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Table of Contents

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 June 30, 2019
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 001-34569
Ellington Financial Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
 
26-0489289
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
53 Forest Avenue, Old Greenwich, Connecticut 06870
(Address of Principal Executive Office) (Zip Code)
(203) 698-1200
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all 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  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
¨
Accelerated Filer
x
Non-Accelerated Filer
¨
Smaller Reporting Company
x
 
 
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  x
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Trading Symbol(s)
 
Name of Each Exchange on Which Registered
Common Stock, $0.001 par value per share
 
EFC
 
The New York Stock Exchange
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
 
Outstanding at August 2, 2019
Common Stock, $0.001 par value per share
 
33,770,776


Table of Contents

ELLINGTON FINANCIAL INC.
INDEX
Part I. Financial Information
 
 
Item 1. Condensed Consolidated Financial Statements (unaudited)
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Item 3. Quantitative and Qualitative Disclosures about Market Risk
 
Item 4. Controls and Procedures
Part II. Other Information
 
 
Item 1. Legal Proceedings
 
Item 1A. Risk Factors
 
Item 6. Exhibits




Table of Contents

PART I—FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited)
ELLINGTON FINANCIAL INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)

 
June 30, 2019
(In thousands, except share amounts)
Expressed in U.S. Dollars
Assets
 
Cash and cash equivalents(1)
$
42,671

Restricted cash(1)
175

Securities, at fair value
1,668,677

Loans, at fair value(1)
1,091,523

Investments in unconsolidated entities, at fair value(1)
69,676

Real estate owned(1)
47,621

Financial derivatives—assets, at fair value
11,150

Reverse repurchase agreements
49,641

Due from brokers(1)
65,083

Investment related receivables(1)
77,882

Other assets(1)
3,495

Total Assets
$
3,127,594

Liabilities
 
Securities sold short, at fair value
$
49,583

Repurchase agreements(1)
1,715,506

Financial derivatives—liabilities, at fair value
27,805

Due to brokers
9,951

Investment related payables(1)
49,516

Other secured borrowings(1)
101,925

Other secured borrowings, at fair value(1)
475,816

Senior notes, net
85,166

Accounts payable and accrued expenses(1)
6,281

Base management fee payable to affiliate
1,661

Dividend payable
4,267

Interest payable(1)
6,741

Other liabilities(1)
262

Total Liabilities
2,534,480

Commitments and contingencies (Note 21)

Equity
 
Common stock, par value $0.001 per share, 100,000,000 shares authorized;
29,745,776 shares issued and outstanding
30

Additional paid-in-capital
664,764

Retained earnings (accumulated deficit)
(102,324
)
Total Stockholders' Equity
562,470

Non-controlling interests(1)
30,644

Total Equity
593,114

Total Liabilities and Equity
$
3,127,594

(1)
Ellington Financial Inc.'s Condensed Consolidated Balance Sheet includes assets and liabilities of variable interest entities it has consolidated. See Note 9 for additional details on Ellington Financial Inc.'s consolidated variable interest entities.

See Notes to Condensed Consolidated Financial Statements
3

Table of Contents

ELLINGTON FINANCIAL INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)

 
Three-Month
Period Ended
June 30, 2019
 
Six-Month Period Ended June 30, 2019
(In thousands, except per share amounts)
Expressed in U.S. Dollars
Net Interest Income
 
 
 
Interest income
$
38,547

 
$
74,563

Interest expense
(19,702
)
 
(37,320
)
Total net interest income
18,845

 
37,243

Other Income (Loss)
 
 
 
Realized gains (losses) on securities and loans, net
(1,505
)
 
(6,827
)
Realized gains (losses) on financial derivatives, net
(10,920
)
 
(22,490
)
Realized gains (losses) on real estate owned, net
98

 
40

Unrealized gains (losses) on securities and loans, net
18,487

 
44,875

Unrealized gains (losses) on financial derivatives, net
(4,921
)
 
(10,610
)
Unrealized gains (losses) on real estate owned, net
(266
)
 
(513
)
Other, net
1,808

 
3,810

Total other income (loss)
2,781

 
8,285

Expenses
 
 
 
Base management fee to affiliate (Net of fee rebates of $508 and $955, respectively)(1)
1,661

 
3,383

Investment related expenses:
 
 
 
Servicing expense
2,244

 
4,637

Debt issuance costs related to Other secured borrowings, at fair value
1,671

 
1,671

Other
1,238

 
2,321

Professional fees
1,178

 
3,134

Compensation expense
903

 
1,975

Other expenses
1,053

 
2,038

Total expenses
9,948

 
19,159

Net Income (Loss) before Income Tax Expense and Earnings from Investments in Unconsolidated Entities
11,678

 
26,369

Income tax expense (benefit)
376

 
376

Earnings from investments in unconsolidated entities
2,354

 
4,151

Net Income (Loss)
13,656

 
30,144

Net Income (Loss) Attributable to Non-Controlling Interests
1,012

 
2,092

Net Income (Loss) Attributable to Common Stockholders
$
12,644

 
$
28,052

Net Income (Loss) per Share of Common Stock:
 
 
 
Basic and Diluted
$
0.43

 
$
0.94

(1)
See Note 13 for further details on management fee rebates.


See Notes to Condensed Consolidated Financial Statements
4

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ELLINGTON FINANCIAL INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(UNAUDITED)
 
Common Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings/(Accumulated Deficit)
 
Total Stockholders' Equity
 
Non-controlling Interest
 
Total Equity
 
Shares
 
Par Value
 
 
 
 
 
(In thousands, except share amounts)
 
 
Expressed in U.S. Dollars
BALANCE, January 1, 2019
29,796,601

 
$

 
$
665,356

 
$
(101,523
)
 
$
563,833

 
$
31,337

 
$
595,170

Share conversion(1)

 
30

 
(30
)
 

 

 

 

Net income (loss)
 
 
 
 
 
 
15,408

 
15,408

 
1,080

 
16,488

Contributions from non-controlling interests
 
 
 
 
 
 
 
 
 
 
2,512

 
2,512

Dividends(2)
 
 
 
 
 
 
(16,360
)
 
(16,360
)
 
(404
)
 
(16,764
)
Distributions to non-controlling interests
 
 
 
 
 
 
 
 
 
 
(4,306
)
 
(4,306
)
Adjustment to non-controlling interests
 
 
 
 
(4
)
 
 
 
(4
)
 
4

 

Repurchase of shares of common stock
(50,825
)
 

 
(782
)
 

 
(782
)
 

 
(782
)
Share-based long term incentive plan unit awards
 
 
 
 
114

 
 
 
114

 
2

 
116

BALANCE, March 31, 2019
29,745,776

 
30

 
664,654

 
(102,475
)
 
562,209

 
30,225

 
592,434

Net income (loss)
 
 
 
 
 
 
12,644

 
12,644

 
1,012

 
13,656

Contributions from non-controlling interests
 
 
 
 
 
 
 
 
 
 
4,936

 
4,936

Dividends(2)
 
 
 
 
 
 
(12,493
)
 
(12,493
)
 
(308
)
 
(12,801
)
Distributions to non-controlling interests
 
 
 
 
 
 
 
 
 
 
(5,225
)
 
(5,225
)
Share-based long term incentive plan unit awards
 
 
 
 
110

 
 
 
110

 
4

 
114

BALANCE, June 30, 2019
29,745,776

 
$
30

 
$
664,764

 
$
(102,324
)
 
$
562,470

 
$
30,644

 
$
593,114

(1)
See Note 1 for further details on the share conversion.
(2)
For the three- and six-month periods ended June 30, 2019, dividends totaling $0.42 and $0.97 per share of common stock outstanding were declared.

See Notes to Condensed Consolidated Financial Statements
5

Table of Contents

ELLINGTON FINANCIAL INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
 
Six-Month
Period Ended
June 30, 2019
(In thousands)
Expressed in U.S. Dollars
Net cash provided by (used in) operating activities
$
43,334

Cash Flows from Investing Activities:
 
Purchase of securities
(1,278,398
)
Purchase of loans
(433,740
)
Capital improvements of real estate owned
(240
)
Proceeds from disposition of securities
1,047,270

Proceeds from disposition of loans
28,326

Contributions to investments in unconsolidated entities
(30,132
)
Distributions from investments in unconsolidated entities
32,251

Proceeds from disposition of real estate owned
636

Proceeds from principal payments of securities
92,539

Proceeds from principal payments of loans
117,911

Proceeds from securities sold short
469,630

Repurchase of securities sold short
(498,774
)
Payments on financial derivatives
(53,100
)
Proceeds from financial derivatives
35,921

Payments made on reverse repurchase agreements
(2,626,503
)
Proceeds from reverse repurchase agreements
2,786,295

Due from brokers, net
8,069

Due to brokers, net
(2,744
)
Net cash provided by (used in) investing activities
(304,783
)
Cash Flows from Financing Activities:
 
Repurchase of common stock
(782
)
Dividends paid
(25,298
)
Contributions from non-controlling interests
7,448

Distributions to non-controlling interests
(9,531
)
Proceeds from issuance of Other secured borrowings
20,430

Principal payments on Other secured borrowings
(32,605
)
Borrowings under repurchase agreements
3,707,941

Repayments of repurchase agreements
(3,479,161
)
Proceeds from issuance of Other secured borrowings, at fair value
70,988

Debt issuance costs paid
(1,034
)
Due from brokers, net
1,818

Due to brokers, net
(1,000
)
Net cash provided by (used in) financing activities
259,214

Net Increase (Decrease) in Cash, Cash Equivalents, and Restricted Cash
(2,235
)
Cash, Cash Equivalents, and Restricted Cash, Beginning of Period
45,081

Cash, Cash Equivalents, and Restricted Cash, End of Period
$
42,846

 
 

See Notes to Condensed Consolidated Financial Statements
6

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ELLINGTON FINANCIAL INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(UNAUDITED)
 
 
 
 
 
Six-Month
Period Ended
June 30, 2019
(In thousands)
Expressed in U.S. Dollars
Supplemental disclosure of cash flow information:
 
Interest paid
$
37,738

Income tax paid
117

Dividends payable
4,267

Share-based long term incentive plan unit awards (non-cash)
230

Purchase of investments (non-cash)
(2,975
)
Transfers from mortgage loans to real estate owned (non-cash)
17,713

Proceeds from principal payments of investments (non-cash)
41,628

Proceeds received from Other secured borrowings, at fair value (non-cash)
148,547

Principal payments on Other secured borrowings, at fair value (non-cash)
(41,628
)
Repayments of repurchase agreements (non-cash)
(148,158
)
Repayment of senior notes (non-cash)
(86,000
)
Issuance of senior notes (non-cash)
86,000


See Notes to Condensed Consolidated Financial Statements
7

Table of Contents

ELLINGTON FINANCIAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2019
(UNAUDITED)
1. Organization and Investment Objective
Ellington Financial Inc., formerly known as Ellington Financial LLC, was originally formed as a Delaware limited liability company on July 9, 2007 and commenced operations on August 17, 2007. On February 28, 2019, Ellington Financial LLC filed a certificate of conversion with the Secretary of State of the State of Delaware (the "Secretary") to convert from a Delaware limited liability company to a Delaware corporation (the "Conversion") and change its name to Ellington Financial Inc. The Conversion became effective on March 1, 2019, and upon effectiveness, each of Ellington Financial LLC's existing common shares representing limited liability company interests, no par value, converted into one issued and outstanding, fully paid and nonassessable share of common stock, $0.001 par value per share, of Ellington Financial Inc. In connection with the Conversion, Ellington Financial Inc.'s Board of Directors (the "Board of Directors") approved Ellington Financial Inc.'s Certificate of Incorporation (which was also filed with the Secretary) and Bylaws.
Ellington Financial Operating Partnership LLC (the "Operating Partnership"), a 97.6% owned consolidated subsidiary of Ellington Financial Inc., was formed as a Delaware limited liability company on December 14, 2012 and commenced operations on January 1, 2013. All of Ellington Financial Inc.'s operations and business activities are conducted through the Operating Partnership. Ellington Financial Inc., the Operating Partnership, and their consolidated subsidiaries are hereafter collectively referred to as the "Company." All intercompany accounts are eliminated in consolidation.
The Company conducts its operations to qualify and be taxed as a real estate investment trust, or "REIT," under the Internal Revenue Code of 1986, as amended (the "Code"), and has elected to be taxed as a corporation effective January 1, 2019. The Company intends to qualify and will elect to be taxed as a REIT for U.S. federal income tax purposes commencing with the tax year ending December 31, 2019, the tax return for which is expected to be filed in 2020. In anticipation of the Company's intended election to be taxed as a REIT under the Code beginning with its 2019 taxable year (the "REIT Election"), the Company implemented an internal restructuring as of December 31, 2018. As part of this restructuring, the Company moved certain of its non-REIT-qualifying investments and financial derivatives to taxable REIT subsidiaries or, "TRSs," and disposed of certain of its investments in non-REIT-qualifying investments and financial derivatives.
The Company invests in a diverse array of financial assets, including residential mortgage-backed securities, or "RMBS," commercial mortgage-backed securities, or "CMBS," residential and commercial mortgage loans, consumer loans and asset-backed securities, or "ABS," backed by consumer loans, collateralized loan obligations, or "CLOs," non-mortgage- and mortgage-related derivatives, equity investments in loan origination companies, and other strategic investments.
Ellington Financial Management LLC ("EFM" or the "Manager") is an SEC-registered investment adviser and a registered commodity pool operator that serves as the Manager to the Company pursuant to the terms of its Seventh Amended and Restated Management Agreement (the "Management Agreement"), which was approved by the Board of Directors effective March 13, 2018. EFM is an affiliate of Ellington Management Group, L.L.C. ("Ellington"), an investment management firm that is registered as both an investment adviser and a commodity pool operator. In accordance with the terms of the Management Agreement, the Manager implements the investment strategy and manages the business and operations on a day-to-day basis for the Company and performs certain services for the Company, subject to oversight by the Board of Directors.
2. Significant Accounting Policies
(A) Basis of Presentation: The Company's unaudited interim condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America, or "U.S. GAAP," and Regulation S-X. The condensed consolidated financial statements include the accounts of the Company, the Operating Partnership, its subsidiaries, and variable interest entities, or "VIEs," for which the Company is deemed to be the primary beneficiary. All intercompany balances and transactions have been eliminated. The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In management's opinion, all material adjustments considered necessary for a fair statement of the Company's interim condensed consolidated financial statements have been included and are only of a normal recurring nature. Interim results are not necessarily indicative of the results that may be expected for the entire fiscal year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2018.


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The Company adopted ASC 946, Financial Services—Investment Companies ("ASC 946") upon its commencement of operations in August 2007, and applied U.S. GAAP for investment companies. In connection with the Company's internal restructuring and the Company's intention to qualify as a REIT for the year ending December 31, 2019, the Company has determined that, effective January 1, 2019, it no longer qualifies for investment company accounting in accordance with ASC 946-10-25, and has prospectively discontinued its use. The Company will elect the fair value option, or "FVO," for, and therefore the Company will continue to measure at fair value, those of its assets and liabilities it had previously measured at fair value and for which such election is permitted, as provided for under ASC 825, Financial Instruments ("ASC 825"). Due to the prospective application of a change in accounting as required under ASC 946-10-25-2, the Company has determined that the presentation of its condensed consolidated financial statements for periods beginning after December 31, 2018 are not comparable to the consolidated financial statements previously prepared for prior periods for which the Company applied ASC 946. As a result, the Company has provided separate consolidated financial statements for applicable prior periods in Item 1 of this Quarterly Report on Form 10-Q.
Reclassification and Presentation
Effective January 1, 2019, the Company prospectively discontinued its application of ASC 946. Upon its change in status, the following significant changes and elections were made:
Investments in securities are now accounted for in accordance with ASC 320, Investments—Debt and Equity Securities ("ASC 320");
The Company elected the FVO as provided for under ASC 825-10-25-4 for all eligible financial instruments for which the Company had previously measured at fair value, including investments in securities, loans, financial derivatives, and certain of the Company's secured borrowings. As a result, all changes in the fair value of such financial instruments will continue to be recorded in earnings on the Company's Condensed Consolidated Statement of Operations;
Real estate owned, or "REO," is not eligible for the FVO election. As a result, REO is carried at the lower of cost or fair value. The Company's cost basis in any REO that was previously measured at fair value under ASC 946 was adjusted on January 1, 2019 to equal the fair value of such investment as of December 31, 2018;
The Company elected not to designate its financial derivatives as hedging instruments in accordance with ASC 815, Derivatives and Hedging ("ASC 815"). As a result, all changes in the fair value of financial derivatives will continue to be recorded in earnings on the Company's Condensed Consolidated Statement of Operations;
Forward settling to-be-announced mortgage-backed-securities, or "TBAs," are no longer classified as investments. TBAs will be classified as financial derivatives, with the difference between the forward contract price and the market value of the TBA position as of the reporting date included in Unrealized gains (losses) on financial derivatives, net, on the Condensed Consolidated Statement of Operations; and
The Company is required to account for certain of its equity investments under ASC 323-10, Investments—Equity Method and Joint Ventures ("ASC 323-10"). The Company has elected the FVO for such equity investments and changes in fair value will be reported in Earnings from investments in unconsolidated entities, on the Condensed Consolidated Statement of Operations.
The discontinuation of the Company's application of ASC 946 prospectively changed the presentation of the Company's condensed consolidated financial statements. The most significant changes are:
The Consolidated Statement of Assets, Liabilities, and Equity has been changed to a Condensed Consolidated Balance Sheet;
The Consolidated Condensed Schedule of Investments has been removed;
The Consolidated Statement of Operations is no longer presented in the format required under ASC 946. The Company will present the Condensed Consolidated Statement of Operations as required under U.S. GAAP for operating companies. A Consolidated Statement of Other Comprehensive Income (Loss) will be presented, if and when applicable;
The Condensed Consolidated Statement of Cash Flows has been changed, and now includes a section for investing activities;
Certain footnotes have been changed to reflect conformity with applicable U.S. GAAP for operating companies;
The Company re-evaluated its interests in all entities to determine whether they are variable interests, and re-evaluated its investments, including it investments in partially owned entities, to determine if they are VIEs, as required under ASC 810, Consolidation ("ASC 810"). The Company also re-evaluated consolidation considerations for all of its


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investments in VIEs and partially owned entities, as required under ASC 810. Applicable disclosures related to VIEs have been included in these notes to condensed consolidated financial statements;
Securities/loans sold under agreements to be repurchased at an agreed-upon price and date, which were formerly referred to as "reverse repurchase agreements," are now referred to as "repurchase agreements";
Securities/loans purchased under agreements to resell at an agreed-upon price and date, which were formerly referred to as "repurchase agreements," are now referred to as "reverse repurchase agreements"; and
The financial highlights disclosures, which are not required under U.S. GAAP for operating companies, have been removed.
(B) Valuation: The Company applies ASC 820-10, Fair Value Measurement ("ASC 820") to its holdings of financial instruments. ASC 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the observability of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
Level 1—inputs to the valuation methodology are observable and reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Currently, the types of financial instruments the Company generally includes in this category are listed equities and exchange-traded derivatives;
Level 2—inputs to the valuation methodology other than quoted prices included in Level 1 are observable for the asset or liability, either directly or indirectly. Currently, the types of financial instruments that the Company generally includes in this category are RMBS for which the principal and interest payments are guaranteed by a U.S. government agency or a U.S. government-sponsored entity, or "Agency RMBS," U.S. Treasury securities and sovereign debt, certain non-Agency RMBS, CMBS, CLOs, corporate debt, and actively traded derivatives such as interest rate swaps, foreign currency forwards, and other over-the-counter derivatives; and
Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement. The types of financial instruments that the Company generally includes in this category are certain RMBS, CMBS, CLOs, ABS, and credit default swaps, or "CDS," on individual ABS, in each case where there is less price transparency. Also included in this category are residential and commercial mortgage loans, consumer loans, and private corporate debt and equity investments.
For certain financial instruments, the various inputs that management uses to measure fair value may fall into different levels of the fair value hierarchy. For each such financial instrument, the determination of which category within the fair value hierarchy is appropriate is based on the lowest level of input that is significant to the fair value measurement. ASC 820 prioritizes the various inputs that management uses to measure fair value, with the highest priority given to inputs that are observable and reflect quoted prices (unadjusted) for identical assets or liabilities in active markets (Level 1), and the lowest priority given to inputs that are unobservable and significant to the fair value measurement (Level 3). The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the financial instrument. The Company may use valuation techniques consistent with the market and income approaches to measure the fair value of its financial instruments. The market approach uses third-party valuations and information obtained from market transactions involving identical or similar financial instruments. The income approach uses projections of the future economic benefit of an instrument to determine its fair value, such as in the discounted cash flow methodology. The inputs or methodology used for valuing financial instruments are not necessarily an indication of the risk associated with investing in these financial instruments. The leveling of each financial instrument is reassessed at the end of each period. Transfers between levels of the fair value hierarchy are assumed to occur at the end of the reporting period.
Summary Valuation Techniques
For financial instruments that are traded in an "active market," the best measure of fair value is the quoted market price. However, many of the Company's financial instruments are not traded in an active market. Therefore, management generally uses third-party valuations when available. If third-party valuations are not available, management uses other valuation techniques, such as the discounted cash flow methodology. The following are summary descriptions, for various categories of financial instruments, of the valuation methodologies management uses in determining fair value of the Company's financial instruments in such categories. Management utilizes such methodologies to assign a fair value (the estimated price that, in an orderly transaction at the valuation date, would be received to sell an asset, or paid to transfer a liability, as the case may be) to each such financial instrument.
For mortgage-backed securities, or "MBS," TBAs, CLOs, and corporate debt and equity, management seeks to obtain at least one third-party valuation, and often obtains multiple valuations when available. Management has been able to obtain third-party valuations on the vast majority of these instruments and expects to continue to solicit third-party valuations in the future. Management generally values each financial instrument at the average of third-party valuations received and not


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rejected as described below. Third-party valuations are not binding, management may adjust the valuations it receives (e.g., downward adjustments for odd lots), and management may challenge or reject a valuation when, based on its validation criteria, management determines that such valuation is unreasonable or erroneous. Furthermore, based on its validation criteria, management may determine that the average of the third-party valuations received for a given financial instrument does not result in what management believes to be the fair value of such instrument, and in such circumstances management may override this average with its own good faith valuation. The validation criteria may take into account output from management's own models, recent trading activity in the same or similar instruments, and valuations received from third parties. The use of proprietary models requires the use of a significant amount of judgment and the application of various assumptions including, but not limited to, assumptions concerning future prepayment rates and default rates. Given their relatively high level of price transparency, Agency RMBS pass-throughs are typically classified as Level 2. Non-Agency RMBS, CMBS, Agency interest only and inverse interest only RMBS, CLOs, and corporate bonds are generally classified as either Level 2 or Level 3 based on analysis of available market data and/or third-party valuations. Private equity investments are generally classified as Level 3. Furthermore, the methodology used by the third-party valuation providers is reviewed at least annually by management, so as to ascertain whether such providers are utilizing observable market data to determine the valuations that they provide.
For residential and commercial mortgage loans and consumer loans, management determines fair value by taking into account both external pricing data, which includes third-party valuations, and internal pricing models. Management has obtained third-party valuations on the majority of these investments and expects to continue to solicit third-party valuations in the future. In determining fair value for non-performing mortgage loans, management evaluates third-party valuations, if applicable, as well as management's estimates of the value of the underlying real estate, using information including general economic data, broker price opinions, or "BPOs," recent sales, property appraisals, and bids. In determining fair value for performing mortgage loans and consumer loans, management evaluates third-party valuations, if applicable, as well as discounted cash flows of the loans based on market assumptions. Cash flow assumptions typically include projected default and prepayment rates and loss severities, and may include adjustments based on appraisals and BPOs. Mortgage and consumer loans are classified as Level 3.
The Company has securitized certain mortgage loans that are not deemed "qualified mortgage," or "QM," loans under the rules of the Consumer Financial Protection Bureau, or "non-QM loans." The Company's securitized non-QM loans are held as part of a collateralized financing entity, or "CFE." A CFE is a VIE that holds financial assets, issues beneficial interests in those assets, and has no more than nominal equity, and for which the issued beneficial interests have contractual recourse only to the related assets of the CFE. ASC 810 allows the Company to elect to measure both the financial assets and financial liabilities of the CFE using the more observable of the fair value of the financial assets and the fair value of the financial liabilities of the CFE. The Company has elected the FVO for initial and subsequent recognition of the debt issued by its consolidated securitization trusts and has determined that each consolidated securitization trust meets the definition of a CFE; see Note 10 "Securitization TransactionsResidential Mortgage Loan Securitizations" for further discussion on the Company's securitization trusts. The Company has determined the inputs to the fair value measurement of the financial liabilities of each of its CFEs to be more observable than those of the financial assets and, as a result, has used the fair value of the financial liabilities of each of the CFEs to measure the fair value of the financial assets of each of the CFEs. The fair value of the debt issued by each CFE is typically valued using discounted cash flows and other market data. The securitized non-QM loans, which are assets of the CFEs, are included in Loans, at fair value, on the Company's Condensed Consolidated Balance Sheet. The debt issued by the CFEs is included in Other secured borrowings, at fair value, on the Company's Condensed Consolidated Balance Sheet. Unrealized gains (losses) from changes in fair value of Other secured borrowings, at fair value, are included in Other, net, on the Company's Condensed Consolidated Statement of Operations. The securitized non-QM loans and the debt issued by the Company's CFEs are both classified as Level 3.
For financial derivatives with greater price transparency, such as CDS on asset-backed indices, CDS on corporate indices, certain options on the foregoing, and total return swaps on publicly traded equities or indices, market-standard pricing sources are used to obtain valuations; these financial derivatives are generally classified as Level 2. Interest rate swaps, swaptions, and foreign currency forwards are typically valued based on internal models that use observable market data, including applicable interest rates and foreign currency rates in effect as of the measurement date; the model-generated valuations are then typically compared to counterparty valuations for reasonableness. These financial derivatives are also generally classified as Level 2. Financial derivatives with less price transparency, such as CDS on individual ABS, are generally valued based on internal models, and are classified as Level 3. In the case of CDS on individual ABS, the valuation process typically starts with an estimation of the value of the underlying ABS. In valuing its financial derivatives, the Company also considers the creditworthiness of both the Company and its counterparties, along with collateral provisions contained in each financial derivative agreement.


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Investments in private operating entities, such as loan originators, are valued based on available metrics, such as relevant market multiples and comparable company valuations, company specific-financial data including actual and projected results, and independent third party valuation estimates. These investments are classified as Level 3.
The Company's repurchase and reverse repurchase agreements are carried at cost, which approximates fair value. Repurchase and reverse repurchase agreements are classified as Level 2, based on the adequacy of the collateral and their short term nature.
The Company's valuation process, including the application of validation criteria, is overseen by the Manager's Valuation Committee (the "Valuation Committee"). The Valuation Committee includes senior level executives from various departments within the Manager, and each quarter, the Valuation Committee reviews and approves the valuations of the Company's financial instruments. The valuation process also includes a monthly review by the Company's third-party administrator. The goal of this review is to replicate various aspects of the Company's valuation process based on the Company's documented procedures.
Because of the inherent uncertainty of valuation, the estimated fair value of the Company's financial instruments may differ significantly from the values that would have been used had a ready market for the financial instruments existed, and the differences could be material to the Company's condensed consolidated financial statements.
(C) Accounting for Securities: Purchases and sales of investments in securities are generally recorded on trade date, and realized and unrealized gains and losses are calculated based on identified cost. Investments in securities are recorded in accordance with ASC 320 or ASC 325-40, Beneficial Interests in Securitized Financial Assets ("ASC 325-40"). The Company generally classifies its securities as available-for-sale. The Company has chosen to elect the FVO pursuant to ASC 825 for its investments in securities. Electing the FVO allows the Company to record changes in fair value in the Condensed Consolidated Statement of Operations, as a component of Unrealized gains (losses) on securities and loans, net, which, in management's view, more appropriately reflects the results of operations for a particular reporting period as all investment activities will be recorded in a similar manner.
Many of the Company's investments in securities, such as MBS and CLOs, are issued by entities that are deemed to be VIEs. For the majority of such investments, the Company has determined it is not the primary beneficiary of such VIEs and therefore has not consolidated such VIEs. The Company's maximum risk of loss in these unconsolidated VIEs is generally limited to the fair value of the Company's investment in the VIE.
The Company evaluates its investments in interest only securities to determine whether they meet the requirements for classification as financial derivatives under ASC 815. For interest only securities, where the holder is entitled only to a portion of the interest payments made on the mortgages underlying certain MBS, and inverse interest only securities, which are interest only securities whose coupon has an inverse relationship to its benchmark rate, such as LIBOR, the Company has determined that such investments do not meet the requirements for treatment as financial derivatives and are classified as securities.
The Company evaluates the cost basis of its investments in securities for other-than-temporary impairment, or "OTTI," on at least a quarterly basis. The determination of whether a security is other-than-temporarily impaired requires judgments, estimates, and assumptions based on subjective and objective factors. As a result, the timing and amount of an OTTI constitutes an accounting estimate that may change materially over time.
When the fair value of a security is less than its amortized cost basis as of the balance sheet date, the security's cost basis is considered impaired, and the impairment is designated as either temporary or other-than-temporary. When a security's cost basis is impaired, an OTTI is considered to have occurred if (i) the Company intends to sell the security (i.e., a decision has been made as of the reporting date), (ii) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, or (iii) the Company does not expect to recover the security's amortized cost basis, even if the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security. Additionally, for securities accounted for under ASC 325-40, an impairment of the cost basis is recorded when there is an adverse change in the expected cash flows to be received and the fair value of the security is less than its carrying amount. In determining whether an adverse change in cash flows has occurred, the present value of the remaining cash flows, as estimated at the initial transaction date (or the last date previously revised), is compared to the present value of the expected cash flows at the current reporting date. The estimated cash flows reflect those that a "market participant" would use and include observations of current information and events, and assumptions related to fluctuations in interest rates, prepayment speeds and the timing and amount of potential credit losses. Cash flows are discounted at a rate equal to the current yield used to accrete interest income. Any resulting OTTI adjustments made to the cost basis of the security are reflected in Realized gains (losses) on securities and loans, net, on the Condensed Consolidated Statement of Operations.
(D) Accounting for Loans: The Company's loan portfolio generally consists of residential mortgage, commercial mortgage, and consumer loans. The Company's loans are accounted for under ASC 310-10, Receivables, and are classified as


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held-for-investment when the Company has the intent and ability to hold such loans for the foreseeable future or to maturity/payoff. When the Company has the intent to sell loans, such loans will be classified as held-for-sale. Mortgage loans held-for-sale are accounted for under ASC 948-310, Financial services—mortgage banking. The Company may aggregate its loans into pools based on common risk characteristics at purchase. Once a pool of loans is assembled, its composition is maintained. The Company has chosen to elect the FVO pursuant to ASC 825 for its loan portfolios. Loans are recorded at fair value on the Condensed Consolidated Balance Sheet and changes in fair value are recorded in earnings on the Condensed Consolidated Statement of Operations as a component of Unrealized gains (losses) on securities and loans, net. Transfers between held-for-investment and held-for-sale occur once the Company's intent to sell the loans changes.
For residential and commercial mortgage loans, the Company generally accrues interest payments. Such loans are typically moved to non-accrual status if the loan becomes 90 days or more delinquent. The Company does not accrue interest payments on its consumer loans; interest payments are recorded upon receipt.
The Company evaluates the collectability of both interest and principal on each of its loan investments and whether the cost basis of the loan is impaired. A loan's cost basis is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the existing contractual terms. When a loan's cost basis is impaired, the Company does not record an allowance for loan loss as it has elected the FVO on all of its loan investments. The Company will recognize impairments through an adjustment to the amortized cost basis and recognize a realized loss in the period such adjustment was made, which is included in Realized gains (losses) on securities and loans, net, on the Condensed Consolidated Statement of Operations.
(E) Interest Income: The Company amortizes premiums and accretes discounts on its debt securities. Coupon interest income on fixed-income investments is generally accrued based on the outstanding principal balance or notional value and the current coupon interest rate.
For debt securities that are deemed to be of high credit quality at the time of purchase (generally Agency RMBS, exclusive of interest only securities), premiums and discounts are amortized/accreted into interest income over the life of such securities using the effective interest method. For such securities whose cash flows vary depending on prepayments, an effective yield retroactive to the time of purchase is periodically recomputed based on actual prepayments and changes in projected prepayment activity, and a catch-up adjustment, or "Catch-up Premium Amortization Adjustment," is made to amortization to reflect the cumulative impact of the change in effective yield.
For debt securities (generally non-Agency RMBS, CMBS, ABS, CLOs, and interest only securities) that are deemed not to be of high credit quality at the time of purchase, interest income is recognized based on the effective interest method. When the fair value of a debt security is less than its amortized cost basis as of the balance sheet date, the security's cost basis is considered impaired. The Company will adjust such impaired cost basis to the present value of the estimated future cash flows. This adjustment to the cost basis is reported in Realized gains (losses) on securities and loans, net, on the Condensed Consolidated Statement of Operations. For purposes of estimating the future expected cash flows, management uses assumptions including, but not limited to, assumptions for future prepayment rates, default rates, and loss severities (each of which may in turn incorporate various macro-economic assumptions, such as future housing prices). These assumptions are re-evaluated not less than quarterly. Changes in projected cash flows will result in prospective changes in the yield/interest income recognized on such securities based on the updated expected future cash flows.
For each loan purchased with the expectation that both interest and principal will be paid in full, the Company generally amortizes or accretes any premium or discount over the life of the loan utilizing the effective interest method. However, based on current information and events, the Company re-assesses the collectability of interest and principal, and generally designates a loan as in non-accrual status either when any payments have become 90 or more days past due, or when, in the opinion of management, it is probable that the Company will be unable to collect either interest or principal in full. Once a loan is designated as in non-accrual status, as long as principal is still expected to be collectible in full, interest payments are recorded as interest income only when received (i.e., under the cash basis method); accruals of interest income are only resumed when the loan becomes contractually current and performance is demonstrated to be resumed. However, if principal is not expected to be collectible in full, the cost recovery method is used (i.e., no interest income is recognized, and all payments received—whether contractually interest or principal—are applied to cost).
For each loan purchased with evidence of credit deterioration since origination and the expectation that either principal or interest will not be paid in full, interest income is generally recognized using the effective interest method for as long as the cash flows can be reasonably estimated. Here, instead of amortizing the purchase discount (i.e., the excess of the unpaid principal balance over the purchase price) over the life of the loan, the Company effectively amortizes the accretable yield (i.e., the excess of the Company's estimate of the total cash flows to be collected over the life of the loan over the purchase price).


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Not less than quarterly, the Company updates its estimate of the cash flows expected to be collected over the life of the loan, and revised yields are prospectively applied.
For certain groups of consumer loans that the Company considers as having sufficiently homogeneous characteristics, the Company aggregates such loans into pools, and accounts for each such pool as a single unit of account. The pool is then treated analogously to a debt security deemed not to be of high credit quality, in that (i) the aggregate premium or discount for the pool is amortized or accreted into interest income based on the pool's effective interest rate; (ii) the effective interest rate is determined based on the net expected cash flows of the pool, taking into account estimates of prepayments, defaults, and loss severities; and (iii) estimates are updated not less than quarterly and revised yields are prospectively applied.
In estimating future cash flows on the Company's debt securities, there are a number of assumptions that will be subject to significant uncertainties and contingencies, including, in the case of MBS, assumptions relating to prepayment rates, default rates, loan loss severities, and loan repurchases. These estimates require the use of a significant amount of judgment.
(F) Investments in unconsolidated entities: The Company has made and may in the future make non-controlling equity investments in various entities, such as loan originators. Such investments are generally in the form of preferred and/or common equity, or membership interests. In certain cases, the Company can exercise significant influence over the entity (e.g. by having representation on the entity's board of directors) but the requirements for consolidation under ASC 810 are not met; in such cases the Company is required to account for such equity investments under ASC 323-10. The Company has chosen to elect the FVO pursuant to ASC 825 for its investments in unconsolidated entities, which, in management's view, more appropriately reflects the results of operations for a particular reporting period, as all investment activities will be recorded in a similar manner. The period change in fair value of the Company's investments in unconsolidated entities is recorded on the Condensed Consolidated Statement of Operations in Earnings from investments in unconsolidated entities.
(G) REO: When the Company obtains possession of real property in connection with a foreclosure or similar action, the Company de-recognizes the associated mortgage loan according to ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure ("ASU 2014-04"). Under the provisions of ASU 2014-04, the Company is deemed to have received physical possession of real estate property collateralizing a mortgage loan when it obtains legal title to the property upon completion of a foreclosure or when the borrower conveys all interest in the property to it through a deed in lieu of foreclosure or similar legal agreement. The Company's cost basis in REO is equal to the fair value of the associated mortgage loan at the time the Company obtains possession. REO valuations are reflected at the lower of cost or fair value. The fair value of such REO is typically based on management's estimates which generally use information including general economic data, BPOs, recent sales, property appraisals, and bids, and takes into account the expected costs to sell the property. REO recorded at fair value on a non-recurring basis are classified as Level 3.
(H) Securities Sold Short: The Company may purchase or engage in short sales of U.S. Treasury securities and sovereign debt to mitigate the potential impact of changes in interest rates and/or foreign exchange rates on the performance of its portfolio. When the Company sells securities short, it typically satisfies its security delivery settlement obligation by borrowing or purchasing the security sold short from the same or a different counterparty. When borrowing a security sold short from a counterparty, the Company generally is required to deliver cash or securities to such counterparty as collateral for the Company's obligation to return the borrowed security. The Company has chosen to elect the FVO pursuant to ASC 825 for its securities sold short. Electing the FVO allows the Company to record changes in fair value in the Condensed Consolidated Statement of Operations, which, in management's view, more appropriately reflects the results of operations for a particular reporting period as all securities activities will be recorded in a similar manner. As such, securities sold short are recorded at fair value on the Condensed Consolidated Balance Sheet and the period change in fair value is recorded in current period earnings on the Condensed Consolidated Statement of Operations as a component of Unrealized gains (losses) on securities and loans, net. A realized gain or loss will be recognized upon the termination of a short sale if the market price is less or greater than the original sale price. Such realized gain or loss is recorded on the Company's Condensed Consolidated Statement of Operations in Realized gains (losses) on securities and loans, net.
(I) Financial Derivatives: The Company enters into various types of financial derivatives subject to its investment guidelines, which include restrictions associated with qualifying and maintaining qualification as a REIT. The Company's financial derivatives are predominantly subject to bilateral collateral arrangements or clearing in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Company may be required to deliver or receive cash or securities as collateral upon entering into derivative transactions. In addition, changes in the relative value of derivative transactions may require the Company or the counterparty to post or receive additional collateral. In the case of cleared derivatives, the clearinghouse becomes the Company's counterparty and a futures commission merchant acts as an intermediary between the Company and the clearinghouse with respect to all facets of the related transaction, including the posting and receipt of required collateral. Cash collateral received by the Company is included in Due to brokers, on the Condensed Consolidated Balance Sheet. Conversely, cash collateral posted by the Company is included in Due from brokers, on the


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Condensed Consolidated Balance Sheet. The types of derivatives primarily utilized by the Company are swaps, TBAs, futures, options, and forwards.
Swaps: The Company may enter into various types of swaps, including interest rate swaps, credit default swaps, and total return swaps. The primary risk associated with the Company's interest rate swap activity is interest rate risk. The primary risk associated with the Company's credit default swaps and total return swaps is credit risk.
The Company is subject to interest rate risk exposure in the normal course of pursuing its investment objectives. Primarily to help mitigate interest rate risk, the Company enters into interest rate swaps. Interest rate swaps are contractual agreements whereby one party pays a floating interest rate on a notional principal amount and receives a fixed-rate payment on the same notional principal, or vice versa, for a fixed period of time. Interest rate swaps change in value with movements in interest rates. The Company also enters into interest rate swaps whereby the Company pays one floating rate and receives a different floating rate, or "basis swaps."
The Company enters into credit default swaps. A credit default swap is a contract under which one party agrees to compensate another party for the financial loss associated with the occurrence of a "credit event" in relation to a "reference amount" or notional value of a "reference asset" (usually a bond, loan, or an index or basket of bonds or loans). The definition of a credit event may vary from contract to contract. A credit event may occur (i) when the reference asset (or underlying asset, in the case of a reference asset that is an index or basket) fails to make scheduled principal or interest payments to its holders, (ii) with respect to credit default swaps referencing mortgage/asset-backed securities and indices, when the reference asset (or underlying asset, in the case of a reference asset that is an index or basket) is downgraded below a certain rating level, or (iii) with respect to credit default swaps referencing corporate entities and indices, upon the bankruptcy of the obligor of the reference asset (or underlying obligor, in the case of a reference asset that is an index). The Company typically writes (sells) protection to take a "long" position with respect to the underlying reference assets, or purchases (buys) protection to take a "short" position with respect to the underlying reference assets or to hedge exposure to other investment holdings.
The Company enters into total return swaps in order to take a "long" or "short" position with respect to an underlying reference asset. The Company is subject to market price volatility of the underlying reference asset. A total return swap involves commitments to pay interest in exchange for a market-linked return based on a notional value. To the extent that the total return of the corporate debt, security, group of securities or index underlying the transaction exceeds or falls short of the offsetting interest obligation, the Company will receive a payment from or make a payment to the counterparty.
Swaps change in value with movements in interest rates, credit quality, or total return of the reference securities. During the term of swap contracts, changes in value are recognized as unrealized gains or losses on the Condensed Consolidated Statement of Operations. When a contract is terminated, the Company realizes a gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Company's basis in the contract, if any. Periodic payments or receipts required by swap agreements are recorded as unrealized gains or losses when accrued and realized gains or losses when received or paid. Upfront payments paid and/or received by the Company to open swap contracts are recorded as an asset and/or liability on the Condensed Consolidated Balance Sheet and are recorded as a realized gain or loss on the termination date.
TBA Securities: The Company transacts in the forward settling TBA market. A TBA position is a forward contract for the purchase ("long position") or sale ("short position") of Agency RMBS at a predetermined price, face amount, issuer, coupon, and maturity on an agreed-upon future delivery date. For each TBA contract and delivery month, a uniform settlement date for all market participants is determined by the Securities Industry and Financial Markets Association. The specific Agency RMBS to be delivered into the contract at the settlement date are not known at the time of the transaction. The Company typically does not take delivery of TBAs, but rather enters into offsetting transactions and settles the associated receivable and payable balances with its counterparties. The Company uses TBAs to mitigate interest rate risk, usually by taking short positions. The Company also invests in TBAs as a means of acquiring additional exposure to Agency RMBS, or for speculative purposes, including holding long positions.
TBAs are accounted for by the Company as financial derivatives. The difference between the forward contract price and the market value of the TBA position as of the reporting date is included in Unrealized gains (losses) on financial derivatives, net, on the Condensed Consolidated Statement of Operations.
Futures Contracts: A futures contract is an exchange-traded agreement to buy or sell an asset for a set price on a future date. The Company enters into Eurodollar and/or U.S. Treasury security futures contracts to hedge its interest rate risk. The Company may also enter into various other futures contracts, including equity index futures and foreign currency futures. Initial margin deposits are made upon entering into futures contracts and can generally be either in the form of cash or securities. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by marking-to-market to reflect the current market value of the contract. Variation margin payments are made or received periodically, depending upon whether unrealized losses or gains are incurred. When the contract is closed, the Company


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records a realized gain or loss equal to the difference between the proceeds of the closing transaction and the Company's basis in the contract.
Options: The Company may purchase or write put or call options contracts or enter into swaptions. The Company enters into options contracts typically to help mitigate overall market, credit, or interest rate risk depending on the type of options contract. However, the Company also enters into options contracts from time to time for speculative purposes. When the Company purchases an options contract, the option asset is initially recorded at an amount equal to the premium paid, if any, and is subsequently marked-to-market. Premiums paid for purchasing options contracts that expire unexercised are recognized on the expiration date as realized losses. If an options contract is exercised, the premium paid is subtracted from the proceeds of the sale or added to the cost of the purchase to determine whether the Company has realized a gain or loss on the related transaction. When the Company writes an options contract, the option liability is initially recorded at an amount equal to the premium received, if any, and is subsequently marked-to-market. Premiums received for writing options contracts that expire unexercised are recognized on the expiration date as realized gains. If an options contract is exercised, the premium received is subtracted from the cost of the purchase or added to the proceeds of the sale to determine whether the Company has realized a gain or loss on the related investment transaction. When the Company enters into a closing transaction, the Company will realize a gain or loss depending upon whether the amount from the closing transaction is greater or less than the premiums paid or received. The Company may also enter into options contracts that contain forward-settling premiums. In this case, no money is exchanged upfront. Instead, the agreed-upon premium is paid by the buyer upon expiration of the option, regardless of whether or not the option is exercised.
Forward Currency Contracts: A forward currency contract is an agreement between two parties to purchase or sell a specific quantity of currency with the delivery and settlement at a specific future date and exchange rate. During the period the forward currency contract is open, changes in the value of the contract are recognized as unrealized gains or losses. When the contract is settled, the Company records a realized gain or loss equal to the difference between the proceeds of the closing transaction and the Company's basis in the contract.
Financial derivative assets are included in Financial derivatives—assets, at fair value, on the Condensed Consolidated Balance Sheet. Financial derivative liabilities are included in Financial derivatives—liabilities, at fair value, on the Condensed Consolidated Balance Sheet. The Company has chosen to elect the FVO pursuant to ASC 825 for its financial derivatives. Electing the FVO allows the Company to record changes in fair value in the Condensed Consolidated Statement of Operations, which, in management's view, more appropriately reflects the results of operations for a particular reporting period as all securities activities will be recorded in a similar manner. Changes in unrealized gains and losses on financial derivatives are included in Unrealized gains (losses) on financial derivatives, net, on the Condensed Consolidated Statement of Operations. Realized gains and losses on financial derivatives are included in Realized gains (losses) on financial derivatives, net, on the Condensed Consolidated Statement of Operations.
(J) Cash and Cash Equivalents: Cash and cash equivalents include cash and short term investments with original maturities of three months or less at the date of acquisition. Cash and cash equivalents typically include amounts held in an interest bearing overnight account and amounts held in money market funds, and these balances generally exceed insured limits. The Company holds its cash at institutions that it believes to be highly creditworthy. Restricted cash represents cash that the Company can use only for specific purposes. See Note 18 for further discussion of restricted cash balances.
(K) Repurchase Agreements: The Company enters into repurchase agreements with third-party broker-dealers whereby it sells securities under agreements to be repurchased at an agreed-upon price and date. The Company accounts for repurchase agreements as collateralized borrowings, with the initial sale price representing the amount borrowed, and with the future repurchase price consisting of the amount borrowed plus interest, at the implied interest rate of the repurchase agreement, on the amount borrowed over the term of the repurchase agreement. The interest rate on a repurchase agreement is based on competitive rates (or competitive market spreads, in the case of agreements with floating interest rates) at the time such agreement is entered into. When the Company enters into a repurchase agreement, the lender establishes and maintains an account containing cash and/or securities having a value not less than the repurchase price, including accrued interest, of the repurchase agreement. Repurchase agreements are carried at their contractual amounts, which approximate fair value as the debt is short-term in nature.
(L) Reverse Repurchase Agreements: The Company enters into reverse repurchase agreement transactions whereby it purchases securities under agreements to resell at an agreed-upon price and date. In general, securities received pursuant to reverse repurchase agreements are delivered to counterparties of short sale transactions. The interest rate on a reverse repurchase agreement is based on competitive rates (or competitive market spreads, in the case of agreements with floating interest rates) at the time such agreement is entered into. Assets held pursuant to reverse repurchase agreements are reflected as assets on the Condensed Consolidated Balance Sheet. Reverse repurchase agreements are carried at their contractual amounts, which approximates fair value due to their short-term nature.


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Repurchase and reverse repurchase agreements that are conducted with the same counterparty may be reported on a net basis if they meet the requirements of ASC 210-20, Balance Sheet Offsetting. There are no repurchase and reverse repurchase agreements reported on a net basis in the Company's condensed consolidated financial statements.
(M) Transfers of Financial Assets: The Company enters into transactions whereby it transfers financial assets to third parties. Upon such a transfer of financial assets, the Company will sometimes retain or acquire interests in the related assets. The Company evaluates transferred assets pursuant to ASC 860-10, Transfers of Financial Assets, or "ASC 860-10," which requires that a determination be made as to whether a transferor has surrendered control over transferred financial assets. That determination must consider the transferor's continuing involvement in the transferred financial asset, including all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer, even if they were not entered into at the time of the transfer. When a transfer of financial assets does not qualify as a sale, ASC 860-10 requires the transfer to be accounted for as a secured borrowing with a pledge of collateral. ASC 860-10 is a standard that requires the Company to exercise significant judgment in determining whether a transaction should be recorded as a "sale" or a "financing."
(N) Variable Interest Entities: VIEs are entities in which: (i) the equity investors do not have the characteristics of a controlling financial interest, or (ii) there is insufficient equity to permit the entity to finance its activities without additional subordinated financial support from other parties. Consolidation of a VIE is required by the entity that is deemed to be the primary beneficiary of the VIE. The Company evaluates all of its interests in VIEs for consolidation under ASC 810. The primary beneficiary is generally the party with both (i) the power to direct the activities of the VIE that most significantly impact its economic performance, and (ii) the obligation to absorb losses and the right to receive benefits from the VIE which could be potentially significant to the VIE.
When the Company has an interest in an entity that has been determined to be a VIE, the Company assesses whether it is deemed to be the primary beneficiary of the VIE. The Company will only consolidate a VIE for which it has concluded it is the primary beneficiary. To assess whether the Company has the power to direct the activities of a VIE that most significantly impact the VIE's economic performance, the Company considers all facts and circumstances, including its role in establishing the VIE and its ongoing rights and responsibilities. This assessment includes (i) identifying the activities that most significantly impact the VIE's economic performance; and (ii) identifying which party, if any, has power over those activities. To assess whether the Company has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE, it considers all of its economic interests, including debt and/or equity investments, as well as other arrangements deemed to be variable interests in the VIE. These assessments to determine whether the Company is the primary beneficiary require significant judgment. In instances where the Company and its related parties have interests in a VIE, the Company considers whether there is a single party in the related party group that meets the criteria to be deemed the primary beneficiary. If one party within the related party group meets such criteria, that reporting entity would be deemed to be the primary beneficiary of the VIE and no further analysis is needed. If no party within the related party group on its own meets the criteria to be deemed the primary beneficiary, but the related party group as a whole meets such criteria, the determination of the primary beneficiary within the related party group requires significant judgment. The Company performs analysis which is based upon qualitative as well as quantitative factors, such as the relationship of the VIE to each of the members of the related party group, as well as the significance of the VIE's activities to those members, with the objective of determining which party is most closely associated with the VIE.
The Company performs ongoing reassessments of (i) whether any entities previously evaluated have become VIEs, based on certain events, and therefore subject to assessment to determine whether consolidation is appropriate, and (ii) whether changes in the facts and circumstances regarding the Company's involvement with a VIE causes its consolidation conclusion regarding the VIE to change. See Note 9 and Note 13 for further information on the Company's consolidated VIEs.
The Company's maximum amount at risk is generally limited to the Company's investment in the VIE. The Company is generally not contractually required to provide and has not provided any form of financial support to the VIEs.
The Company holds beneficial interests in certain securitization trusts that are considered VIEs. The beneficial interests in these securitization trusts are represented by certificates issued by the trusts. The securitization trusts have been structured as pass-through entities that receive principal and interest payments on the underlying collateral and distribute those payments to the certificate holders, which include both third-party investors and the Company. The certificates held by the Company typically include some or all of the most subordinated tranches. The assets held by the trusts are restricted in that they can only be used to fulfill the obligations of the related trust. In certain cases, the design and structure of the securitization trust is such that the Company effectively retains control of the assets as well as the activities that most significantly impact the economic performance of the trust. In such cases, the Company is determined to be the primary beneficiary, and the Company consolidates the trust and all intercompany transactions are eliminated in consolidation. In cases where the Company does not effectively retain control of the assets of, or have the power to direct the activities that most significantly impact the economic


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performance of, the related trust, it does not consolidate the trust. See Note 10 for further discussion of the Company's securitization trusts.
(O) Offering Costs/Underwriters' Discount: Offering costs and underwriters' discount are charged against stockholders' equity as incurred. Offering costs typically include legal, accounting, and other fees associated with the cost of raising capital.
(P) Debt Issuance Costs: Debt issuance costs associated with debt for which the Company has elected the FVO are expensed at the issuance of the debt, and are included in Investment related expenses—Other on the Condensed Consolidated Statement of Operations. Costs associated with the issuance of debt for which the Company has not elected the FVO are deferred and amortized over the life of the debt, which approximates the effective interest rate method, and are included in Interest expense on the Condensed Consolidated Statement of Operations. Deferred debt issuance costs are presented on the Condensed Consolidated Balance Sheet as a direct deduction from the related debt liability, unless such deferred debt issuance costs are associated with borrowing facilities that are expected to have a future benefit, such as giving the Company the ability to access additional borrowings over the contractual term of the debt, in which case such deferred debt issuance costs are included in Other assets on the Condensed Consolidated Balance Sheet. Debt issuance costs include legal and accounting fees, purchasers' or underwriters' discount, as well as other fees associated with the cost of the issuance of the related debt.
(Q) Expenses: Expenses are recognized as incurred on the Condensed Consolidated Statement of Operations.
(R) Investment Related Expenses: Investment related expenses consist of expenses directly related to specific financial instruments. Such expenses generally include dividend expense on common stock sold short, servicing fees and corporate and escrow advances on mortgage and consumer loans, and various other expenses and fees related directly to the Company's financial instruments. The Company has elected the FVO for its investments, and as a result all investment related expenses are expensed as incurred and included in Investment related expenses on the Condensed Consolidated Statement of Operations.
(S) Long term incentive plan units: Long term incentive plan units of the Operating Partnership ("OP LTIP Units") have been issued to the Company's dedicated or partially dedicated personnel and certain of its directors as well as the Manager. Costs associated with OP LTIP Units issued to dedicated or partially dedicated personnel, or to the Company's directors, are measured as of the grant date based on the closing stock price on the New York Stock Exchange and are amortized over the vesting period in accordance with ASC 718-10, Compensation—Stock Compensation. The vesting periods for OP LTIP Units are typically one year from issuance for non-executive directors, and are typically one year to two years from issuance for dedicated or partially dedicated personnel.
(T) Non-controlling interests: Non-controlling interests include interests in the Operating Partnership represented by units convertible into shares of the Company's common stock ("Convertible Non-controlling Interests"). Convertible Non-controlling Interests include both the OP LTIP Units and those common units ("OP Units") of the Operating Partnership not held by the Company (collectively, the "Convertible Non-controlling Interest Units"). Non-controlling interests also include the interests of joint venture partners in certain of our consolidated subsidiaries. The joint venture partners' interests are not convertible into shares of the Company's common stock. The Company adjusts the Convertible Non-controlling Interests to align their carrying value with their share of total outstanding Operating Partnership units, including both the OP Units held by the Company and the Convertible Non-controlling Interests. Any such adjustments are reflected in Adjustment to non-controlling interests, on the Condensed Consolidated Statement of Changes in Equity. See Note 15 for further discussion of non-controlling interests.
(U) Dividends: Dividends payable are recorded on the declaration date.
(V) Shares Repurchased: Shares of common stock that are repurchased by the Company subsequent to issuance are immediately retired upon settlement and decrease the total number of shares of common stock issued and outstanding. The cost of such repurchases is charged against Additional paid-in-capital on the Company's Condensed Consolidated Balance Sheet.
(W) Earnings Per Share ("EPS"): Basic EPS is computed using the two class method by dividing net income (loss) after adjusting for the impact of Convertible Non-controlling Interests which are participating securities, by the weighted average number of shares of common stock outstanding calculated including Convertible Non-controlling Interests. Because the Company's Convertible Non-controlling Interests are participating securities, they are included in the calculation of both basic and diluted EPS.
(X) Foreign Currency: The functional currency of the Company is U.S. dollars. Assets and liabilities denominated in foreign currencies are remeasured into U.S. dollars at current exchange rates at the following dates: (i) assets, liabilities, and unrealized gains/losses—at the valuation date; and (ii) income, expenses, and realized gains/losses—at the accrual/transaction date. The Company isolates the portion of realized and change in unrealized gain (loss) resulting from changes in foreign currency exchange rates on investments and financial derivatives from the fluctuations arising from changes in fair value of


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investments and financial derivatives held. Changes in realized and change in unrealized gain (loss) due to foreign currency are included in Other, net, on the Condensed Consolidated Statement of Operations.
Our reporting currency is U.S. Dollars. If the Company has investments in unconsolidated entities that have a functional currency other than U.S. Dollars, the fair value is translated to U.S. dollars using the current exchange rate at the valuation date. The cumulative translation adjustment, if any, associated with the Company's investments in unconsolidated entities is recorded in accumulated other comprehensive income (loss), a component of consolidated stockholders' equity.
(Y) Income Taxes: The Company intends to elect to be taxed as a REIT under Sections 856 through 860 of the Code. As a REIT, the Company is generally not subject to corporate-level federal and state income tax on net income it distributes to its stockholders within the prescribed timeframes. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including distributing at least 90% of its annual taxable income to stockholders. Even if the Company qualifies as a REIT, it may be subject to certain federal, state, local and foreign taxes on its income and property, and to federal income and excise taxes on its undistributed taxable income. If the Company fails to qualify as a REIT, and does not qualify for certain statutory relief provisions, it will be subject to U.S. federal, state, and local income taxes and may be precluded from qualifying as a REIT for the four taxable years following the year in which the Company fails to qualify as a REIT. The Company believes that it will operate in a manner that will allow it to qualify for taxation as a REIT. As a result of the Company's expected REIT qualification and expected distributions, it does not generally expect to pay federal or state corporate income taxes. Many of the REIT requirements, however, are highly technical and complex.
As a REIT, if the Company fails to distribute in any calendar year (subject to specific timing rules for certain dividends paid in January) at least the sum of (i) 85% of its ordinary income for such year, (ii) 95% of its capital gain net income for such year, and (iii) any undistributed taxable income from the prior year, the Company would be subject to a non-deductible 4% excise tax on the excess of such required distribution over the sum of (i) the amounts actually distributed and (ii) the amounts of income retained and on which the Company has paid corporate income tax.
The Company elected to treat certain domestic and foreign subsidiaries as TRSs, and may in the future elect to treat other current or future subsidiaries as TRSs. 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. A domestic TRS may, but is not required to, declare dividends to the Company; such dividends will be included in the Company's taxable income/(loss) and may necessitate a distribution to the Company's stockholders. Conversely, if the Company retains earnings at the level of a domestic TRS, such earnings will increase the book equity of the consolidated entity. A domestic TRS is subject to U.S. federal, state, and local corporate income taxes. The Company has elected and may elect in the future to treat certain of its foreign corporate subsidiaries as TRSs and, accordingly, taxable income generated by these TRSs may not be subject to U.S. federal, state, and local corporate income taxation, but generally will be included in the Company's income on a current basis as Subpart F income, whether or not distributed. However, certain of the Company’s foreign subsidiaries may be subject to income taxes in the relevant foreign jurisdictions.
The Company's financial results are generally not expected to reflect provisions for current or deferred income taxes, except for any activities conducted through one or more TRSs that are subject to corporate income taxation.
The Company follows the authoritative guidance on accounting for and disclosure of uncertainty on tax positions, which requires management to determine whether a tax position of the Company is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. For uncertain tax positions, the tax benefit to be recognized is measured as the largest amount of benefit that is more than 50% likely to be realized upon ultimate settlement. The Company did not have any unrecognized tax benefits resulting from tax positions related to the current period or to 2018, 2017, 2016, or 2015 (its open tax years). In the normal course of business, the Company may be subject to examination by federal, state, local, and foreign jurisdictions, where applicable, for the current period, 2018, 2017, 2016, and 2015 (its open tax years). The Company may take positions with respect to certain tax issues which depend on legal interpretation of facts or applicable tax regulations. Should the relevant tax regulators successfully challenge any of such positions, the Company might be found to have a tax liability that has not been recorded in the accompanying consolidated financial statements. Also, management's conclusions regarding the authoritative guidance may be subject to review and adjustment at a later date based on changing tax laws, regulations, and interpretations thereof.
(Z) Recent Accounting Pronouncements: In August 2018, the Financial Accounting Standards Board, or "FASB," issued ASU 2018-13, Fair Value Measurement—Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"). This amends ASC 820 to remove or modify various current disclosure requirements related to fair value measurement. Additionally, ASU 2018-13 requires certain additional disclosures around fair value measurement. ASU 2018-13 is effective for annual periods beginning after December 15, 2019 and interim periods within those years, with


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early adoption permitted. Entities are permitted to early adopt any removed or modified disclosures and delay adoption of the additional disclosures until their effective date. The Company has elected to early adopt the removal and modification of various disclosure requirements in accordance with ASU 2018-13; early adoption has not had a material impact on the Company's consolidated financial statements. The Company has elected not to early adopt the additional disclosure requirements. The adoption of the additional disclosure requirements, as required under ASU 2018-13, is not expected to have a material impact on the Company's consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses ("ASU 2016-13"). ASU 2016-13 introduces a new model related to the accounting for credit losses on financial assets subject to credit losses and measured at amortized cost and certain off-balance sheet credit exposures. ASU 2016-13 amends the current guidance, which requires an OTTI charge only when fair value is below the amortized cost of an asset. The length of time the fair value of an available-for-sale debt security has been below the amortized cost will no longer impact the determination of whether a credit loss exists. As a result, it is no longer an other-than-temporary model. In addition, credit losses on available-for-sale debt securities will now be limited to the difference between the security's amortized cost basis and its fair value. The new debt security model will also require the use of an allowance to record estimated credit losses. The new guidance also expands the disclosure requirements regarding an entity's assumptions and models. In addition, public entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination (i.e., by vintage year). ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The Company is currently evaluating its method of adoption and the impact this ASU will have on its consolidated financial statements.
3. Valuation
The table below reflects the value of the Company's Level 1, Level 2, and Level 3 financial instruments that are measured at fair value on a recurring basis as of June 30, 2019:
Description
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
(In thousands)
Assets:
 
 
 
 
 
 
 
 
Securities, at fair value:
 
 
 
 
 
 
 
 
Agency RMBS
 
$

 
$
1,327,867

 
$
11,034

 
$
1,338,901

Non-Agency RMBS
 

 
88,226

 
96,790

 
185,016

CMBS
 

 
31,380

 
6,278

 
37,658

CLOs
 

 
58,989

 
17,222

 
76,211

Asset-backed securities, backed by consumer loans
 

 

 
25,019

 
25,019

Corporate debt securities
 

 

 
4,081

 
4,081

Corporate equity securities
 

 

 
1,791

 
1,791

Loans, at fair value:
 
 
 
 
 
 
 
 
Residential mortgage loans
 

 

 
663,880

 
663,880

Commercial mortgage loans
 

 

 
260,034

 
260,034

Consumer loans
 

 

 
162,609

 
162,609

Corporate loans
 

 

 
5,000

 
5,000

Investment in unconsolidated entities, at fair value
 

 

 
69,676

 
69,676

Financial derivatives–assets, at fair value:
 
 
 
 
 
 
 
 
Credit default swaps on asset-backed securities
 

 

 
1,090

 
1,090

Credit default swaps on asset-backed indices
 

 
2,164

 

 
2,164

Credit default swaps on corporate bonds
 

 
521

 

 
521

Credit default swaps on corporate bond indices
 

 
5,714

 

 
5,714

Interest rate swaps
 

 
1,434

 

 
1,434

TBAs
 

 
140

 

 
140

Total return swaps
 

 

 
87

 
87

Total assets
 
$

 
$
1,516,435

 
$
1,324,591

 
$
2,841,026

 
 
 
 
 
 
 
 
 


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Table of Contents

Description
 
Level 1
 
Level 2
 
Level 3
 
Total
(continued)
 
(In thousands)
Liabilities:
 
 
 
 
 
 
 
 
Securities sold short, at fair value:
 
 
 
 
 
 
 
 
Government debt
 
$

 
$
(49,113
)
 
$

 
$
(49,113
)
Corporate debt securities
 

 
(470
)
 

 
(470
)
Financial derivatives–liabilities, at fair value:
 
 
 
 
 
 
 
 
Credit default swaps on asset-backed indices
 

 
(202
)
 

 
(202
)
Credit default swaps on corporate bonds
 

 
(686
)
 

 
(686
)
Credit default swaps on corporate bond indices
 

 
(14,113
)
 

 
(14,113
)
Interest rate swaps
 

 
(7,658
)
 

 
(7,658
)
TBAs
 

 
(2,443
)
 

 
(2,443
)
Futures
 
(2,380
)
 

 

 
(2,380
)
Forwards
 

 
(265
)
 

 
(265
)
Total return swaps
 

 
(58
)
 

 
(58
)
Other secured borrowings, at fair value
 

 

 
(475,816
)
 
(475,816
)
Total liabilities
 
$
(2,380
)
 
$
(75,008
)
 
$
(475,816
)
 
$
(553,204
)
The following table identifies the significant unobservable inputs that affect the valuation of the Company's Level 3 assets and liabilities as of June 30, 2019:
 
 
Fair Value
 
Valuation 
Technique
 
Unobservable Input
 
Range
 
Weighted
Average
Description
 
 
 
 
Min
 
Max
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Non-Agency RMBS
 
$
40,642

 
Market Quotes
 
Non Binding Third-Party Valuation
 
$
65.77

 
$
163.50

 
$
84.87

CMBS
 
5,201

 
Market Quotes
 
Non Binding Third-Party Valuation
 
5.87

 
79.27

 
67.48

CLOs
 
9,174

 
Market Quotes
 
Non Binding Third-Party Valuation
 
27.65

 
276.53

 
73.75

Agency interest only RMBS
 
935

 
Market Quotes
 
Non Binding Third-Party Valuation
 
1.84

 
17.07

 
7.42

Total return swaps
 
87

 
Market Quotes
 
Non Binding Third-Party Valuation
 
89.5

 
89.9

 
89.7

Non-Agency RMBS
 
56,148

 
Discounted Cash Flows
 
Yield
 
0.4
%
 
27.7
%
 
10.0
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
5.9
%
 
71.5
%
 
51.5
%
 
 
 
 
 
 
Projected Collateral Losses
 
0.1
%
 
14.9
%
 
7.1
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
1.5
%
 
18.3
%
 
9.5
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
17.8
%
 
77.8
%
 
31.9
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Non-Agency CMBS
 
1,077

 
Discounted Cash Flows
 
Yield
 
21.5
%
 
21.5
%
 
21.5
%
 
 
 
 
 
 
Projected Collateral Losses
 
1.1
%
 
1.1
%
 
1.1
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
2.3
%
 
2.3
%
 
2.3
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
96.6
%
 
96.6
%
 
96.6
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Corporate debt and equity
 
5,872

 
Discounted Cash Flows
 
Yield
 
10.0
%
 
22.9
%
 
18.9
%


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(continued)
 
Fair Value
 
Valuation 
Technique
 
Unobservable Input
 
Range
 
Weighted
Average
Description
 
 
 
 
Min
 
Max
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
CLOs
 
8,048

 
Discounted Cash Flows
 
Yield
 
11.2
%
 
60.7
%
 
13.0
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
9.0
%
 
87.1
%
 
49.6
%
 
 
 
 
 
 
Projected Collateral Losses
 
2.9
%
 
33.4
%
 
15.0
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
3.8
%
 
13.0
%
 
8.8
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
%
 
77.3
%
 
26.6
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
ABS backed by consumer loans
 
25,019

 
Discounted Cash Flows
 
Yield
 
12.0
%
 
20.1
%
 
12.2
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
0.0
%
 
10.8
%
 
9.3
%
 
 
 
 
 
 
Projected Collateral Losses
 
0.8
%
 
36.0
%
 
15.0
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
64.0
%
 
99.2
%
 
75.7
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Consumer loans
 
162,609

 
Discounted Cash Flows
 
Yield
 
7.0
%
 
10.0
%
 
8.0
%
 
 
 
 
 
 
Projected Collateral Prepayments
 
0.0
%
 
56.7
%
 
42.5
%
 
 
 
 
 
 
Projected Collateral Losses
 
1.9
%
 
86.3
%
 
8.0
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
13.7
%
 
98.1
%
 
49.5
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Corporate loans
 
5,000

 
Discounted Cash Flows
 
Yield
 
15.0
%
 
15.0
%
 
15.0
%
Performing commercial mortgage loans
 
206,710

 
Discounted Cash Flows
 
Yield
 
7.9
%
 
12.0
%
 
8.8
%
Non-performing commercial mortgage loans
 
53,324

 
Discounted Cash Flows
 
Yield
 
10.8
%
 
25.4
%
 
15.5
%
 
 
 
 
 
 
Months to Resolution
 
2.0

 
6.0

 
3.0

Performing and re-performing residential mortgage loans
 
147,108

 
Discounted Cash Flows
 
Yield
 
3.9
%
 
29.3
%
 
6.5
%
Securitized residential mortgage loans(1)
 
503,090

 
Discounted Cash Flows
 
Yield
 
3.8
%
 
5.1
%
 
4.4
%
Non-performing residential mortgage loans
 
13,682

 
Discounted Cash Flows
 
Yield
 
3.6
%
 
56.0
%
 
12.3
%
 
 
 
 
 
 
Months to Resolution
 
0.0

 
102.7

 
45.7

Credit default swaps on asset-backed securities
 
1,090

 
Net Discounted Cash Flows
 
Projected Collateral Prepayments
 
34.6
%
 
44.4
%
 
37.6
%
 
 
 
 
 
 
Projected Collateral Losses
 
11.4
%
 
18.7
%
 
13.7
%
 
 
 
 
 
 
Projected Collateral Recoveries
 
13.7
%
 
18.1
%
 
16.2
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
23.4
%
 
36.1
%
 
32.5
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
Agency interest only RMBS
 
10,099

 
Option Adjusted Spread ("OAS")
 
LIBOR OAS(2)
 
93

 
3,527

 
581

 
 
 
 
 
 
Projected Collateral Prepayments
 
29.1
%
 
100.0
%
 
71.9
%
 
 
 
 
 
 
Projected Collateral Scheduled Amortization
 
0.0
%
 
70.9
%
 
28.1
%
 
 
 
 
 
 
 
 
 
 
 
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 


22

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(continued)
 
Fair Value
 
Valuation 
Technique
 
Unobservable Input
 
Range
 
Weighted
Average
Description
 
 
 
 
Min
 
Max
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
 
 
Investment in unconsolidated entities
 
32,588

 
Enterprise Value
 
Equity Price-to-Book(3)
 
1.0x
 
3.1x
 
1.4x
Investment in unconsolidated entities
 
3,000

 
Recent Transactions
 
Transaction Price
 
n/a
 
n/a
 
n/a
Investment in unconsolidated entities
 
34,088

 
Discounted Cash Flows
 
Yield(4)
 
3.1%
 
15.6%
 
9.1%
Other secured borrowings, at fair value(1)
 
(475,816
)
 
Discounted Cash Flows
 
Yield
 
3.1%
 
4.5%
 
3.8%
(1)
Securitized residential mortgage loans and Other secured borrowings, at fair value, represent financial assets and liabilities of the Company's CFE as discussed in Note 2.
(2)
Shown in basis points.
(3)
Represent an estimation of where market participants might value an enterprise on a price-to-book basis.
(4)
Represents the significant unobservable inputs used to fair value the financial instruments of the unconsolidated entity. The fair value of such financial instruments is the largest component of the valuation of such entity as a whole.
Third-party non-binding valuations are validated by comparing such valuations to internally generated prices based on the Company's models and, when available, to recent trading activity in the same or similar instruments.
For those instruments valued using discounted and net discounted cash flows, collateral prepayments, losses, recoveries, and scheduled amortization are projected over the remaining life of the collateral and expressed as a percentage of the collateral's current principal balance. Averages are weighted based on the fair value of the related instrument. In the case of credit default swaps on asset-backed securities, averages are weighted based on each instrument's bond equivalent value. Bond equivalent value represents the investment amount of a corresponding position in the reference obligation, calculated as the difference between the outstanding principal balance of the underlying reference obligation and the fair value, inclusive of accrued interest, of the derivative contract. For those assets valued using the LIBOR Option Adjusted Spread ("LIBOR OAS") valuation methodology, cash flows are projected using the Company's models over multiple interest rate scenarios, and these projected cash flows are then discounted using the LIBOR rates implied by each interest rate scenario. The LIBOR OAS of an asset is then computed as the unique constant yield spread that, when added to all LIBOR rates in each interest rate scenario generated by the model, will equate (a) the expected present value of the projected asset cash flows over all model scenarios to (b) the actual current market price of the asset. LIBOR OAS is therefore model-dependent. Generally speaking, LIBOR OAS measures the additional yield spread over LIBOR that an asset provides at its current market price after taking into account any interest rate options embedded in the asset. The Company considers the expected timeline to resolution in the determination of fair value for its non-performing commercial and residential mortgage loans.
Material changes in any of the inputs above in isolation could result in a significant change to reported fair value measurements. Additionally, fair value measurements are impacted by the interrelationships of these inputs. For example, for instruments subject to prepayments and credit losses, such as non-Agency RMBS and consumer loans and ABS backed by consumer loans, a higher expectation of collateral prepayments will generally be accompanied by a lower expectation of collateral losses. Conversely, higher losses will generally be accompanied by lower prepayments. Because the Company's credit default swaps on asset-backed security holdings represent credit default swap contracts whereby the Company has purchased credit protection, such credit default swaps on asset-backed securities generally have the directionally opposite sensitivity to prepayments, losses, and recoveries as compared to the Company's long securities holdings. Prepayments do not represent a significant input for the Company's commercial mortgage-backed securities and commercial mortgage loans. Losses and recoveries do not represent a significant input for the Company's Agency RMBS interest only securities, given the guarantee of the issuing government agency or government-sponsored enterprise.


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Table of Contents

The tables below include a roll-forward of the Company's financial instruments for the three- and six-month periods ended June 30, 2019 (including the change in fair value), for financial instruments classified by the Company within Level 3 of the valuation hierarchy.
Level 3—Fair Value Measurement Using Significant Unobservable Inputs:
Three-Month Period Ended June 30, 2019
(In thousands)
Beginning Balance as of 
March 31, 2019
 
Accreted
Discounts /
(Amortized
Premiums)
 
Net Realized
Gain/
(Loss)
 
Change in Net
Unrealized
Gain/(Loss)
 
Purchases/
Payments
 
Sales/
Issuances
 
Transfers Into Level 3
 
Transfers Out of Level 3
 
Ending
Balance as of 
June 30, 2019
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities, at fair value:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency RMBS
$
6,389

 
$
(676
)
 
$
(450
)
 
$
349

 
$
1,594

 
$
(236
)
 
$
4,889

 
$
(825
)
 
$
11,034

Non-Agency RMBS
94,670

 
108

 
(384
)
 
2,909

 
2,050

 
(3,294
)
 
6,366

 
(5,635
)
 
96,790

CMBS
5,137

 
25

 
50

 
363

 

 
(374
)
 
1,077

 

 
6,278

CLOs
21,438

 
165

 
(1,151
)
 
772

 

 

 
2,988

 
(6,990
)
 
17,222

Asset-backed securities backed by consumer loans
24,108

 
(360
)
 
(152
)
 
95

 
4,610

 
(3,282
)
 

 

 
25,019

Corporate debt securities
5,737

 
6

 
(345
)
 
(1
)
 
2,449

 
(3,765
)
 

 

 
4,081

Corporate equity securities
1,469

 

 
(142
)
 
464

 

 

 

 

 
1,791

Loans, at fair value:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage loans
583,252

 
(1,347
)
 
2,089

 
2,257

 
103,844

 
(26,215
)
 

 

 
663,880

Commercial mortgage loans
239,623

 
834

 
1,413

 
(2,018
)
 
47,555

 
(27,373
)
 

 

 
260,034

Consumer loans
192,115

 
(7,386
)
 
(1,455
)
 
857

 
16,626

 
(38,148
)
 

 

 
162,609

Corporate loans

 

 

 

 
5,000

 

 

 

 
5,000

Investment in unconsolidated entities, at fair value
58,148

 

 
124

 
2,230

 
17,026

 
(7,852
)
 

 

 
69,676

Financial derivatives–assets, at fair value-
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit default swaps on asset-backed securities
1,233

 

 
128

 
(143
)
 
5

 
(133
)
 

 

 
1,090

Total return swaps

 

 
17

 
87

 

 
(17
)
 

 

 
87

Total assets, at fair value
$
1,233,319

 
$
(8,631
)
 
$
(258
)
 
$
8,221

 
$
200,759

 
$
(110,689
)
 
$
15,320

 
$
(13,450
)
 
$
1,324,591

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other secured borrowings, at fair value
$
(282,124
)
 
$

 
$

 
$
(17
)
 
$
25,861

 
$
(219,536
)
 
$

 
$

 
$
(475,816
)
Total liabilities, at fair value
$
(282,124
)
 
$

 
$

 
$
(17
)
 
$
25,861

 
$
(219,536
)
 
$

 
$

 
$
(475,816
)
All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Condensed Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at June 30, 2019, as well as Level 3 financial instruments disposed of by the Company during the three-month period ended June 30, 2019. For Level 3 financial instruments held by the Company at June 30, 2019, change in net unrealized gain (loss) of $5.7 million, $3.8 million, $2.0 million, $(56) thousand, and $(17) thousand, for the three-month period ended June 30, 2019 relate to securities, loans, investments in unconsolidated entities, financial derivatives–assets, and other secured borrowings, at fair value, respectively.
At June 30, 2019, the Company transferred $13.5 million of assets from Level 3 to Level 2 and $15.3 million from Level 2 to Level 3. Transfers between these hierarchy levels were based on the availability of sufficient observable inputs to meet Level 2 versus Level 3 criteria. The leveling of each financial instrument is reassessed at the end of each period, and is based on pricing information received from third-party pricing sources.


24

Table of Contents

Six-Month Period Ended June 30, 2019
(In thousands)
Beginning Balance as of 
January 1, 2019
 
Accreted
Discounts /
(Amortized
Premiums)
 
Net Realized
Gain/
(Loss)
 
Change in Net
Unrealized
Gain/(Loss)
 
Purchases/
Payments
 
Sales/
Issuances
 
Transfers Into Level 3
 
Transfers Out of Level 3
 
Ending
Balance as of 
June 30, 2019
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities, at fair value:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency RMBS
$
7,293

 
$
(1,449
)
 
$
(1,075
)
 
$
642

 
$
1,600

 
$
(236
)
 
$
5,596

 
$
(1,337
)
 
$
11,034

Non-Agency RMBS
91,291

 
195

 
(650
)
 
2,358

 
17,595

 
(20,220
)
 
11,308

 
(5,087
)
 
96,790

CMBS
803

 
(23
)
 

 
(7
)
 

 

 
5,505

 

 
6,278

CLOs
14,915

 
(483
)
 
(1,676
)
 
1,660

 
831

 

 
1,975

 

 
17,222

Asset-backed securities backed by consumer loans
22,800

 
(969
)
 
(665
)
 
857

 
9,551

 
(6,555
)
 

 

 
25,019

Corporate debt securities
6,318

 
22

 
(345
)
 
(78
)
 
2,832

 
(4,668
)
 

 

 
4,081

Corporate equity securities
1,534

 

 
(142
)
 
399

 

 

 

 

 
1,791

Loans, at fair value:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage loans
496,829

 
(2,274
)
 
1,954

 
4,158

 
261,446

 
(98,233
)
 

 

 
663,880

Commercial mortgage loans
195,301

 
1,139

 
1,414

 
(2,352
)
 
96,412

 
(31,880
)
 

 

 
260,034

Consumer loans
183,961

 
(15,958
)
 
(3,510
)
 
2,699

 
70,882

 
(75,465
)
 

 

 
162,609

Corporate loan

 

 

 

 
5,000

 

 

 

 
5,000

Investment in unconsolidated entities, at fair value
72,298

 
276

 
1,684

 
2,190

 
30,454

 
(37,226
)
 

 

 
69,676

Financial derivatives–assets, at fair value-
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit default swaps on asset-backed securities
1,472

 

 
403

 
(382
)
 
8

 
(411
)
 

 

 
1,090

Total return swaps

 

 
17

 
87

 

 
(17
)
 

 

 
87

Total assets, at fair value
$
1,094,815

 
$
(19,524
)
 
$
(2,591
)
 
$
12,231

 
$
496,611

 
$
(274,911
)
 
$
24,384

 
$
(6,424
)
 
$
1,324,591

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other secured borrowings, at fair value
$
(297,948
)
 
$

 
$

 
$
40

 
$
41,628

 
$
(219,536
)
 
$

 
$

 
$
(475,816
)
Total liabilities, at fair value
$
(297,948
)
 
$

 
$

 
$
40

 
$
41,628

 
$
(219,536
)
 
$

 
$

 
$
(475,816
)
All amounts of net realized and change in net unrealized gain (loss) in the table above are reflected in the accompanying Condensed Consolidated Statement of Operations. The table above incorporates changes in net unrealized gain (loss) for both Level 3 financial instruments held by the Company at June 30, 2019, as well as Level 3 financial instruments disposed of by the Company during the six-month period ended June 30, 2019. For Level 3 financial instruments held by the Company at June 30, 2019, change in net unrealized gain (loss) of $6.1 million, $6.0 million, $(0.2) million, $(0.3) million, and $40 thousand, for the six-month period ended June 30, 2019 relate to securities, loans, investments in unconsolidated entities, financial derivatives–assets, and other secured borrowings, at fair value, respectively.
At June 30, 2019, the Company transferred $6.4 million of assets from Level 3 to Level 2 and $24.4 million from Level 2 to Level 3. Transfers between these hierarchy levels were based on the availability of sufficient observable inputs to meet Level 2 versus Level 3 criteria. The leveling of each financial instrument is reassessed at the end of each period, and is based on pricing information received from third-party pricing sources.


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Table of Contents

The following table summarizes the estimated fair value of all other financial instruments not measured at fair value on a recurring basis as of June 30, 2019:
(In thousands)
 
Fair Value
 
Carrying Value
Other financial instruments
 
 
 
 
Assets:
 
 
 
 
Cash and cash equivalents
 
$
42,671

 
$
42,671

Restricted cash
 
175

 
175

Due from brokers
 
65,083

 
65,083

Reverse repurchase agreements
 
49,641

 
49,641

Liabilities:
 
 
 
 
Repurchase agreements
 
1,715,506

 
1,715,506

Other secured borrowings
 
101,925

 
101,925

Senior notes, net
 
85,166

 
85,166

Due to brokers
 
9,951

 
9,951

Cash and cash equivalents includes cash held in an interest bearing overnight account, for which fair value equals the carrying value, and cash held in money market accounts, which are liquid in nature and for which fair value equals the carrying value; such assets are considered Level 1. Restricted cash includes cash held in a segregated account for which fair value equals the carrying value; such assets are considered Level 1. Due from brokers and Due to brokers include collateral transferred to or received from counterparties, along with receivables and payables for open and/or closed derivative positions. These receivables and payables are short term in nature and any collateral transferred consists primarily of cash; fair value of these items is approximated by carrying value and such items are considered Level 1. The Company's reverse repurchase agreements, repurchase agreements, and other secured borrowings are carried at cost, which approximates fair value due to their short term nature. Reverse repurchase agreements, repurchase agreements, and other secured borrowings are classified as Level 2 based on the adequacy of the collateral and their short term nature. The Senior notes are considered Level 3 liabilities given the relative unobservability of the most significant inputs to valuation estimation as well as the lack of trading activity of these instruments.


26

Table of Contents

4. Investment in Securities
The Company's securities portfolio primarily consists of Agency RMBS, non-Agency RMBS, CMBS, CLOs, ABS backed by consumer loans, and corporate debt and equity. The following table details the Company's investment in securities as of June 30, 2019.
 
 
 
 
 
 
 
 
Gross Unrealized
 
 
 
Weighted Average
($ in thousands)
 
Current Principal
 
Unamortized Premium (Discount)
 
Amortized Cost
 
Gains
 
Losses
 
Fair Value
 
Coupon(1)
 
Yield
 
Life (Years)(2)
Long:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-year fixed-rate mortgages
 
133,432

 
3,326

 
136,758

 
1,158

 
(503
)