

11.	FAIR VALUE MEASUREMENTS

The Company follows fair value guidance in accordance with GAAP to account for its financial instruments. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

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

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

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

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

The Company designates its securities as trading, available-for-sale or held-to-maturity depending upon the type of security and the Company’s intent and ability to hold such security to maturity. Securities classified as available-for-sale and trading are reported at fair value on a recurring basis.

The following is a description of the valuation methodologies used for instruments carried at fair value. These methodologies are applied to assets and liabilities across the three-level fair value hierarchy, with the observability of inputs determining the appropriate level.

Residential Investment Securities, interest rate swaps, swaptions and other derivatives are valued using quoted prices or internally estimated prices for similar assets using internal models. The Company incorporates common market pricing methods, including a spread measurement to the Treasury curve as well as underlying characteristics of the particular security including coupon, prepayment speeds, periodic and life caps, rate reset period and expected life of the security in its estimates of fair value. Fair value estimates for residential mortgage loans are generated by a discounted cash flow model and are primarily based on observable market-based inputs including discount rates, prepayment speeds, delinquency levels, and credit losses. Management reviews and indirectly corroborates its estimates of the fair value derived using internal models by comparing its results to independent prices provided by dealers in the securities and/or third party pricing services. Certain liquid asset classes, such as Agency fixed-rate pass-throughs, may be priced using independent sources such as quoted prices for TBA securities.

Futures contracts are valued using quoted prices for identical instruments in active markets and are classified as Level 1.

Residential Investment Securities, residential mortgage loans, interest rate swap and swaption markets and MBS options are considered to be active markets such that participants transact with sufficient frequency and volume to provide transparent pricing information on an ongoing basis. The liquidity of the Residential Investment Securities, interest rate swaps, swaptions, TBA derivatives and MBS options markets and the similarity of the Company’s securities to those actively traded enable the Company to observe quoted prices in the market and utilize those prices as a basis for formulating fair value measurements. Consequently, the Company has classified Residential Investment Securities, interest rate swaps, swaptions, TBA derivatives and MBS options as Level 2 inputs in the fair value hierarchy.

The fair value of commercial mortgage-backed securities classified as available-for-sale is determined based upon quoted prices of similar assets in recent market transactions and requires the application of judgment due to differences in the underlying collateral. Consequently, as discussed in the “Commercial Real Estate Investments” Note, Commercial real estate debt investments carried at fair value are classified as Level 2.

For the fair value of securitized debt of consolidated VIEs, refer to the Note titled “Variable Interest Entities” for additional information.

The Company classifies its investments in MSRs as Level 3 in the fair value measurements hierarchy. Fair value estimates for these investments are obtained from models, which use significant unobservable inputs in their valuations. These valuations primarily utilize discounted cash flow models that incorporate unobservable market data inputs including prepayment rates, delinquency levels, costs to service and discount rates. Model valuations are then compared to valuations obtained from third-party pricing providers. Management reviews the valuations received from third-party pricing providers and uses them as a point of comparison to its internally modeled values. The valuation of MSRs requires significant judgment by management and the third-party pricing providers. Assumptions used for which there is a lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s financial statements.

The following tables present the estimated fair values of financial instruments measured at fair value on a recurring basis. There were no transfers between levels of the fair value hierarchy during the periods presented.



	December 31, 2017
	Level 1		Level 2		Level 3		Total
	(dollars in thousands)
Assets:
Agency mortgage-backed securities	$	—	$	90,551,763	$	—	$	90,551,763
Credit risk transfer securities	—		651,764		—		651,764
Non-Agency mortgage-backed securities	—		1,097,294		—		1,097,294
Residential mortgage loans	—		1,438,322		—		1,438,322
Mortgage servicing rights	—		—		580,860		580,860
Commercial real estate debt investments	—		3,089,108		—		3,089,108
Interest rate swaps	—		30,272		—		30,272
Other derivatives	218,361		65,252		—		283,613
Total assets	$	218,361	$	96,923,775	$	580,860	$	97,722,996
Liabilities:
Securitized debt of consolidated VIEs	$	—	$	2,971,771	$	—	$	2,971,771
Interest rate swaps	—		569,129		—		569,129
Other derivatives	12,285		26,440		—		38,725
Total liabilities	$	12,285	$	3,567,340	$	—	$	3,579,625



	December 31, 2016
	Level 1		Level 2		Level 3		Total
	(dollars in thousands)
Assets:
Agency mortgage-backed securities	$	—	$	75,589,873	$	—	$	75,589,873
Credit risk transfer securities	—		724,722		—		724,722
Non-Agency mortgage-backed securities	—		1,401,307		—		1,401,307
Residential mortgage loans	—		342,289		—		342,289
Mortgage servicing rights	—		—		652,216		652,216
Commercial real estate debt investments	—		4,321,739		—		4,321,739
Interest rate swaps	—		68,194		—		68,194
Other derivatives	168,209		3,057		—		171,266
Total assets	$	168,209	$	82,451,181	$	652,216	$	83,271,606
Liabilities:
Securitized debt of consolidated VIEs	$	—	$	3,655,802	$	—	$	3,655,802
Interest rate swaps	—		1,443,765		—		1,443,765
Other derivatives	24,912		61,525		—		86,437
Total liabilities	$	24,912	$	5,161,092	$	—	$	5,186,004

Quantitative Information about Level 3 Fair Value Measurements

The Company considers unobservable inputs to be those for which market data is not available and that are developed using the best information available to us about the assumptions that market participants would use when pricing the asset. Relevant inputs vary depending on the nature of the instrument being measured at fair value. The following paragraph provides a general description of sensitivities of significant unobservable inputs along with interrelationships between and among the significant unobservable inputs and their impact on the fair value measurements. The effect of a change in a particular assumption in the sensitivity analysis below is considered independently of changes in any other assumptions. In practice, simultaneous changes in assumptions may not always have a linear effect on the inputs discussed below. Interrelationships may also exist between observable and unobservable inputs. Such relationships have not been included in the discussion below. For each of the individual relationships described below, the inverse relationship would also generally apply.

For MSRs, in general, increases in the discount, prepayment or delinquency rates or in annual servicing costs in isolation would result in a lower fair value measurement. A decline in interest rates could lead to higher-than-expected prepayments of mortgages underlying the Company’s investments in MSRs, which in turn could result in a decline in the estimated fair value of MSRs. Refer to the Note titled “Mortgage Servicing Rights” for additional information.

The table below presents information about the significant unobservable inputs used for recurring fair value measurements for Level 3 MSRs. The table does not give effect to the Company’s risk management practices that might offset risks inherent in these Level 3 investments.



	December 31, 2017		December 31, 2016
		Range		Range
Valuation Technique	Unobservable Input ⁽¹⁾	(Weighted Average )	Unobservable Input ⁽¹⁾	(Weighted Average )
Discounted cash flow	Discount rate	10.0% -15.0% (10.4%)	Discount rate	10.0% -15.0% (10.4%)
	Prepayment rate	4.6% - 22.3% (9.4%)	Prepayment rate	5.1% - 18.8% (8.7%)
	Delinquency rate	0.0% - 13.0% (2.2%)	Delinquency rate	0.0% - 10.0% (2.3%)
	Cost to service	$84 - $181 ($102)	Cost to service	$83 - $152 ($100)

(1) Represents rates, estimates and assumptions that the Company believes would be used by market participants when valuing these assets.

Fair Value Information about Financial Instruments Not Carried at Fair Value

GAAP requires disclosure of fair value information about financial instruments, whether or not recognized in the financial statements, for which it is practical to estimate the value. In cases where quoted market prices are not available, fair values are based upon discounted cash flows using market yields, methodologies that incorporate market-based transactions or other valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, fair values are not necessarily indicative of the amount the Company would realize on disposition of the financial instruments. The use of different market assumptions or estimation methodologies could have a material effect on the estimated fair value amounts.

The carrying value of short-term instruments, including cash and cash equivalents, reverse repurchase agreements, repurchase agreements and other secured financing whose term is less than twelve months, generally approximates fair value due to the short-term nature of the instruments.

The estimated fair value of commercial real estate debt and preferred equity investments takes into consideration changes in credit spreads and interest rates from the date of origination or purchase to the reporting date. The fair value also reflects consideration of asset-specific maturity dates and other items that could have an impact on the fair value as of the reporting date.

Estimates of fair value of corporate debt require the use of judgments and inputs including, but not limited to, the enterprise value of the borrower (i.e., an estimate of the total fair value of the borrower’s debt and equity), the nature and realizable value of any collateral, the borrower’s ability to make payments when due and its earnings history. Management also considers factors that affect the macro and local economic markets in which the borrower operates.

The fair value of fixed-rate repurchase agreements with remaining maturities greater than one year or with embedded optionality are valued as structured notes, with term to maturity, LIBOR rates and the Treasury curve being primary determinants of estimated fair value.

The fair value of mortgages payable is calculated using the estimated yield of a new par loan to value the remaining terms in place. A par loan is created using the identical terms of the existing loan; however, the coupon is derived by using the original spread against the interpolated Treasury. The fair value of mortgages payable also reflects consideration of the value of the underlying collateral and changes in credit risk from the time the debt was originated.

The carrying value of participation sold is based on the loan’s amortized cost. The fair value of participation sold is based on the fair value of the underlying related commercial loan.

The following table summarizes the estimated fair values for financial assets and liabilities at December 31, 2017 and 2016.



		December 31, 2017				December 31, 2016
	Level in Fair Value Hierarchy	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets:		(dollars in thousands)
Cash and cash equivalents ⁽¹⁾	1	$	706,589	$	706,589	$	1,539,746	$	1,539,746
Agency mortgage-backed securities	2	90,551,763		90,551,763		75,589,873		75,589,873
Credit risk transfer securities	2	651,764		651,764		724,722		724,722
Non-Agency mortgage-backed securities	2	1,097,294		1,097,294		1,401,307		1,401,307
Residential mortgage loans	2	1,438,322		1,438,322		342,289		342,289
Mortgage servicing rights	3	580,860		580,860		652,216		652,216
Commercial real estate debt investments	2	3,089,108		3,089,108		4,321,739		4,321,739
Commercial real estate debt and preferred equity, held for investment	3	1,029,327		1,035,095		970,505		968,824
Commercial loans held for sale, net	3	—		—		114,425		114,425
Corporate debt ⁽²⁾	2	1,011,275		1,014,139		773,274		776,310
Interest rate swaps ⁽¹⁾	2	30,272		30,272		68,194		68,194
Other derivatives	1,2	283,613		283,613		171,266		171,266
Financial liabilities:
Repurchase agreements	1,2	$	77,696,343	$	77,697,828	$	65,215,810	$	65,256,505
Other secured financing	1,2	3,837,528		3,837,595		3,884,708		3,885,430
Securitized debt of consolidated VIEs	2	2,971,771		2,971,771		3,655,802		3,655,802
Participation sold	2	—		—		12,869		12,827
Mortgage payable	3	309,686		310,218		311,636		312,442
Interest rate swaps ⁽¹⁾	2	569,129		569,129		1,443,765		1,443,765
Other derivatives	1,2	38,725		38,725		86,437		86,437

(1)

As a result of a change to a clearing organization’s rulebook effective January 3, 2017, beginning with the first quarter 2017 and in subsequent periods the Company is presenting the fair value of centrally cleared interest rate swaps net of variation margin pledged under such transactions. The variation margin was previously reported under cash and cash equivalents and is currently reported as a reduction to interest rate swaps, at fair value.


(2)	Includes a held-to-maturity debt security carried at amortized cost of $84.5 million, with a fair value of $87.8 million, at December 31, 2016. The bond was repaid in April 2017.