
1,266,234

$
1,974,805

$
708,877

$
(306
)
$
708,571

Senior, interest-only
5,844,053

297,221


297,221

242,244

22,612

(77,589
)
(54,977
)
Subordinated
379,077

8,985

(169,497
)
218,565

278,022

59,949

(492
)
59,457

Subordinated, interest-only
244,298

10,648


10,648

12,636

2,081

(93
)
1,988

Agency MBS
 

 

 

 

 

 

 



Residential
6,730,675

214,066


6,944,741

6,811,047

1,029

(134,723
)
(133,694
)
Commercial
2,532,460

55,295

(4,542
)
2,583,213

2,475,531

216

(107,898
)
(107,682
)
Interest-only
2,865,073

123,635


123,635

119,514

862

(4,983
)
(4,121
)
Total
$
21,009,567

$
710,416

$
(1,322,302
)
$
11,444,257

$
11,913,799

$
795,626

$
(326,084
)
$
469,542


 
 
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.

 
For the Quarters Ended
For the Nine Months Ended
 
September 30, 2018
September 30, 2017
September 30, 2018
September 30, 2017
 
(dollars in thousands)
(dollars in thousands)
Balance at beginning of period
$
1,266,640

$
1,383,188

$
1,303,590

$
1,550,110

Purchases
4,444

8,196

10,178

18,380

Yield income earned
(57,078
)
(66,042
)
(174,595
)
(202,618
)
Reclassification (to) from non-accretable difference
32,022

53,884

113,517

15,777

Sales and deconsolidation
(1,733
)
(17,755
)
(8,395
)
(20,178
)
Balance at end of period
$
1,244,295

$
1,361,471

$
1,244,295

$
1,361,471


The table below presents the outstanding principal balance and related amortized cost at September 30, 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.

11



 
For the Nine Months Ended
For the Year Ended
 
September 30, 2018
December 31, 2017
 
(dollars in thousands)
Outstanding principal balance:
 
 
Beginning of period
$
2,673,350

$
3,138,265

End of period
$
2,378,436

$
2,673,350

Amortized cost:
 

 

Beginning of period
$
1,381,839

$
1,695,079

End of period
$
1,180,207

$
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 September 30, 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.

 
 
 
September 30, 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 Positions
 
Estimated Fair Value
Unrealized Losses
Number of Positions
 
Estimated Fair Value
Unrealized Losses
Number of Positions
Non-Agency RMBS
 
 
 
 
 
 
 
 
 
 
 
Senior
$
37,480

$
(306
)
2

 
$

$


 
$
37,480

$
(306
)
2

Senior, interest-only
33,026

(5,155
)
34

 
87,805

(72,434
)
93

 
120,831

(77,589
)
127

Subordinated
16,590

(492
)
10

 


6

 
16,590

(492
)
16

Subordinated, interest-only
408

(31
)
2

 
386

(62
)
1

 
794

(93
)
3

Agency MBS
 

 



 


 

 

 
 

 

 

Residential
4,889,446

(30,727
)
68

 
1,794,683

(103,996
)
106

 
6,684,129

(134,723
)
174

Commercial
2,033,817

(82,812
)
608

 
414,565

(25,086
)
150

 
2,448,382

(107,898
)
758

Interest-only
8,472

(197
)
4

 
41,016

(4,786
)
14

 
49,488

(4,983
)
18

Total
$
7,019,239

$
(119,720
)
728

 
$
2,338,455

$
(206,364
)
370

 
$
9,357,694

$
(326,084
)
1,098


 
 
 
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 Positions
 
Estimated Fair Value
Unrealized Losses
Number of Positions
 
Estimated Fair Value
Unrealized Losses
Number of Positions
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 September 30, 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

12



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 September 30, 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 $138 million and $41 million as of September 30, 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 September 30, 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 $596 thousand and $283 thousand at September 30, 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 and nine months ended September 30, 2018 and 2017 are presented below.

 
For the Quarters Ended
 
For the Nine Months Ended
 
September 30, 2018
September 30, 2017
 
September 30, 2018
September 30, 2017
 
(dollars in thousands)
 
(dollars in thousands)
Total other-than-temporary impairment losses
$
(772
)
$
(784
)
 
$
(1,871
)
$
(4,245
)
Portion of loss recognized in other comprehensive income (loss)
(6,461
)
(10,684
)
 
(15,651
)
(39,431
)
Net other-than-temporary credit impairment losses
$
(7,233
)
$
(11,468
)
 
$
(17,522
)
$
(43,676
)
 
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
For the Nine Months Ended
 
September 30, 2018
September 30, 2017
September 30, 2018
September 30, 2017
 
(dollars in thousands)
Cumulative credit loss beginning balance
$
582,661

$
571,639

$
591,521

$
556,485

Additions:
 

 

 

 

Other-than-temporary impairments not previously recognized
4,929


6,069

12,399

Reductions for securities sold or deconsolidated during the period
(1,032
)
(4,965
)
(5,980
)
(12,405
)
Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments
2,304

11,468

11,453

29,302

Reductions for increases in cash flows expected to be collected over the remaining life of the securities
(2,237
)
(3,241
)
(16,438
)
(10,880
)
Cumulative credit impairment loss ending balance
$
586,625

$
574,901

$
586,625

$
574,901



13



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 Nine Months Ended
 
September 30, 2018
September 30, 2017
Loss Severity
 
 
Weighted Average
63%
67%
Range
34% - 132%
28% - 89%
60+ days delinquent
 
 
Weighted Average
21%
21%
Range
13% - 30%
11% - 27%
Credit Enhancement (1)

 
Weighted Average
24%
15%
Range
0% - 55%
0% - 50%
3 Month CPR
 
 
Weighted Average
12%
13%
Range
0% - 39%
2% - 24%
12 Month CPR
 
 
Weighted Average
12%
13%
Range
1% - 28%
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 September 30, 2018 and December 31, 2017 .
 
 
September 30, 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
$
708,877

$

$
708,877

$
(306
)
$

$
(306
)
Senior, interest-only

22,612

22,612


(77,589
)
(77,589
)
Subordinated
56,780

3,169

59,949

(290
)
(202
)
(492
)
Subordinated, interest-only

2,081

2,081


(93
)
(93
)
Agency MBS
 

 

 
 

 

 
Residential
1,029


1,029

(82,889
)
(51,834
)
(134,723
)
Commercial
24

192

216

(55,289
)
(52,609
)
(107,898
)
Interest-only

862

862


(4,983
)
(4,983
)
Total
$
766,710

$
28,916

$
795,626

$
(138,774
)
$
(187,310
)
$
(326,084
)

14



 
 
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 September 30, 2018 and December 31, 2017 .
 
September 30, 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
$
2,413,931

$
52.46

$
81.81

4.9
%
18.8
%
Senior, interest-only
5,844,053

5.09

4.15

1.2
%
9.1
%
Subordinated
379,077

57.66

73.34

4.3
%
11.0
%
Subordinated, interest-only
244,298

4.36

5.17

1.2
%
16.1
%
Agency MBS
 

 

 

 

 

Residential pass-through
6,730,675

103.18

101.19

4.0
%
3.5
%
Commercial pass-through
2,532,460

102.00

97.75

3.6
%
3.4
%
Interest-only
2,865,073

4.32

4.17

0.8
%
4.1
%
(1) Bond Equivalent Yield at period end.

 
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.

15




The following table presents the weighted average credit rating of the Company’s Non-Agency RMBS portfolio at September 30, 2018 and December 31, 2017 based on fair value. Previously issued financial statement filings were based on unpaid principal balances. We believe fair value provides an improved representation of the credit rating distribution of the Company's Non-Agency RMBS portfolio.

 
September 30, 2018
December 31, 2017

AAA
0.6
%
%
AA
%
%
A
0.3
%
%
BBB
0.5
%
0.5
%
BB
0.9
%
0.7
%
B
0.5
%
0.6
%
Below B
60.7
%
63.1
%
Not Rated
36.5
%
35.1
%
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 September 30, 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.
 
September 30, 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
$
8,436

$
546,137

$
755,517

$
664,715

$
1,974,805

Senior interest-only
1,028

37,826

91,620

111,770

242,244

Subordinated

42,800

119,021

116,201

278,022

Subordinated interest-only

8,464

1,877

2,295

12,636

Agency MBS
 

 

 

 

 

Residential

358,386

6,437,979

14,682

6,811,047

Commercial

15,565

27,791

2,432,175

2,475,531

Interest-only
48,247

51,701

19,566


119,514

Total fair value
$
57,711

$
1,060,879

$
7,453,371

$
3,341,838

$
11,913,799

Amortized cost
 

 

 

 

 

Non-Agency RMBS
 
 

 

 

 

Senior
$
8,295

$
399,944

$
437,177

$
420,818

$
1,266,234

Senior interest-only
2,821

49,856

114,891

129,653

297,221

Subordinated

31,679

86,181

100,705

218,565

Subordinated interest-only

6,790

1,710

2,148

10,648

Agency MBS
 

 

 

 

 

Residential

361,065

6,568,266

15,410

6,944,741

Commercial

15,649

29,525

2,538,039

2,583,213

Interest-only
48,086

56,265

19,284


123,635

Total amortized cost
$
59,202

$
921,248

$
7,257,034

$
3,206,773

$
11,444,257


16



 
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