Document
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q 
(Mark One)
ý
 Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the quarterly period ended June 30, 2018
 
o
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:  001-35543
logoa45.gif
 Western Asset Mortgage Capital Corporation
(Exact name of Registrant as specified in its charter) 
Delaware
 
27-0298092
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification Number)
 
Western Asset Mortgage Capital Corporation
385 East Colorado Boulevard
Pasadena, California 91101
(Address of Registrant’s principal executive offices)
 
(626) 844-9400
(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 ý No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes ý No o 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 (check one). 
Large accelerated filer
o
 
Accelerated filer
x
 
 
 
 
 
Non-accelerated filer
(Do not check if a smaller reporting company)
o
 
Smaller reporting company
o
 
 
 
 
 
 
 
 
Emerging growth company
o
 
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. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Securities Exchange Act of 1934).  Yes o No ý
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

As of August 3, 2018, there were 41,616,379 shares, par value $0.01, of the registrant’s common stock outstanding.

Table of Contents

TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

Part I
ITEM I. Financial Statements

Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Balance Sheets
(in thousands—except share and per share data)
(Unaudited)
 
June 30,
2018
 
December 31, 2017
Assets:
 

 
 

Cash and cash equivalents
$
16,295

 
$
48,024

Restricted cash
58,747

 
—

Agency mortgage-backed securities, at fair value ($2,440,683 and $2,833,595 pledged as collateral, at fair value, respectively)
2,495,161

 
2,858,600

Non-Agency mortgage-backed securities, at fair value ($432,352 and $266,189 pledged as collateral, at fair value, respectively)
432,596

 
378,158

Other securities, at fair value ($107,864 and $89,823 pledged as collateral, at fair value, respectively)
108,001

 
122,065

Residential Whole-Loans, at fair value ($335,149 and $237,423 pledged as collateral, at fair value, respectively)
335,149

 
237,423

Residential Bridge Loans ($236,359 and $64,526 at fair value and $259,339 and $106,673 pledged as collateral, respectively)
259,339

 
106,673

Securitized commercial loans, at fair value
1,309,195

 
24,876

Commercial Loans, at fair value ($20,515 and $0 pledged as collateral, at fair value, respectively)
70,717

 
—

Investment related receivable
37,286

 
7,665

Interest receivable
19,487

 
13,603

Due from counterparties
64,791

 
86,930

Derivative assets, at fair value
6,998

 
728

Other assets
3,571

 
2,161

Total Assets (1)
$
5,217,333

 
$
3,886,906

 
 
 
 
Liabilities and Stockholders’ Equity:
 

 
 

Liabilities:
 

 
 

Repurchase agreements, net
$
3,267,369

 
$
3,251,686

Convertible senior unsecured notes, net
109,401

 
108,743

Securitized debt, at fair value (includes $348,799 and $10,945 held by affiliates, respectively)
1,231,300

 
10,945

Interest payable (includes $976 and $70 on securitized debt held by affiliates, respectively)
10,309

 
8,322

Investment related payables
52,530

 
17,217

Due to counterparties
5,208

 
1,490

Derivative liability, at fair value
1,623

 
4,346

Accounts payable and accrued expenses
2,531

 
3,118

Payable to affiliate
3,062

 
2,041

Dividend payable
12,901

 
12,960

  Other liabilities
59,308

 
—

Total Liabilities (2)
4,755,542

 
3,420,868

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Stockholders’ Equity:
 

 
 

Common stock: $0.01 par value, 500,000,000 shares authorized, 41,616,379 and 41,794,079 outstanding, respectively
419

 
419

Preferred stock, $0.01 par value, 100,000,000 shares authorized and no shares outstanding
—

 
—

Treasury stock, at cost, 303,422 and 125,722 shares held, respectively
(2,965
)
 
(1,232
)
Additional paid-in capital
768,945

 
768,763

Retained earnings (accumulated deficit)
(304,608
)
 
(301,912
)
Total Stockholders’ Equity
461,791

 
466,038

Total Liabilities and Stockholders’ Equity
$
5,217,333

 
$
3,886,906

 See notes to unaudited consolidated financial statements.
Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Balance Sheets (Continued)
(in thousands—except share and per share data)
(Unaudited)
 
June 30,
2018
 
December 31, 2017
(1) Assets of consolidated VIEs included in the total assets above:
 

 
 

Cash and cash equivalents
$
364

 
$
—

Restricted cash
58,747

 
—

Residential Whole-Loans, at fair value ($335,149 and $237,423 pledged as collateral, at fair value, respectively)
335,149

 
237,423

Residential Bridge Loans ($236,359 and $64,526 at fair value and $259,339 and $106,673 pledged as collateral, respectively)
259,339

 
106,673

Securitized commercial loans, at fair value
1,309,195

 
24,876

Commercial Loans, at fair value ($20,515 and $0 pledged as collateral, at fair value, respectively)
20,515

 
—

Investment related receivable
37,286

 
7,665

Interest receivable
9,794

 
3,358

Other assets
548

 
—

Total assets of consolidated VIEs
$
2,030,937

 
$
379,995

 
 
 
 
(2) Liabilities of consolidated VIEs included in the total liabilities above:
 

 
 

Securitized debt, at fair value (includes $348,799 and $10,945 held by affiliates, respectively)
$
1,231,300

 
$
10,945

Interest payable (includes $976 and $70 on securitized debt held by affiliates, respectively)
2,687

 
70

Accounts payable and accrued expenses
678

 
189

Other liabilities
59,309

 
—

Total liabilities of consolidated VIEs
$
1,293,974

 
$
11,204


See notes to unaudited consolidated financial statements.


2
Table of Contents

Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Statements of Operations
(in thousands—except share and per share data)
(Unaudited)
 
 
For the three months ended June 30, 2018
 
For the three months ended June 30, 2017
 
Six Months Ended June 30, 2018
 
Six Months Ended June 30, 2017
Net Interest Income
 

 
 

 
 
 
 
Interest income
$
57,154

 
$
30,055

 
$
96,881

 
$
58,485

Interest expense (includes $4,719, $248, $5,207 and $494 on securitized debt held by affiliates, respectively)
38,134

 
10,407

 
58,831

 
19,144

Net Interest Income
19,020

 
19,648

 
38,050

 
39,341

 
 
 
 
 
 
 
 
Other Income (Loss)
 

 
 

 
 

 
 

Realized gain (loss) on sale of investments, net
(5,608
)
 
(2,488
)
 
(5,033
)
 
18,770

Other than temporary impairment
(2,974
)
 
(6,579
)
 
(5,890
)
 
(12,676
)
Unrealized gain (loss), net
(31,693
)
 
35,017

 
(100,654
)
 
29,877

Gain (loss) on derivative instruments, net
28,490

 
(18,555
)
 
108,072

 
(23,252
)
Other, net
(145
)
 
222

 
(98
)
 
625

Other Income (Loss)
(11,930
)
 
7,617

 
(3,603
)
 
13,344

 
 
 
 
 
 
 
 
Expenses
 

 
 

 
 

 
 

Management fee to affiliate
2,259

 
1,830

 
4,439

 
4,306

Other operating expenses
1,555

 
736

 
2,524

 
1,153

General and administrative expenses:
 

 
 

 
 
 
 
Compensation expense
572

 
664

 
1,082

 
1,404

Professional fees
818

 
832

 
2,113

 
1,720

Other general and administrative expenses
397

 
404

 
758

 
749

Total general and administrative expenses
1,787

 
1,900

 
3,953

 
3,873

Total Expenses
5,601

 
4,466

 
10,916

 
9,332

 
 
 
 
 
 
 
 
Income before income taxes
1,489

 
22,799

 
23,531

 
43,353

Income tax provision
36

 
2,115

 
349

 
2,427

Net income
$
1,453

 
$
20,684

 
$
23,182

 
$
40,926

 
 
 
 
 
 
 
 
Net income per Common Share — Basic
$
0.03

 
$
0.49

 
$
0.55

 
$
0.97

Net income per Common Share — Diluted
$
0.03

 
$
0.49

 
$
0.55

 
$
0.97

Dividends Declared per Share of Common Stock
$
0.31

 
$
0.31

 
$
0.62

 
$
0.62


See notes to unaudited consolidated financial statements.

3
Table of Contents

Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
(in thousands—except shares and share data)
(Unaudited)
 
 
Common Stock Outstanding
 
Additional 
Paid-In Capital
 
Retained 
Earnings 
(Accumulated Deficit)
 
Treasury Stock
 
 
 
Shares
 
Par
 
 
 
 
Total
Balance at December 31, 2016
41,919,801

 
$
419

 
$
765,042

 
$
(334,979
)
 
$
—

 
$
430,482

Vesting of restricted stock
—

 
—

 
981

 
—

 
—

 
981

Equity component of convertible senior unsecured notes
—

 
—

 
2,656

 
—

 
—

 
2,656

Treasury stock
(125,722
)
 
—

 
—

 
—

 
(1,232
)
 
(1,232
)
Net income
—

 
—

 
—

 
85,097

 
—

 
85,097

Dividends declared on common stock
—

 
—

 
84

 
(52,030
)
 
—

 
(51,946
)
Balance at December 31, 2017
41,794,079

 
$
419

 
$
768,763

 
$
(301,912
)
 
$
(1,232
)
 
$
466,038

Vesting of restricted stock
—

 
—

 
125

 
—

 
—

 
125

Treasury stock
(177,700
)
 
—

 
—

 
—

 
(1,733
)
 
(1,733
)
Net income
—

 
—

 
—

 
23,182

 
—

 
23,182

Dividends declared on common stock
—

 
—

 
57

 
(25,878
)
 
—

 
(25,821
)
Balance at June 30, 2018
41,616,379

 
$
419

 
$
768,945

 
$
(304,608
)
 
$
(2,965
)
 
$
461,791


See notes to unaudited consolidated financial statements.


4
Table of Contents

Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Statements of Cash Flows (in thousands)
(Unaudited)

 
For the six months ended June 30, 2018
 
For the six months ended June 30, 2017
Cash flows from operating activities:
 

 
 

Net income
$
23,182

 
$
40,926

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 

 
 

Premium amortization and (discount accretion), net
277

 
(2,044
)
Interest income earned added to principal of securities
—

 
(46
)
Amortization of deferred financing costs
384

 
—

Amortization of discount on convertible senior notes
275

 
—

Restricted stock amortization
125

 
577

Interest payments and basis recovered on MAC interest rate swaps
293

 
258

Premium on purchase of Residential Whole-Loans
(2,677
)
 
(354
)
Premium on purchase of Residential Bridge Loans
(2,196
)
 
(425
)
Premium on purchase of securitized commercial loans
(3,019
)
 
—

Unrealized (gain) loss, net
100,654

 
(29,877
)
Unrealized (gain) loss on derivative instruments, net
(5,576
)
 
(156,696
)
Other than temporary impairment
5,890

 
12,676

Realized (gain) loss on sale of securities, net
5,033

 
(18,770
)
(Gain) loss on derivatives, net
(7,769
)
 
156,245

Loss on foreign currency transactions, net
—

 
2

Changes in operating assets and liabilities:
 

 
 

(Increase) decrease in interest receivable
(5,884
)
 
7,006

Increase in other assets
(1,267
)
 
(695
)
Increase (decrease) in interest payable
1,987

 
(10,596
)
Decrease in accounts payable and accrued expenses
(587
)
 
(447
)
Increase (decrease) in payable to affiliate
1,021

 
(671
)
Net cash provided by (used in) operating activities
110,146

 
(2,931
)
Cash flows from investing activities:
 

 
 

Purchase of securities
(235,043
)
 
(1,656,239
)
Proceeds from sale of securities
416,869

 
962,404

Principal repayments and basis recovered on securities
67,259

 
140,813

Purchase of Residential Whole-Loans
(124,225
)
 
(35,317
)
Principal repayments on Residential Whole-Loans
23,871

 
24,000

Purchase of Commercial Loans
(70,257
)
 
—

Purchase of securitized commercial loans
(1,350,000
)
 
—

Principal repayments on securitized commercial loans
78,907

 
—

Purchase of Residential Bridge Loans
(276,173
)
 
(73,565
)
Principal repayments on Residential Bridge Loans
98,528

 
8,160

Payment of premium for option derivatives
(467
)
 
(4,786
)
Premium received from option derivatives
298

 
3,750

Premium received from credit default swaps
(174
)
 
—

Net settlements of TBAs
134

 
2,558

Proceeds from (Payments on) termination of futures, net
4,591

 
(9,153
)
Interest payments and basis recovered on MAC interest rate swaps
(293
)
 
(258
)
Due from counterparties
—

 
4,124

Payments on total return swaps, net
—

 
(500
)
Premium for interest rate swaptions, net
—

 
(115
)
Net cash used in investing activities
(1,366,175
)
 
(634,124
)
 
 
 
 
Cash flows from financing activities:
 

 
 


5
Table of Contents

Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Statements of Cash Flows (Continued) (in thousands)
(Unaudited)


 
For the six months ended June 30, 2018
 
For the six months ended June 30, 2017
Repurchase of common stock
(1,733
)
 
—

Proceeds from repurchase agreement borrowings
9,929,408

 
7,464,705

Repayments of repurchase agreement borrowings
(9,913,725
)
 
(6,818,742
)
Proceeds from securitized debt
1,285,219

 
—

Repayments of securitized debt
(74,845
)
 
—

Proceeds from forward contracts
—

 
5,407

Repayments of forward contracts
—

 
(5,427
)
Due from counterparties, net
22,139

 
10,647

Due to counterparties, net
3,718

 
1,445

Increase in other liabilities
58,746

 
—

Dividends paid on common stock
(25,880
)
 
(25,991
)
Net cash provided by financing activities
1,283,047

 
632,044

 
 
 
 
Effect of exchange rate changes on cash and cash equivalents
—

 
(2
)
 
 
 
 
Net increase (decrease) in cash, cash equivalents and restricted cash
27,018

 
(5,013
)
Cash, cash equivalents and restricted cash, beginning of period
48,024

 
46,172

Cash, cash equivalents and restricted cash, end of period
$
75,042

 
$
41,159

 
 
 
 
Supplemental disclosure of operating cash flow information:
 

 
 

Interest paid
$
56,935

 
$
16,902

   Income taxes paid
$
1,635

 
$
2,380

Supplemental disclosure of non-cash financing/investing activities:
 

 
 

Principal payments of securities, not settled
$
—

 
$
16

Securities sold, not settled
$
—

 
$
209,310

Securities purchased, not settled
$
(52,530
)
 
$
—

Dividends and distributions declared, not paid
$
12,901

 
$
12,995

Principal payments of Residential Whole-Loans, not settled
$
5,845

 
$
1,598

Principal payments of Residential Bridge Loans, not settled
$
31,441

 
$
809

Derivative collateral offset against derivatives
$
—

 
$
(157,913
)
Other assets
$
143

 
$
—

See notes to unaudited consolidated financial statements.



6
Table of Contents

Western Asset Mortgage Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(in thousands- except share and per share data)
 
The following defines certain of the commonly used terms in these Notes to Consolidated Financial Statements: “Agency” or “Agencies” refer to a federally chartered corporation, such as the Federal National Mortgage Association (“Fannie Mae” or “FNMA”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac” or “FHLMC”), or an agency of the U.S. Government, such as the Government National Mortgage Association (“Ginnie Mae” or “GNMA”); references to “MBS” refer to mortgage backed securities, including residential mortgage-backed securities or “RMBS,” commercial mortgage-backed securities or “CMBS,” and “Interest-Only Strips” (as defined herein); “Agency MBS” refer to RMBS, CMBS and Interest-Only Strips issued or guaranteed by the Agencies while “Non-Agency MBS” refer to RMBS, CMBS and Interest-Only Strips that are not issued or guaranteed by the Agencies; references to “ARMs” refers to adjustable rate mortgages; references to “Interest-Only Strips” refer to interest-only (“IO”) and inverse interest-only (“IIO”) securities issued as part of or collateralized with MBS; references to “TBA” refer to To-Be-Announced Securities; and references to “Residential Whole-Loans", “Residential Bridge Loans" and “Commercial Loans" (collectively “Whole-Loans”) refer to individual mortgage loans secured by single family, multifamily and commercial properties.

Note 1 — Organization
 
Western Asset Mortgage Capital Corporation, a Delaware corporation, and its subsidiaries (the “Company”), commenced operations in May 2012. The Company invests in, finances and manages a diversified portfolio of real estate related securities, whole-loans and other financial assets.  The Company’s portfolio is comprised of Agency CMBS, Agency RMBS (including TBAs), Non-Agency RMBS, Non-Agency CMBS, Residential Whole Loans, Residential Bridge Loans and Commercial Loans. In addition, and to a significantly lesser extent, the Company has invested in other securities including certain Agency obligations that are not technically MBS as well as certain Non U.S. CMBS and in asset-backed securities (“ABS”) investments secured by a portfolio of private student loans.  The Company’s investment strategy is based on Western Asset Management Company’s (the “Manager”) perspective of which mix of portfolio assets it believes provides the Company with the best risk-reward opportunities at any given time.  The Manager will vary the allocation among various asset classes subject to maintaining the Company’s qualification as a REIT and maintaining its exemption from the Investment Company Act of 1940 (the “1940 Act”).  These restrictions limit the Company’s ability to invest in non-qualifying MBS, non-real estate assets and/or assets which are not secured by real estate.  Accordingly, the Company’s portfolio will continue to be principally invested in qualifying MBS, Whole-Loans and other real estate related assets.
 
The Company is externally managed by the Manager, an investment advisor registered with the Securities and Exchange Commission (“SEC”).  The Manager is a wholly-owned subsidiary of Legg Mason, Inc.  The Company operates and has elected to be taxed as a real estate investment trust or “REIT” commencing with its taxable year ended December 31, 2012.
 
Note 2 — Summary of Significant Accounting Policies
 
Basis of Presentation and Consolidation
 
The accompanying unaudited financial statements and related notes have been prepared in conformity with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial reporting in accordance with Article 10 of Regulation S-X and the instructions to Form 10-Q.  Certain prior period amounts have been reclassified to conform to the current period’s presentation. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary have been made to state fairly the Company’s financial position, results of operations and cash flows. The results of operations for the period ended June 30, 2018, are not necessarily indicative of the results to be expected for the full year or any future period. These consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on March 29, 2018.
 
The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiary and variable interest entities (“VIEs”) in which it is considered the primary beneficiary.   All intercompany amounts between the Company and its subsidiary and consolidated VIEs have been eliminated in consolidation.


7
Table of Contents

Variable Interest Entities
 
VIEs are defined as entities that by design either lack sufficient equity for the entity to finance its activities without additional subordinated financial support or are unable to direct the entity’s activities or are not exposed to the entity’s losses or entitled to its residual returns. The Company evaluates all of its interests in VIEs for consolidation. When the interests are determined to be variable interests, the Company assesses whether it is deemed the primary beneficiary. The primary beneficiary of a VIE is determined to be the party that has both the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE.
 
To assess whether the Company has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, it considers all facts and circumstances, including its role in establishing the VIE and its ongoing rights and responsibilities. This assessment includes: first, identifying the activities that most significantly impact the VIE’s economic performance; and second, identifying which party, if any, has power over those activities. In general, the parties that make the most significant decisions affecting the VIE or have the right to unilaterally remove those decision makers is deemed to have the power to direct the activities of a VIE.
 
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. This assessment requires the Company to apply judgment in determining whether these interests, in the aggregate, are considered potentially significant to the VIE. Factors considered in assessing significance include: the design of the VIE, including its capitalization structure; subordination of interests; payment priority; relative share of interests held across various classes within the VIE’s capital structure; and the reasons why the interests are held by the Company.
 
In instances where the Company and its related parties have variable interests in a VIE, the Company considers whether there is a single party in the related party group that meets both the power and losses or benefits criteria on its own as though no related party relationship existed.  If one party within the related party group meets both these criteria, such reporting entity is the primary beneficiary of the VIE and no further analysis is needed.  If no party within the related party group on its own meets both the power and losses or benefits criteria, but the related party group as a whole meets these two criteria, the determination of primary beneficiary within the related party group requires significant judgment. The analysis 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. 
 
Ongoing assessments of whether an enterprise is the primary beneficiary of a VIE are required.
 
Use of Estimates
 
The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.  Actual results could differ from those estimates.

Significant Accounting Policies

There have been no changes to our accounting policies included in Note 2 to the consolidated financial statements of our
Annual Report on Form 10-K for the year ended December 31, 2017, other than the significant accounting policies disclosed below.

Restricted Cash

Restricted cash represents cash held by the trustee or servicer for mortgage escrows in connection with the Company's securitized loan and commercial loan investments held in two consolidated VIEs. These escrows consist of principal and interest escrows, capital improvement reserves, repair reserves, real estate tax and insurance reserves and tenant reserves. The corresponding liability is recorded in "Other liabilities" in the Consolidated Balance Sheets. The restricted cash is not available for general corporate use.

 

8
Table of Contents


Securitized Commercial Loans

Securitized commercial loans are comprised of commercial loans of consolidated variable interest entities which were sponsored by third parties. These loans are recorded in accordance with ASC 310-20, "Nonrefundable Fees and Other Costs". The Company has chosen to make the fair value election pursuant to ASC 825. Accordingly, these loans are recorded at fair value with periodic changes in fair value being recorded in earnings as a component of "Unrealized gain (loss), net".

The securitized commercial loans are typically collateralized by commercial real estate. As a result, the Company regularly evaluates the extent and impact of any credit migration associated with the performance and/or value of the underlying collateral property as well as the financial and operating capability of the borrower on a loan by loan basis. On a quarterly basis, the Company evaluates the collectability of both interest and principal of each loan, if circumstances warrant, to determine whether such loan is impaired. A loan 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 is impaired, the Company does not record an allowance for loan loss as the Company has elected the fair value option.  However, income recognition is suspended for loans at the earlier of the date at which payments become 90-days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. When the ultimate collectability of the principal of an impaired loan is in doubt, all payments are applied to principal under the cost recovery method. When the ultimate collectability of the principal of an impaired loan is not in doubt, contractual interest is recorded as interest income when received, under the cash basis method until an accrual is resumed. Interest income accrual is resumed when the loan becomes contractually current and performance is demonstrated. A loan is written off when it is no longer realizable and/or legally discharged.

Commercial Loans

Investments in Commercial Loans, which are comprised of commercial mortgage loans and commercial mezzanine loans, are recorded in accordance with ASC 310-20, "Nonrefundable Fees and Other Costs". The Company has chosen to make the fair value election pursuant to ASC 825 for its Commercial Loan portfolio. Accordingly, these loans are recorded at fair value with periodic changes in fair value being recorded in earnings as a component of "Unrealized gain (loss), net". All other costs incurred in connection with acquiring the Commercial Loans or committing to purchase these loans are charged to expense as incurred.
 
The Company’s loans are typically collateralized by commercial real estate. As a result, the Company regularly evaluates the extent and impact of any credit migration associated with the performance and or value of the underlying collateral property as well as the financial and operating capability of the borrower on a loan by loan basis. On a quarterly basis, the Company evaluates the collectability of both interest and principal of each loan, if circumstances warrant, to determine whether such loan is impaired. A loan 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 is impaired, the Company does not record an allowance for loan loss as the Company has elected the fair value option.  However, income recognition is suspended for loans at the earlier of the date at which payments become 90-days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. When the ultimate collectability of the principal of an impaired loan is in doubt, all payments are applied to principal under the cost recovery method. When the ultimate collectability of the principal of an impaired loan is not in doubt, contractual interest is recorded as interest income when received, under the cash basis method until an accrual is resumed. Interest income accrual is resumed when the loan becomes contractually current and performance is demonstrated. A loan is written off when it is no longer realizable and/or legally discharged.
 
Interest Income Recognition

Loan Portfolio

Interest income on the Company's residential loan portfolio and commercial loan portfolio is recorded using the effective interest method based on the contractual payment terms of the loan. Any premium amortization or discount accretion will be reflected as a component of "Interest income" in the Consolidated Statements of Operations.





9
Table of Contents

Recently adopted accounting pronouncements

Description
 
Adoption Date
 
Effect on Financial Statements
 
 
 
 
 
 In May 2014, the FASB issued ASU 2014-9, “Revenue from Contracts with Customers (Topic 606).” The guidance changes an entity’s recognition of revenue from contracts with customers.  The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  In addition, the new guidance requires improved disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In March 2016, the FASB issued implementation guidance which clarifies principal versus agent considerations in reporting revenue gross versus net (ASU 2016-8). In April 2016, the FASB issued implementation guidance which clarifies the identification of performance obligations (ASU 2016-10). In May 2016, the FASB issued amendments that affect only the narrow aspects of Topic 606 (ASU2016-12).
 
First quarter 2018.
 
The Company's revenue is mainly derived from interest income on our investments and to a lesser extent gains on sales of investments, which are not impacted by this standard. Therefore, the adoption of this standard did not have a material impact on the Company's consolidated financial statements.

 
 
 
 
 
In January 2016, the FASB issued ASU 2016-1, “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” The guidance improves certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. In February 2018, the FASB issued a separate Update for technical corrections and improvements related to the ASU 2016-01 to increase stakeholders' awareness of the amendments and to expedite the improvements (ASU 2018-3).
 
First quarter 2018.
 
The standard does not change the guidance for classifying and measuring investments in debt securities and loans as well nonrecourse liabilities of consolidated collateralized financing entities. Therefore, the adoption of this standard did not have a material impact on the Company's consolidated financial statements.
 
 
 
 
 
In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments (Topic 230)." The guidance is intended to reduce diversity in practice in how certain transactions are classified on the statement of cash flows.
 
First quarter 2018 and requires retrospective adoption.
 
The adoption of this standard did not have a material impact on its Consolidated Statements of Cash Flows.
 
 
 
 
 
In November 2016, the FASB issued ASU 2016-18 "Statement of Cash Flows (Topic 230): Restricted Cash, a consensus of the FASB's Emerging Issues Task Force." The guidance requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents as well as disclose information about the nature of the restrictions on its cash and cash equivalents.
 
First quarter 2018 and requires retrospective adoption.
 
The adoption of this standard did not have a material impact on its Consolidated Statements of Cash Flows.
 
 
 
 
 
In January 2017, the FASB issued ASU 2017-01 "Business Combinations (Topic 805): Clarifying the Definition of a Business." This ASU provides a more robust framework to use in determining when a set of assets and activities constitutes a business.
 
First quarter 2018. The guidance should be applied prospectively on or after the effective date.
 
The adoption of this standard did not have a material impact on its Consolidated Statements of Cash Flows.
 
 
 
 
 
In May 2017, the FASB issued ASU 2017-09 "Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting." The amendments in this update provide guidance about which changes to the terms or conditions of a shared-based payment award require an entity to apply modification accounting in Topic 718.
 
First quarter 2018.
 
There are no changes to the terms and conditions of the Company's share-based compensation. The adoption of this standard did not have a material impact on the Company's consolidated financial statements.


10
Table of Contents

Recently issued accounting pronouncements
Description
 
Effective Date
 
Effect on Financial Statements
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” This standard significantly changes how an entity will measure credit losses for most financial assets and certain other instruments that aren't measured at fair value through the income statement. The standard will replace the current "incurred loss" approach with an "expected loss" model for instruments measured at amortized cost. For available for sale debt securities, entities will be required to record an allowance rather than reduce the carrying amount, as is currently done under the other than temporary impairment model. It also simplifies the accounting model for purchased credit impaired debt securities and loans.
 
First quarter 2020.
 
The Company is currently evaluating the impact the standard may have on its consolidated financial statements when adopted.
 
 
 
 
 
In July 2017, the FASB issued ASU 2017-11, "Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivative and Hedges (Topic 815): Part I - Accounting for Certain Financial Instruments with Down Round Features and Part II - Replacement of the Indefinite Deferral for Mandatory Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatory Redeemable Noncontrolling Interest with a Scope Exception". Part I of this update changes the classification analysis of certain financial instruments (such as warrants and convertible instruments) with down round features. Down round features are features of certain equity-linked financial instruments (or embedded features) that result in the strike price being reduced on the basis of the pricing of future equity offerings. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. Entities that present earnings per share are required to recognize the effect of the down round feature when it is triggered. The amendments in Part II of this update recharacterize the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception. Those amendments do not have an accounting effect.
 
First quarter 2019.
 
The Company is evaluating the impact this standard may have on its consolidated financial statements.
 
 
 
 
 
In June 2018, the FASB issued ASU 2018-07, "Compensation-Stock Compensation (Topic 718), Improvements to Nonemployee Share-Based Payment Accounting." The amendments in this update expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees.
 
First quarter 2019.
 
The Company is evaluating the impact this standard may have on its consolidated financial statements.
 
 
 
 
 
In July 2018, the FASB issued ASU 2018-09, "Codification Improvements." The amendments in this update affect a wide variety of Topics in the Codification including derivatives and hedging, stock compensation-income taxes, distinguishing liabilities from equity, debt modification and extinguishment, reporting comprehensive income, business combinations-income taxes, financial services and Plan accounting.
 
First quarter 2019.
 
The Company is evaluating the impact this standard may have on its consolidated financial statements.
    

11
Table of Contents

Note 3 — Fair Value of Financial Instruments
 
The following tables present the Company’s financial instruments carried at fair value as of June 30, 2018 and December 31, 2017, based upon the valuation hierarchy (dollars in thousands):
 
 
June 30, 2018
 
Fair Value
 
Level I
 
Level II
 
Level III
 
Total
Assets
 

 
 

 
 

 
 

Agency RMBS
$
—

 
$
402,853

 
$
—

 
$
402,853

Agency RMBS Interest-Only Strips
—

 
—

 
13,559

 
13,559

Agency RMBS Interest-Only Strips accounted for as derivatives, included in MBS
—

 
—

 
9,247

 
9,247

Agency CMBS
—

 
2,012,342

 
52,237

 
2,064,579

Agency CMBS Interest-Only Strips accounted for as derivatives, included in MBS
—

 
4,923

 
—

 
4,923

Subtotal Agency MBS
—

 
2,420,118

 
75,043

 
2,495,161

 
 
 
 
 
 
 
 
Non-Agency RMBS
—

 
84,896

 
13

 
84,909

Non-Agency RMBS Interest-Only Strips
—

 
—

 
16,294

 
16,294

Non-Agency CMBS
—

 
331,393

 
—

 
331,393

Subtotal Non-Agency MBS
—

 
416,289

 
16,307

 
432,596

 
 
 
 
 
 
 
 
Other securities
—

 
99,046

 
8,955

 
108,001

Total mortgage-backed securities and other securities
—

 
2,935,453

 
100,305

 
3,035,758

 
 
 
 
 
 
 
 
Residential Whole-Loans
—

 
—

 
335,149

 
335,149

Residential Bridge Loans
—

 
—

 
236,359

 
236,359

Securitized commercial loans
—

 
—

 
1,309,195

 
1,309,195

Commercial Loans
—

 
—

 
70,717

 
70,717

Derivative assets
3,723

 
3,275

 
—

 
6,998

Total Assets
$
3,723

 
$
2,938,728

 
$
2,051,725

 
$
4,994,176

 
 
 
 
 
 
 
 
Liabilities
 

 
 

 
 

 
 

Derivative liabilities
$
26

 
$
1,597

 
$
—

 
$
1,623

Securitized debt
—

 
1,228,430

 
2,870

 
1,231,300

Total Liabilities
$
26

 
$
1,230,027

 
$
2,870

 
$
1,232,923


12
Table of Contents

 
December 31, 2017
 
Fair Value
 
Level I
 
Level II
 
Level III
 
Total
Assets
 

 
 

 
 

 
 

Agency RMBS
$
—

 
$
672,177

 
$
—

 
$
672,177

Agency RMBS Interest-Only Strips
—

 
15,437

 
—

 
15,437

Agency RMBS Interest-Only Strips accounted for as derivatives, included in MBS
—

 
10,419

 
—

 
10,419

Agency CMBS
—

 
2,137,583

 
17,217

 
2,154,800

Agency CMBS Interest-Only Strips
—

 
10

 
—

 
10

Agency CMBS Interest-Only Strips accounted for as derivatives, included in MBS
—

 
5,757

 
—

 
5,757

Subtotal Agency MBS
—

 
2,841,383

 
17,217

 
2,858,600

 
 
 
 
 
 
 
 
Non-Agency RMBS
—

 
90,819

 
13

 
90,832

Non-Agency RMBS Interest-Only Strips
—

 
—

 
8,722

 
8,722

Non-Agency CMBS
—

 
278,604

 
—

 
278,604

Subtotal Non-Agency MBS
—

 
369,423

 
8,735

 
378,158

 
 
 
 
 
 
 
 
Other securities
—

 
112,826

 
9,239

 
122,065

Total mortgage-backed securities and other securities
—

 
3,323,632

 
35,191

 
3,358,823

 
 
 
 
 
 
 
 
Residential Whole-Loans
—

 
—

 
237,423

 
237,423

Residential Bridge Loans
—

 
—

 
64,526

 
64,526

Securitized commercial loan
—

 
—

 
24,876

 
24,876

Derivative assets
728

 
—

 
—

 
728

Total Assets
$
728

 
$
3,323,632

 
$
362,016

 
$
3,686,376

 
 
 
 
 
 
 
 
Liabilities
 

 
 

 
 

 
 

Derivative liabilities
$
50

 
$
4,296

 
$
—

 
$
4,346

Securitized debt
—

 
—

 
10,945

 
10,945

Total Liabilities
$
50

 
$
4,296

 
$
10,945

 
$
15,291

 
When available, the Company uses quoted market prices to determine the fair value of an asset or liability. If quoted market prices are not available, the Company will use independent pricing services and if the independent pricing service cannot price a particular asset or liability, the Company will obtain third party broker quotes.  The Manager’s pricing group, which functions independently from its portfolio management personnel, reviews the third party broker quotes by comparing the broker quotes for reasonableness to alternate sources when available.  If independent pricing service, or third party broker quotes are not available, the Company determines the fair value of the securities using valuation techniques that use, when possible, current market-based or independently-sourced market parameters, such as interest rates and when applicable, estimates of prepayments and credit losses.

In instances when the Company is required to consolidate a VIE that is determined to be a qualifying collateralized financing entity ("CFE"), under GAAP, the Company will measure both the financial assets and financial liabilities of the VIE using the fair value of either the VIE’s financial assets or financial liabilities, whichever is more observable.

Mortgage-backed securities and other securities
 
In determining the proper fair value hierarchy or level, the Company considers the amount of available observable market data for each security. Agency RMBS, given the amount of available observable market data, are classified in Level II.  For Non-Agency RMBS, CMBS and other securities, to determine whether a security should be a Level II, the securities are grouped by

13
Table of Contents

security type and the Manager reviews the internal trade history, for the quarter, for each security type. If there is sufficient trade data above a predetermined threshold of a security type, the Manager determines it has sufficient observable market data and the security will be categorized as a Level II.
 
Values for the Company’s securities are based upon prices obtained from independent third party pricing services. The valuation methodology of the third party pricing services incorporates a commonly used market pricing method. Depending on the type of asset and the underlying collateral, the primary inputs to the model include yields for TBAs, Agency RMBS, the U.S. Treasury market and floating rate indices such as LIBOR, the Constant Maturity Treasury rate and the prime rate as a benchmark yield. In addition, the model may incorporate the current weighted average maturity and additional pool level information such as prepayment speeds, default frequencies and default severities, if applicable. When the third party pricing service cannot adequately price a particular security, the Company utilizes a broker’s quote which is reviewed for reasonableness by the Manager’s pricing group.

Residential Whole-Loans and Residential Bridge Loans
 
Values for the Company's Residential Whole-Loans and Bridge Loans are based upon prices obtained from an independent third party pricing service that specializes in loan valuation, utilizing a valuation model that is calibrated to recent loan trade execution. Their valuation methodology incorporates commonly used market pricing methods, including loan to value ("LTV"), debt to income, maturity, interest rates, collateral location, and unpaid principal balance, prepayment penalties, FICO scores, lien position and times late. Due to the inherent uncertainty of such valuation, the fair values established for residential loans held by the Company may differ from the fair values that would have been established if a readily available market existed for these loans. Accordingly, the Company's loans are classified as Level III.

Commercial Loans

Values for the Company's Commercial Loans are based upon either prices obtained from an independent third party pricing service that specializes in loan valuation, utilizing a valuation model that is calibrated to recent loan trade execution or a broker quote. The third party pricing service uses a valuation methodology incorporates commonly used market pricing methods, including loan to value ("LTV"), debt to income, maturity, interest rates, collateral location, and unpaid principal balance, prepayment penalties, lien position and times late. Due to the inherent uncertainty of such valuation, the fair values established for commercial loans held by the Company may differ from the fair values that would have been established if a readily available market existed for these loans. Accordingly, the Company's commercial loans are classified as a Level III.
 
Securitized commercial loans
 
Values for the Company’s securitized commercial loans are based on the CFE valuation methodology.  Since there is an extremely limited market for the securitized commercial loans, the Company determined the securitized debt is more actively traded and therefore was more observable.  Due to the inherent uncertainty of such valuation, the Company classifies its securitized commercial loans as Level III.

Securitized debt

In determining the proper fair value hierarchy or level, the Company considers the amount of available observable market data for each security. Since the securitized debt represents traded debt securities, the Manager's pricing team reviews the trade activity during the quarter for each security to determine the appropriate level within the fair value hierarchy. If there is sufficient trade data above a predetermined threshold, the Manager determines it has sufficient observable market data and the debt security will be categorized as a Level II. If there is not sufficient observable market data the debt security will be categorized as a Level III.

Derivatives
 
Values for the Company's derivatives are based upon prices from third party pricing services, whose pricing is subject to review by the Manager’s pricing committee. In valuing its over-the-counter interest rate derivatives, such as swaps and swaptions, its currency derivatives, such as swaps and forwards and credit derivatives such as total return swaps, the Company considers the creditworthiness of both the Company and its counterparties, along with collateral provisions contained in each derivative agreement, from the perspective of both the Company and its counterparties. No credit valuation adjustment was made in determining the fair value of interest rate and/or currency derivatives for the periods ended June 30, 2018 and December 31, 2017.
 

14
Table of Contents

The Company performs quarterly reviews of the independent third party pricing data. These reviews may consist of a review of the daily change in the prices provided by the independent pricing vendor which exceed established tolerances or comparisons to executed transaction prices, utilizing the Manager’s pricing group.  The Manager’s pricing group, which functions independently from its portfolio management personnel, reviews the price differences or changes in price by comparing the vendor price to alternate sources including other independent pricing services or broker quotations.  If the price change or difference cannot be corroborated, the Manager’s pricing group consults with the portfolio management team for market color in reviewing such pricing data as warranted.  To the extent that the Manager has information, typically in the form of broker quotations that would indicate that a price received from the independent pricing service is outside of a tolerance range, the Manager generally challenges the independent pricing service price.


15
Table of Contents

The following tables present additional information about the Company’s financial instruments which are measured at fair value on a recurring basis for which the Company has utilized Level III inputs to determine fair value:
 
 
Three months ended June 30, 2018
$ in thousands
Agency MBS
 
Non-Agency MBS
 
Other Securities
 
Residential 
Whole-Loans
 
Residential
Bridge Loans
 
Commercial Loans
 
Securitized 
commercial 
loans
 
Securitized debt
Beginning balance
$
44,802

 
$
17,000

 
$
9,113

 
$
296,719

 
$
129,469

 
$
40,455

 
$
1,383,044

 
$
12

Transfers into Level III from Level II
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Transfers from Level III into Level II
(19,461
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

Purchases
52,530

 
—

 
—

 
54,019

 
156,730

 
29,851

 
—

 
—

Principal repayments
—

 
—

 
(177
)
 
(14,902
)
 
(49,402
)
 
—

 
(78,807
)
 
—

Total net gains / losses included in net income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other than temporary impairment
(207
)
 
(19
)
 
—

 
—

 
—

 
—

 
—

 
—

Unrealized gains/(losses), net on assets(1)
(1,181
)
 
(53
)
 
(25
)
 
(475
)
 
(108
)
 
374

 
5,621

 
—

Unrealized (gains)/losses, net on liabilities(2)
—

 
—

 
—

 
—

 
—

 
—

 
—

 
2,834

Premium and discount amortization, net
(1,440
)
 
(621
)
 
44

 
(212
)
 
(330
)
 
37

 
(663
)
 
24

Ending balance
$
75,043

 
$
16,307

 
$
8,955

 
$
335,149

 
$
236,359

 
$
70,717

 
$
1,309,195

 
$
2,870

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gains/(losses), net on assets held at the end of the period(1)
$
(798
)
 
$
(53
)
 
$
(25
)
 
$
(274
)
 
$
140

 
$
374

 
$
5,621

 
$
—

Unrealized gains/(losses), net on liabilities held at the end of the period(2)
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(2,834
)

 
Three months ended June 30, 2017
$ in thousands
Agency MBS
 
Non-Agency MBS
 
Other Securities
 
Residential 
Whole-Loans
 
Securitized 
commercial 
loan
 
Securitized debt
 
Derivative liability
Beginning balance
$
50,273

 
$
15,622

 
$
21,432

 
$
215,800

 
$
24,500

 
$
10,780

 
$
459

Transfers into Level III from Level II
—

 
—

 
—

 
—

 
—

 
—

 
—

Transfers from Level III into Level II
(50,999
)
 
—

 
—

 
—

 
—

 
—

 
—

Purchases
131

 
—

 
—

 
—

 
—

 
—

 
—

Sales and settlements
—

 
—

 
—

 
—

 
—

 
—

 
(14,711
)
Principal repayments
(15
)
 
(1,698
)
 
—

 
(12,220
)
 
—

 
—

 
—

Total net gains / losses included in net income
 
 
 
 
0

 
 

 
 

 
 

 
 

Realized (gains)/losses, net on liabilities
—

 
—

 
—

 
—

 
—

 
—

 
14,711

Other than temporary impairment
—

 
—

 
(438
)
 
—

 
—

 
—

 
—

Unrealized gains/(losses), net on assets(1)
614

 
392

 
603

 
260

 
375

 
—

 
—

Unrealized (gains)/losses, net on liabilities(2)
—

 
—

 
—

 
—

 
—

 
165

 
(130
)
Premium and discount amortization, net
(4
)
 
10

 
808

 
(300
)
 
—

 
—

 
—

Ending balance
$
—

 
$
14,326

 
$
22,405

 
$
203,540

 
$
24,875

 
$
10,945

 
$
329

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gains/(losses), net on assets held at the end of the period(1)
$
—

 
$
392

 
$
603

 
$
478

 
$
375

 
$
—

 
$
—

Unrealized gains/(losses), net on liabilities held at the end of the period(2)
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(165
)
 
$
130



16
Table of Contents

 
Six months ended June 30, 2018
$ in thousands
Agency MBS
 
Non-Agency MBS
 
Other Securities
 
Residential 
Whole-Loans
 
Residential
Bridge Loans
 
Commercial Loans
 
Securitized 
commercial 
loans
 
Securitized debt
Beginning balance
$
17,217

 
$
8,735

 
$
9,239

 
$
237,423

 
$
64,526

 
$
—

 
$
24,876

 
$
10,945

Transfers into Level III from Level II
22,794

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Transfers from Level III into Level II
(16,805
)
 
—

 
—

 
—

 
—

 
—

 
—

 
(10,899
)
Purchases
54,623

 
8,602

 
—

 
122,014

 
214,843

 
70,257

 
1,353,019

 
—

Sales and settlements
—

 
—

 
—

 
—

 
—

 
—

 
—

 
12

Principal repayments
(53
)
 
—

 
(317
)
 
(22,679
)
 
(42,544
)
 
—

 
(78,907
)
 
(44
)
Total net gains / losses included in net income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other than temporary impairment
(207
)
 
(48
)
 
—

 
—

 
—

 
—

 
—

 
—

Unrealized gains/(losses), net on assets(1)
(1,070
)
 
(56
)
 
(54
)
 
(1,273
)
 
(130
)
 
416

 
10,870

 
—

Unrealized (gains)/losses, net on liabilities(2)
—

 
—

 
—

 
—

 
—

 
—

 
—

 
2,832

Premium and discount amortization, net
(1,456
)
 
(926
)
 
87

 
(336
)
 
(336
)
 
44

 
(663
)
 
24

Ending balance
$
75,043

 
$
16,307

 
$
8,955

 
$
335,149

 
$
236,359

 
$
70,717

 
$
1,309,195

 
$
2,870

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gains/(losses), net on assets held at the end of the period(1)
$
(712
)
 
$
(56
)
 
$
(54
)
 
$
(888
)
 
$
151

 
$
416

 
$
10,870

 
$
—

Unrealized gains/(losses), net on liabilities held at the end of the period(2)
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(2,834
)

 
Six months ended June 30, 2017
$ in thousands
Agency MBS
 
Non-Agency MBS
 
Other Securities
 
Residential 
Whole-Loans
 
Securitized 
commercial 
loan
 
Securitized debt
 
Derivative liability
Beginning balance
$
73,059

 
$
75,576

 
$
31,356

 
$
192,136

 
$
24,225

 
$
10,659

 
$
1,673

Transfers into Level III from Level II
—

 
15,610

 
—

 
—

 
—

 
—

 
—

Transfers from Level III into Level II
(73,715
)
 
(7,434
)
 
(9,227
)
 
—

 
—

 
—

 
—

Purchases
—

 
—

 
—

 
35,671

 
—

 
—

 
—

Sales and settlements
—

 
(60,132
)
 
—

 
—

 
—

 
—

 
(14,197
)
Principal repayments
—

 
(2,075
)
 
(172
)
 
(24,357
)
 
—

 
—

 
—

Total net gains / losses included in net income
 
 
 
 
 
 
 

 
 

 
 

 
 

Realized gains/(losses), net on assets
—

 
2,623

 
—

 
—

 
—

 
—

 
—

Realized (gains)/losses, net on liabilities
—

 
—

 
—

 
—

 
—

 
—

 
14,197

Other than temporary impairment
—

 
—

 
(1,702
)
 
—

 
—

 
—

 
—

Unrealized gains/(losses), net on assets(1)
636

 
(9,007
)
 
456

 
638

 
650

 
—

 
—

Unrealized (gains)/losses, net on liabilities(2)
—

 
—

 
—

 
—

 
—

 
286

 
(1,344
)
Premium and discount amortization, net
20

 
(835
)
 
1,694

 
(548
)
 
—

 
—

 
—

Ending balance
$
—

 
$
14,326

 
$
22,405

 
$
203,540

 
$
24,875

 
$
10,945

 
$
329

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized gains/(losses), net on assets held at the end of the period(1)
$
—

 
$
392

 
$
385

 
$
792

 
$
650

 
$
—

 
$
—

Unrealized gains/(losses), net on liabilities held at the end of the period(2)
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(286
)
 
$
1,344

 
(1)
Gains and losses are included in "Unrealized gain (loss), net" in the Consolidated Statements of Operations.
(2)
Gains and losses on securitized debt and derivative liability are included in "Unrealized gain (loss), net" and "Gain (loss) on derivative instruments, net" in the Consolidated Statements of Operations, respectively.


17
Table of Contents

Transfers between hierarchy levels during operations for the three and six months ended June 30, 2018 and June 30, 2017 were based on the availability of sufficient observable inputs to meet Level II versus Level III criteria.  The leveling of these assets was based on information received from a third party pricing service which, along with the back-testing of historical sales transactions performed by the Manager, provided the sufficient observable data for the movement from Level III to Level II. The Company did not have transfers between Level I and Level II for the three and six months ended June 30, 2018 and June 30, 2017.
 
Other Fair Value Disclosures
 
Certain Residential Bridge Loans, repurchase agreement borrowings and convertible senior unsecured notes are not carried at fair value in the consolidated financial statements. The following table presents the carrying value and estimated fair value of the Company’s financial instruments that are not carried at fair value as of June 30, 2018 and December 31, 2017 in the consolidated financial statements (dollars in thousands):
 
June 30, 2018
 
December 31, 2017
 
Carrying Value
 
 Estimated Fair Value
 
Carrying Value
 
 Estimated Fair Value
Assets
 
 
 
 
 
 
 
Residential Bridge Loans
$
22,980

 
$
22,805

 
$
42,147

 
$
42,881

Total
$
22,980

 
$
22,805

 
$
42,147

 
$
42,881

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Borrowings under repurchase agreements
$
3,267,369

 
$
3,265,879

 
$
3,251,686

 
$
3,257,956

Convertible senior unsecured notes
109,401

 
116,512

 
108,743

 
114,819

Total
$
3,376,770

 
$
3,382,391

 
$
3,360,429

 
$
3,372,775


"Due from counterparties" and "Due to counterparties" in the Company’s Consolidated Balance Sheets are reflected at cost which approximates fair value.
 
Residential Bridge Loans

The fair values of the Residential Bridge Loans are based upon prices obtained from an independent third party pricing service that specializes in loan valuation, utilizing a valuation model that is calibrated to recent loan trade execution. Their valuation methodology uses a discount cash flow model and incorporates commonly used market pricing methods, including loan to value (“LTV”), debt to income, maturity, interest rates, collateral location, and unpaid principal balance, prepayment penalties, FICO scores, lien position and times late. Due to the inherent uncertainty of such valuation, the fair values established for residential bridge loans held by the Company may differ from the fair values that would have been established if a readily available market existed for these loans. Accordingly, the Company's loans are classified as Level III.

Borrowings under repurchase agreements

The fair values of the borrowings under repurchase agreements are based on a net present value technique. This method discounts future estimated cash flows using rates the Company determined best estimates current market interest rates that would be offered for loans with similar characteristics and credit quality. The use of different market assumptions or estimation methodologies could have a material effect on the fair value amounts. This fair value measurement is based on observable inputs, and as such, are classified as Level II.

Convertible senior unsecured notes

The fair value of the convertible senior unsecured notes is based on quoted market prices. Accordingly, the Company's convertible senior unsecured notes are classified as Level I.

Note 4 – Mortgage-Backed Securities and other securities
 
The following tables present certain information about the Company’s investment portfolio at June 30, 2018 and December 31, 2017 (dollars in thousands):
 

18
Table of Contents

 
June 30, 2018
 
 
Principal
Balance
 
Unamortized
Premium
(Discount),
net
 
Discount
Designated as
Credit Reserve
and OTTI
 
Amortized
Cost
 
Unrealized
Gain
 
Unrealized
Loss
 
Estimated
Fair Value
 
Net
Weighted
Average
Coupon 
 
Agency RMBS
$
403,154

 
$
13,467

 
$
—

 
$
416,621

 
$
—

 
$
(13,768
)
 
$
402,853

 
3.6
%
 
Agency RMBS Interest-Only Strips (2)
N/A

 
N/A

 
N/A

 
13,501

 
835

 
(777
)
 
13,559

 
2.3
%
(1)
Agency RMBS Interest-Only Strips, accounted for as derivatives (1) (2)
N/A

 
N/A

 
N/A

 
N/A

 
N/A

 
N/A

 
9,247

 
2.7
%
(1)
Subtotal Agency RMBS
403,154