MBS

The Company’s MBS are comprised of Agency MBS and Non-Agency MBS. These MBS are secured by: (i) hybrid mortgages (“Hybrids”), which have interest rates that are fixed for a specified period of time and, thereafter, generally adjust annually to an increment over a specified interest rate index; (ii) adjustable-rate mortgages (“ARMs”); (iii) mortgages that have interest rates that reset more frequently (collectively, “ARM-MBS”); and (iv) 15-year and longer-term fixed rate mortgages. MBS do not have a single maturity date, and further, the mortgage loans underlying ARM-MBS do not all reset at the same time.

The Company pledges a significant portion of its MBS as collateral against its borrowings under repurchase agreements and Swaps. Non-Agency MBS that are accounted for as components of Linked Transactions are not reflected in the tables set forth in this note, as they are accounted for as derivatives. (See Notes 5 and 7)

Agency MBS: Agency MBS are guaranteed as to principal and/or interest by a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae. The payment of principal and/or interest on Ginnie Mae MBS is explicitly backed by the full faith and credit of the U.S. Government. Since the third quarter of 2008, Fannie Mae and Freddie Mac have been under the conservatorship of the Federal Housing Finance Agency, which significantly strengthened the backing for these government-sponsored entities.

Non-Agency MBS (including Non-Agency MBS transferred to consolidated VIEs): The Company’s Non-Agency MBS are secured by pools of residential mortgages, which are not guaranteed by an agency of the U.S. Government or any federally chartered corporation. Non-Agency MBS may be rated by one or more Rating Agencies or may be unrated (i.e., not assigned a rating by any Rating Agency). The rating indicates the opinion of the Rating Agency as to the creditworthiness of the investment, indicating the obligor’s ability to meet its full financial commitment on the obligation. A rating of “D” is assigned when a security has defaulted on any of its contractual terms.

The following tables present certain information about the Company’s MBS at December 31, 2013 and 2012:

December 31, 2013



(In Thousands)	Principal/ Current Face		Purchase Premiums		Accretable Purchase Discounts			Discount Designated as Credit Reserve and OTTI (1)			Amortized Cost (2)		Fair Value		Gross Unrealized Gains		Gross Unrealized Losses			Net Unrealized Gain/(Loss)
Agency MBS:
Fannie Mae	$	5,092,410	$	181,710	$	(87	)	$	—		$	5,274,033	$	5,315,363	$	96,516	$	(55,186	)	$	41,330
Freddie Mac	1,171,841		44,967		—			—			1,217,927		1,190,670		9,842		(37,099		)	(27,257		)
Ginnie Mae	12,668		218		—			—			12,886		13,188		302		—			302
Total Agency MBS	6,276,919		226,895		(87		)	—			6,504,846		6,519,221		106,660		(92,285		)	14,375
Non-Agency MBS (3)
Rated AAA	14,162		60		(160		)	—			14,062		14,389		327		—			327
Rated A	17,679		503		—			—			18,182		17,663		—		(519		)	(519		)
Rated BBB	26,755		5		(1,091		)	—			25,669		27,156		1,496		(9		)	1,487
Rated BB	102,019		59		(7,220		)	(598		)	94,260		98,494		4,505		(271		)	4,234
Rated B	265,488		—		(33,354		)	(5,372		)	226,762		253,208		26,446		—			26,446
Rated CCC	1,191,641		11		(133,607		)	(179,239		)	878,806		1,056,356		178,964		(1,414		)	177,550
Rated CC	353,912		—		(33,498		)	(80,300		)	240,114		291,333		51,226		(7		)	51,219
Rated C	203,153		—		(32,704		)	(23,340		)	147,109		182,424		35,508		(193		)	35,315
Rated D	3,369,202		—		(213,238		)	(736,308		)	2,419,656		2,852,101		433,781		(1,336		)	432,445
Not Rated	72,027		—		(5,167		)	(17,880		)	48,980		59,013		10,033		—			10,033
Total Non-Agency MBS	5,616,038		638		(460,039		)	(1,043,037		)	4,113,600		4,852,137		742,286		(3,749		)	738,537
Total MBS	$	11,892,957	$	227,533	$	(460,126	)	$	(1,043,037	)	$	10,618,446	$	11,371,358	$	848,946	$	(96,034	)	$	752,912

December 31, 2012



(In Thousands)	Principal/ Current Face		Purchase Premiums		Accretable Purchase Discounts			Discount Designated as Credit Reserve and OTTI (1)			Amortized Cost (2)		Fair Value		Gross Unrealized Gains		Gross Unrealized Losses			Net Unrealized Gain/(Loss)
Agency MBS:
Fannie Mae	$	5,977,388	$	196,686	$	(58	)	$	—		$	6,174,016	$	6,351,621	$	178,970	$	(1,365	)	$	177,605
Freddie Mac	800,854		30,447		—			—			835,724		858,560		22,925		(89		)	22,836
Ginnie Mae	14,526		251		—			—			14,777		15,279		502		—			502
Total Agency MBS	6,792,768		227,384		(58		)	—			7,024,517		7,225,460		202,397		(1,454		)	200,943
Non-Agency MBS (3)
Rated AAA	25,209		158		(219		)	—			25,148		25,905		757		—			757
Rated A	1,147		24		—			—			1,171		1,086		—		(85		)	(85		)
Rated BBB	49,301		637		(1,741		)	(378		)	47,819		48,563		1,806		(1,062		)	744
Rated BB	118,031		39		(8,892		)	(853		)	108,325		112,905		4,937		(357		)	4,580
Rated B	247,532		—		(31,133		)	(12,462		)	203,937		225,281		21,452		(108		)	21,344
Rated CCC	1,235,638		14		(107,618		)	(201,126		)	926,908		1,055,757		131,826		(2,977		)	128,849
Rated CC	579,632		—		(41,191		)	(132,061		)	406,380		468,017		61,739		(102		)	61,637
Rated C	952,984		—		(55,294		)	(166,529		)	731,161		812,523		81,850		(488		)	81,362
Rated D	3,219,744		—		(123,673		)	(843,773		)	2,252,298		2,573,238		321,048		(108		)	320,940
Not Rated	80,342		—		(1,865		)	(23,324		)	55,153		58,890		4,748		(1,011		)	3,737
Total Non-Agency MBS	6,509,560		872		(371,626		)	(1,380,506		)	4,758,300		5,382,165		630,163		(6,298		)	623,865
Total MBS	$	13,302,328	$	228,256	$	(371,684	)	$	(1,380,506	)	$	11,782,817	$	12,607,625	$	832,560	$	(7,752	)	$	824,808

(1) Discount designated as Credit Reserve and amounts related to OTTI are generally not expected to be accreted into interest income. Amounts disclosed at December 31, 2013 reflect Credit Reserve of $998.5 million and OTTI of $44.5 million. Amounts disclosed at December 31, 2012 reflect Credit Reserve of $1.332 billion and OTTI of $48.7 million.

(2) Includes principal payments receivable of $1.1 million and $4.4 million at December 31, 2013 and 2012, respectively, which are not included in the Principal/Current Face.

(3) Non-Agency MBS, including Non-Agency MBS transferred to consolidated VIEs, are reported based on the lowest rating issued by a Rating Agency, if more than one rating is issued on the security, at the date presented.

Unrealized Losses on MBS and Impairments

The following table presents information about the Company’s MBS that were in an unrealized loss position at December 31, 2013:



	Unrealized Loss Position For:
	Less than 12 Months					12 Months or more					Total
(In Thousands)	Fair Value		Unrealized Losses		Number of Securities	Fair Value		Unrealized Losses		Number of Securities	Fair Value		Unrealized Losses
Agency MBS:
Fannie Mae	$	1,778,144	$	49,283	161	$	141,118	$	5,903	35	$	1,919,262	$	55,186
Freddie Mac	671,463		28,946		90	146,238		8,153		22	817,701		37,099
Total Agency MBS	2,449,607		78,229		251	287,356		14,056		57	2,736,963		92,285
Non-Agency MBS:
Rated A	—		—		—	17,663		519		2	17,663		519
Rated BBB	6,354		4		1	40		5		1	6,394		9
Rated BB	—		—		—	2,572		271		4	2,572		271
Rated CCC	15,276		248		4	11,075		1,166		3	26,351		1,414
Rated CC	1,555		7		2	—		—		—	1,555		7
Rated C	8,661		193		1	—		—		—	8,661		193
Rated D	72,353		1,304		11	1		32		1	72,354		1,336
Total Non-Agency MBS	104,199		1,756		19	31,351		1,993		11	135,550		3,749
Total MBS	$	2,553,806	$	79,985	270	$	318,707	$	16,049	68	$	2,872,513	$	96,034

At December 31, 2013, the Company did not intend to sell any of its MBS that were in an unrealized loss position, and it is “more likely than not” that the Company will not be required to sell these MBS before recovery of their amortized cost basis, which may be at their maturity. With respect to Non-Agency MBS held by consolidated VIEs, the ability of any entity to cause the sale by the VIE prior to the maturity of these Non-Agency MBS is either specifically precluded, or is limited to specified events of default, none of which have occurred to date.

Gross unrealized losses on the Company’s Agency MBS were $92.3 million at December 31, 2013. Agency MBS are issued by Government Sponsored Entities (“GSEs”) that enjoy either the implicit or explicit backing of the full faith and credit of the U.S. Government. While the Company’s Agency MBS are not rated by any rating agency, they are currently perceived by market participants to be of high credit quality, with risk of default limited to the unlikely event that the U.S. Government would not continue to support the GSEs. In addition the GSEs are currently profitable on a stand-alone basis with such profits being remitted to the U.S. Treasury. Given the credit quality inherent in Agency MBS, the Company does not consider any of the current impairments on its Agency MBS to be credit related. In assessing whether it is more likely than not that it will be required to sell any impaired security before its anticipated recovery, which may be at their maturity, the Company considers for each impaired security, the significance of each investment, the amount of impairment, the projected future performance of such impaired securities, as well as the Company’s current and anticipated leverage capacity and liquidity position. Based on these analyses, the Company determined that at December 31, 2013 any unrealized losses on its Agency MBS were temporary.

Unrealized losses on the Company’s Non-Agency MBS (including Non-Agency MBS transferred to consolidated VIEs) were $3.7 million at December 31, 2013. Based upon the most recent evaluation, the Company does not consider these unrealized losses to be indicative of OTTI and does not believe that these unrealized losses are credit related, but are rather due to non-credit related factors. The Company has reviewed its Non-Agency MBS that are in an unrealized loss position to identify those securities with losses that are other-than-temporary based on an assessment of changes in expected cash flows for such MBS, which considers recent bond performance and expected future performance of the underlying collateral.

The Company did not recognize any credit-related OTTI losses through earnings related to its MBS during the year ended December 31, 2013. During 2012, the Company recognized OTTI losses of $1.2 million in connection with Non-Agency MBS. Non-Agency MBS on which OTTI is recognized have experienced, or are expected to experience, credit-related adverse cash flow changes. The Company’s estimate of cash flows for its Non-Agency MBS is based on its review of the underlying mortgage loans securing these MBS. The Company considers information available about the structure of the securitization, including structural credit enhancement, if any, and the past and expected future performance of underlying mortgage loans, including timing of expected future cash flows, prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, FICO scores at loan origination, year of origination, loan-to-value ratios, geographic concentrations, as well as Rating Agency reports, general market assessments, and dialogue with market participants. Changes in the Company’s evaluation of each of these factors impacts the cash flows expected to be collected at the OTTI assessment date. For Non-Agency MBS purchased at a discount to par that were assessed for OTTI during the quarter, such cash flow estimates indicated that the amount of expected losses decreased compared to the previous OTTI assessment date. These positive cash flow changes are primarily driven by recent improvements in loan-to-value ratios due to loan amortization and home price appreciation, which, in turn, positively impacts the Company’s estimates of default rates and loss severities for the underlying collateral. In addition, voluntary prepayments (i.e. loans that prepay in full with no loss) have generally trended higher for these MBS which also positively impacts the Company’s estimate of expected loss. Overall, the combination of higher voluntary prepayments and lower loan-to-value ratios supports the Company’s assessment that such MBS are not other-than-temporarily impaired. Significant judgment is used in both the Company’s analysis of the expected cash flows for its Non-Agency MBS and any determination of the credit component of OTTI.

The following table presents the composition of OTTI charges recorded by the Company for the years ended December 31, 2013, 2012 and 2011:



	For the Year Ended December 31,
(In Thousands)	2013		2012			2011
Total OTTI losses	$	—	$	(879	)	$	(45,144	)
OTTI (reclassified from)/recognized in OCI	—		(321		)	34,574
OTTI recognized in earnings	$	—	$	(1,200	)	$	(10,570	)

The following table presents a roll-forward of the credit loss component of OTTI on the Company’s Non-Agency MBS for which a non-credit component of OTTI was previously recognized in OCI. Changes in the credit loss component of OTTI are presented based upon whether the current period is the first time OTTI was recorded on a security or a subsequent OTTI charge was recorded.



	For the Year Ended December 31,
(In Thousands)	2013		2012		2011
Credit loss component of OTTI at beginning of period	$	36,115	$	34,915	$	24,345
Additions for credit related OTTI not previously recognized	—		458		7,158
Subsequent additional credit related OTTI recorded	—		742		3,412
Credit loss component of OTTI at end of period	$	36,115	$	36,115	$	34,915

The significant inputs considered and assumptions made at time of impairment in determining the measurement of the component of OTTI recorded in earnings for the Company’s Non-Agency MBS are summarized as follows:



	For the Year Ended December 31,
	2013	2012	2011
Credit enhancement (1)(2)
Weighted average (3)	—	3.26%	2.90%
Range (4)	—	0.00-16.50%	0.00-13.30%

Projected CPR (2)(5)
Weighted average (3)	—	9.90%	10.70%
Range (4)	—	9.10-13.30%	1.90-13.80%

Projected Loss Severity (2)(6)
Weighted average (3)	—	55.50%	52.10%
Range (4)	—	45.90-60.00%	41.90-70.00%

60+ days delinquent (2)(7)
Weighted average (3)	—	24.40%	22.60%
Range (4)	—	18.20-32.40%	7.30-36.70%

(1) Represents a level of protection for these securities, expressed as a percentage of total current underlying loan balance.

(2) Information provided is based on loans for all groups that provide credit enhancement for MBS with credit enhancement. If an MBS no longer has credit enhancement, information provided is based on loans for the individual group owned by the Company.

(3) Calculated by weighting the relevant input/assumptions for each individual security by current outstanding face of the security.

(4) Represents the range of inputs/assumptions based on individual securities.

(5) CPR - conditional prepayment rate.

(6) Projected loss severity represents the projected amount of loss realized on liquidated properties as a percentage of the principal balance.

(7) Includes, for each security, underlying loans 60 or more days delinquent, foreclosed loans and other real estate owned.

Purchase Discounts on Non-Agency MBS

The following table presents the changes in the components of the Company’s purchase discount on its Non-Agency MBS between purchase discount designated as Credit Reserve and OTTI and accretable purchase discount for the years ended December 31, 2013 and 2012:



	For the Year Ended December 31,
	2013						2012
(In Thousands)	Discount Designated as Credit Reserve and OTTI (1)			Accretable Discount (1)(2)			Discount Designated as Credit Reserve and OTTI (3)			Accretable Discount (2)(3)
Balance at beginning of period	$	(1,380,506	)	$	(371,626	)	$	(1,228,766	)	$	(250,479	)
Accretion of discount	—			73,422			—			38,185
Realized credit losses	163,478			—			162,458			—
Purchases	(79,320		)	32,152			(427,741		)	3,497
Sales	45,371			13,953			—			—
Reclass discount for OTTI	—			—			866			(866		)
Net impairment losses recognized in earnings	—			—			(1,200		)	—
Unlinking of Linked Transactions	—			—			(38,662		)	(9,424		)
Transfers/release of credit reserve	207,940			(207,940		)	152,539			(152,539		)
Balance at end of period	$	(1,043,037	)	$	(460,039	)	$	(1,380,506	)	$	(371,626	)

(1) The Company reallocated $695,000 of purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions for the year ended December 31, 2013.

(2) Together with coupon interest, accretable purchase discount is recognized as interest income over the life of the security.

(3) In addition, the Company reallocated $420,000 of purchase discount designated as accretable purchase discount to Credit Reserve on Non-Agency MBS underlying Linked Transactions for the year ended December 31, 2012.

Impact of MBS on AOCI

The following table presents the impact of the Company’s MBS on its AOCI for the years ended December 31, 2013, 2012, and 2011:



	For the Year Ended December 31,
(In Thousands)	2013			2012			2011
AOCI from MBS:
Unrealized gain on MBS at beginning of period	$	824,808		$	55,491		$	393,822
Unrealized (loss)/gain on Agency MBS, net	(186,568		)	(7,820		)	61,149
Unrealized gain/(loss) on Non-Agency MBS, net	134,505			785,830			(381,410		)
Reclassification adjustment for MBS sales included in net income	(19,833		)	(7,493		)	(7,500		)
Reclassification adjustment for OTTI included in net income	—			(1,200		)	(10,570		)
Change in AOCI from MBS	(71,896		)	769,317			(338,331		)
Balance at end of period	$	752,912		$	824,808		$	55,491

Sales of MBS

During 2013, the Company sold certain Non-Agency MBS for $152.6 million, realizing gross gains of $25.8 million. During 2012, the Company sold $168.9 million of Agency MBS, realizing gross gains of $9.0 million. During 2011, the Company sold $150.6 million of Agency MBS realizing gross gains of $6.7 million. The Company has no continuing involvement with any of the sold MBS.

MBS Interest Income

The following table presents components of interest income on the Company’s Agency MBS for the years ended December 31, 2013, 2012 and 2011:



	For the Year Ended December 31,
(In Thousands)	2013			2012			2011
Coupon interest	$	213,995		$	248,048		$	280,206
Effective yield adjustment (1)	(57,949		)	(51,990		)	(38,212		)
Agency MBS interest income	$	156,046		$	196,058		$	241,994

(1) Includes amortization of premium paid net of accretion of purchase discount. For Agency MBS, interest income is recorded at an effective yield, which reflects net premium amortization based on actual prepayment activity.

The following table presents components of interest income for the Company’s Non-Agency MBS (including MBS transferred to consolidated VIEs) for the years ended December 31, 2013, 2012 and 2011:



	For the Year Ended December 31,
(In Thousands)	2013		2012		2011
Coupon interest	$	253,581	$	265,018	$	212,452
Effective yield adjustment (1)	73,189		37,954		42,165
Non-Agency MBS interest income	$	326,770	$	302,972	$	254,617

(1) The effective yield adjustment is the difference between the net interest income calculated using the net yield, which is based on management’s estimates of future cash flows for Non-Agency MBS, less the current coupon yield.