3. 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 March 31, 2013 and December 31, 2012:

March 31, 2013

								Discount
								Designated
	Principal/				Accretable			as Credit							Gross		Gross			Net
	Current		Purchase		Purchase			Reserve			Amortized				Unrealized		Unrealized			Unrealized
(In Thousands)	Face		Premiums		Discounts			and OTTI (1)			Cost (2)		Fair Value		Gains		Losses			Gain/(Loss)
Agency MBS:
Fannie Mae	$	5,631,101	$	188,186	$	(51	)	$	—		$	5,819,236	$	5,974,186	$	157,790	$	(2,840	)	$	154,950
Freddie Mac	1,100,024		42,866		—			—			1,146,602		1,164,812		21,227		(3,017		)	18,210
Ginnie Mae	14,170		245		—			—			14,415		14,907		492		—			492
Total Agency MBS	6,745,295		231,297		(51		)	—			6,980,253		7,153,905		179,509		(5,857		)	173,652
Non-Agency MBS (3)
Rated AAA	22,658		135		(205		)	—			22,588		23,338		750		—			750
Rated A	1,008		21		—			—			1,029		988		—		(41		)	(41		)
Rated BBB	42,818		580		(1,346		)	—			42,052		43,440		2,079		(691		)	1,388
Rated BB	118,881		53		(9,028		)	(874		)	109,032		116,887		8,088		(233		)	7,855
Rated B	241,825		—		(31,771		)	(10,377		)	199,677		228,401		28,724		—			28,724
Rated CCC	1,205,624		13		(115,858		)	(188,857		)	900,922		1,063,379		163,933		(1,476		)	162,457
Rated CC	554,897		—		(36,537		)	(132,586		)	385,774		459,565		73,791		—			73,791
Rated C	733,338		—		(47,516		)	(126,533		)	559,289		639,835		80,568		(22		)	80,546
Unrated and D-rated (4)	3,392,056		—		(139,652		)	(853,725		)	2,398,679		2,812,444		413,925		(160		)	413,765
Total Non-Agency MBS	6,313,105		802		(381,913		)	(1,312,952		)	4,619,042		5,388,277		771,858		(2,623		)	769,235
Total MBS	$	13,058,400	$	232,099	$	(381,964	)	$	(1,312,952	)	$	11,599,295	$	12,542,182	$	951,367	$	(8,480	)	$	942,887

December 31, 2012

								Discount
								Designated
	Principal/				Accretable			as Credit							Gross		Gross			Net
	Current		Purchase		Purchase			Reserve			Amortized				Unrealized		Unrealized			Unrealized
(In Thousands)	Face		Premiums		Discounts			and OTTI (1)			Cost (2)		Fair Value		Gains		Losses			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
Unrated and D-rated (4)	3,300,086		—		(125,538		)	(867,097		)	2,307,451		2,632,128		325,796		(1,119		)	324,677
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 March 31, 2013 reflect Credit Reserve of $1.266 billion and OTTI of $46.9 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 $3.7 million and $4.4 million at March 31, 2013 and December 31, 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.

(4) Includes 268 Non-Agency MBS that were D-rated and had an aggregate amortized cost and fair value of $2.348 billion and $2.754 billion, respectively, at March 31, 2013 and 246 Non-Agency MBS that were D-rated and had an aggregate amortized cost and fair value of $2.252 billion and $2.573 billion, respectively, at December 31, 2012.

Unrealized Losses on MBS and Impairments

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

Unrealized Loss Position For:

	Less than 12 Months					12 Months or more					Total
	Fair		Unrealized		Number of	Fair		Unrealized		Number of	Fair		Unrealized
(In Thousands)	Value		Losses		Securities	Value		Losses		Securities	Value		Losses
Agency MBS:
Fannie Mae	$	550,988	$	2,063	66	$	42,957	$	777	11	$	593,945	$	2,840
Freddie Mac	525,500		3,015		63	2,623		2		1	528,123		3,017
Total Agency MBS	1,076,488		5,078		129	45,580		779		12	1,122,068		5,857
Non-Agency MBS:
Rated A	—		—		—	989		41		2	989		41
Rated BBB	—		—		—	20,225		691		2	20,225		691
Rated BB	—		—		—	2,130		233		3	2,130		233
Rated CCC	—		—		—	23,683		1,476		4	23,683		1,476
Rated C	3,869		22		2	—		—		—	3,869		22
Unrated and other	15,190		88		1	16,563		72		2	31,753		160
Total Non-Agency MBS	19,059		110		3	63,590		2,513		13	82,649		2,623
Total MBS	$	1,095,547	$	5,188	132	$	109,170	$	3,292	25	$	1,204,717	$	8,480

At March 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 $5.9 million at March 31, 2013. 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 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 March 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 $2.6 million at March 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 during the three months ended March 31, 2013. The Company recognized credit-related OTTI losses through earnings of $920,000 on Non-Agency MBS during the three months ended March 31, 2012.

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. 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 three months ended March 31, 2013 and 2012:

	Three Months Ended
	March 31,
(In Thousands)	2013		2012
Total OTTI losses	$	—	$	(879	)
OTTI reclassified from OCI	—		(41		)
OTTI recognized in earnings	$	—	$	(920	)

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.

	Three Months Ended
	March 31,
(In Thousands)	2013		2012
Credit loss component of OTTI at beginning of period	$	36,115	$	34,915
Additions for credit related OTTI not previously recognized	—		458
Subsequent additional credit related OTTI recorded	—		462
Credit loss component of OTTI at end of period	$	36,115	$	35,835

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 for the three months ended March 31, 2013 and March 31, 2012 are summarized as follows:

	Three Months Ended
	March 31,
	2013	2012
Credit enhancement (1) (2)
Weighted average (3)	—	4.40%
Range (4)	—	0.00-16.50%

Projected CPR (2) (5)
Weighted average (3)	—	10.20%
Range (4)	—	9.40-13.30%

Projected Loss Severity (2) (6)
Weighted average (3)	—	55.40%
Range (4)	—	45.90-60.00%

60+ days delinquent (2) (7)
Weighted average (3)	—	21.50%
Range (4)	—	18.20-23.80%

(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 tables present 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 three months ended March 31, 2013 and March 31, 2012:

	Three Months Ended						Three Months Ended
	March 31, 2013						March 31, 2012
	Discount						Discount
	Designated as						Designated as
	Credit Reserve			Accretable			Credit Reserve			Accretable
(In Thousands)	and OTTI (1)			Discount (1) (2)			and OTTI (3)			Discount (2)(3)

Balance at beginning of period	$	(1,380,506	)	$	(371,626	)	$	(1,228,766	)	$	(250,479	)
Accretion of discount	—			12,051			—			9,410
Realized credit losses	50,307			—			22,394			—
Purchases	(23,535		)	11,229			(108,449		)	(7,433		)
Sales	6,283			932			—			—
Reclass discount for OTTI	—			—			684			(684		)
Net impairment losses recognized in earnings	—			—			(920		)	—
Unlinking of Linked Transactions	—			—			(38,579		)	(6,078		)
Transfers/release of credit reserve	34,499			(34,499		)	8,918			(8,918		)
Balance at end of period	$	(1,312,952	)	$	(381,913	)	$	(1,344,718	)	$	(264,182	)

(1) In addition, the Company reallocated $13,000 of purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions during the three months ended March 31, 2013.

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

(3) The Company reallocated $629,000 of purchase discount designated as accretable purchase discount to Credit Reserve on Non-Agency MBS underlying Linked Transactions during the three months ended March 31, 2012.

Impact of MBS on AOCI

The following table presents the impact of the Company’s MBS on its AOCI for the three months ended March 31, 2013 and 2012:

	Three Months Ended
	March 31,
(In Thousands)	2013			2012
AOCI from MBS:
Unrealized gain on MBS at beginning of period	$	824,808		$	55,491
Unrealized loss on Agency MBS, net	(27,291		)	(3,158		)
Unrealized gain on Non-Agency MBS, net	146,730			262,602
Reclassification adjustment for MBS sales included in net income	(1,360		)	(2,901		)
Reclassification adjustment for OTTI included in net income	—			920
Change in AOCI from MBS	$	118,079		$	257,463
Balance at end of period	$	942,887		$	312,954

Sales of MBS

During the first three months of 2013, the Company sold certain Non-Agency MBS for $6.1 million, realizing gross gains of $1.7 million. During the first three months of 2012, the Company sold certain Agency MBS for $71.1 million, realizing gross gains of $3.0 million. The Company has no continuing involvement with any of the sold MBS.

MBS Interest Income

The following table presents the components of interest income on the Company’s Agency MBS for the three months ended March 31, 2013 and 2012:

	Three Months Ended March 31,
(In Thousands)	2013			2012
Coupon interest	$	57,504		$	64,008
Effective yield adjustment (1)	(14,717		)	(10,708		)
Agency MBS interest income	$	42,787		$	53,300

(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 three months ended March 31, 2013 and 2012:

	Three Months Ended March 31,
(In Thousands)	2013		2012
Coupon interest	$	67,933	$	60,860
Effective yield adjustment (1)	11,982		9,344
Non-Agency MBS interest income	$	79,915	$	70,204

(1) The effective yield adjustment is the difference between the net 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.